DRS 1 filename1.htm DRS
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As confidentially submitted to the Securities and Exchange Commission on July 23, 2019

Registration No. 333-            

 

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Canaan Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Cayman Islands   3674   Not Applicable

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

30/F, Dicara Silver Tower

29 Jiefang East Road

Jianggan District, Hangzhou, 310016

People’s Republic of China

+86-571-8999-5063

(Address and Telephone Number of Registrant’s Principal Executive Offices)

 

 

[Agent of service]

[Address]

+1-[phone number]

(Name, address and telephone number of agent for service)

 

 

Copies to:

 

Chris K.H. Lin, Esq.
Simpson Thacher & Bartlett LLP
c/o 35th Floor, ICBC Tower
3 Garden Road
Central, Hong Kong
+852-2514-7600
 

Calvin C. Lai, Esq.

Freshfields Bruckhaus Deringer

55th Floor, One Island East
Taikoo Place
Quarry Bay, Hong Kong
+852-2846-3400

 

Valerie Ford Jacob, Esq.

Michael Levitt, Esq.

Freshfields Bruckhaus Deringer U.S. LLP

601 Lexington Avenue,

New York,

NY 10022, USA

+1 212 277 4000

 

 

Approximate date of commencement of the proposed sale to the public:

As soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.   ☐

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   ☐

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933.

Emerging growth company   ☒

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 7(a)(2)(B) of the Securities Act.   ☐

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered(1)(2)

 

Proposed

Maximum Aggregate
Offering Price(3)

 

Amount of

Registration Fee

Ordinary shares, par value US$0.00000005 per share

       

 

 

(1)

American depositary shares, or ADSs, evidenced by American depositary receipts issuable upon deposit of the ordinary shares registered hereby will be registered under a separate registration statement on Form F-6. Each ADS represents            ordinary shares.

(2)

Includes (a) ordinary shares represented by ADSs that may be purchased by the underwriters pursuant to their option to purchase additional ADSs and (b) all ordinary shares represented by ADSs initially offered and sold outside the United States that may be resold from time to time in the United States either as part of the distribution or within 40 days after the later of the effective date of this registration statement and the date the securities are first bona fide offered to the public.

(3)

Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.

 

 

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the United States Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting any offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion. Dated                , 2019.

American Depositary Shares

[To insert LOGO]

Canaan Inc.

Representing            Ordinary Shares

This is the initial public offering of Canaan Inc., or Canaan.

We are offering            American depositary shares, or            ADSs. Each ADS represents            ordinary shares, par value US$0.00000005 per share.

Prior to this offering, there has been no public market for our ADSs or ordinary shares. It is currently estimated that the initial public offering price per ADS will be between US$            and US$            . We will apply for listing of the ADSs on the [New York Stock Exchange] [Nasdaq Global Market] under the symbol “[●].”

We are an “emerging growth company” under applicable U.S. federal securities laws and are eligible for reduced public company reporting requirements.

Investing in our ADSs involves risks. See “Risk Factors” beginning on page [13] to read about factors you should consider before buying the ADSs.

Neither the United States Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

     Per ADS      Total  

Initial public offering price

   US$                    US$                

Underwriting discounts and commissions

   US$                    US$                

Proceeds, before expenses, to us

   US$                    US$                

To the extent that the underwriters sell more than            ADSs in this offering, the underwriters have a 30-day option to purchase up to an aggregate of            additional ADSs from us at the initial public offering price less the underwriting discounts and commissions.

 

Credit Suisse   Citigroup

The underwriters expect to deliver the ADSs against payment in U.S. dollars to purchasers on or about                , 2019.

Prospectus dated                , 2019.


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[Insert inside front cover artwork]


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TABLE OF CONTENTS

 

Prospectus Summary

     1  

The Offering

     7  

Summary Consolidated Financial and Operating Data

     9  

Risk Factors

     13  

Special Note Regarding Forward-Looking Statements

     48  

Use of Proceeds

     49  

Dividend Policy

     50  

Capitalization

     51  

Dilution

     52  

Enforcement of Civil Liabilities

     54  

Our History and Corporate Structure

     56  

Selected Consolidated Financial and Operating Data

     58  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     62  

Industry Overview

     83  

Business

     93  

Regulation

     109  

Management

     119  

Principal Shareholders

     125  

Related Party Transactions

     127  

Description of Share Capital

     128  

Description of American Depositary Shares

     138  

Shares Eligible for Future Sale

     149  

Taxation

     151  

Underwriting

     157  

Expenses Related to this Offering

     168  

Legal Matters

     169  

Experts

     169  

Where You Can Find More Information

     170  

Index to Consolidated Financial Statements

     F-1  

This prospectus contains estimates and information concerning our industry, including our market position and the size and growth rates of the markets in which we participate, that are based on industry publications and reports. This prospectus contains statistical data and estimates published by Frost & Sullivan (Beijing) Inc., Shanghai Branch Co., or Frost & Sullivan, an independent research firm, the China Internet Network Information Center, or CNNIC, and the National Bureau of Statistics of China, including a report titled “Global Integrated Circuit Chip Market Study in 2019”, which we requested Frost & Sullivan to prepare, for which we paid a fee. This information involves a number of assumptions and limitations, and you are cautioned not to place undue reliance on these estimates. We have not independently verified the accuracy or completeness of the data contained in these industry publications and reports. The industry in which we operate is subject to a high degree of uncertainty and risk due to a variety of factors, including those described in the “Risk Factors” section. These and other factors could cause results to differ materially from those expressed in these publications and reports.

No dealer, salesperson or other person is authorized to give any information or to represent as to anything not contained in this prospectus or in any free writing prospectus we may authorize to be delivered or made available to you. You must not rely on any unauthorized information or representations. In particular, we have made previous listing applications, including to China’s National Equities Exchange Quotations Co., Ltd. and The Stock Exchange of Hong Kong Limited. The information contained in those listing applications does not and will not form a part of this prospectus, and you should not place any reliance on any such information. This prospectus is an offer to sell, and we are seeking offers to buy, only the ADSs offered hereby, and only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date, regardless of the time of delivery of this prospectus or any sale of the ADSs.

 

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Neither we nor the underwriters have done anything that would permit this offering or the possession or distribution of this prospectus or any filed free writing prospectus in any jurisdiction where other action for that purpose is required, other than in the United States. Persons outside the United States who come into possession of this prospectus or any free writing prospectus filed with the United States Securities and Exchange Commission, or SEC, must inform themselves about, and observe any restrictions relating to, the offering of the ADSs and the distribution of this prospectus or any filed free writing prospectus outside of the United States.

Until                 , 2019 (the 25th day after the date of this prospectus), all dealers that buy, sell or trade ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

This summary highlights selected information contained in greater detail elsewhere in this prospectus. This summary may not contain all of the information that you should consider before investing in our ADSs. You should carefully read the entire prospectus, including “Risk Factors” and the financial statements, before making an investment decision. This prospectus contains information from an industry report commissioned by us and prepared by Frost & Sullivan, an independent research firm, to provide information regarding our industry and our market position in China.

Overview

We provide supercomputing solutions through our proprietary high performance computing ASICs. Our visionary management team has a clear strategy to commercialize supercomputing technology. In January 2013, Mr. Nangeng Zhang, our chairman and chief executive officer, and his team, invented and delivered one of the first Bitcoin mining machines incorporating ASIC technology. Our founders and management team have a clear strategy to commercialize supercomputing technology. We initially dedicated our research and development efforts to ASIC applications for Bitcoin mining, which rapidly built up our know-how of ASIC design. Such experience provides us with a solid foundation in terms of both technology and capital resources, which better prepares us for further research and development involving AI chips. We were the second largest designer and manufacturer of Bitcoin mining machines globally in terms of computing power sold in the six months ended June 30, 2019, according to Frost & Sullivan. During the same period, our Bitcoin mining machines sold accounted for 21.9% of the combined computing power of all the Bitcoin mining machines sold in the global market, according to Frost & Sullivan. We were the first in the industry to deliver commercial edge computing AI chips based on Risc-V architecture and self-developed neural-network accelerator with outstanding performance in September 2018. As we are a fabless IC designer, the ICs that we design are manufactured, packaged and tested by industry-leading suppliers, including TSMC, STATS ChipPac, ASE and SPIL.

We have developed significant advantages in our business and technological capabilities, including the following:

 

   

Our mastery of the whole IC design process;

 

   

Our years of accumulated engineering experience in applying theoretical research to the mass production of new products, producing over 100 million chips in 2017 and 2018;

 

   

Our ability to achieve a fast time-to-market with our products and our successful early monetization of the ASIC design in blockchain applications have provided us with an early advantage with respect to both technology and capital reserve to pursue our strategic initiatives;

 

   

Our breakthroughs in various technological fields to improve ASIC performance, such as low voltage and high power efficiency operations and high computing density, all of which are crucial features for blockchain and AI solutions;

 

   

Our ownership of most of the intellectual property we employ, and our accumulation of valuable know-how and multiple generations of proprietary silicon data through our years of ASIC design experience;

 

   

Our ability to provide a holistic AI solution to our customers, including AI chips, algorithm development and optimization, hardware module, end-product and software services; and

 

   

Our close and trusted partnerships with leading global suppliers, which have enabled us to achieve high-quality, high yield rate and stable production, with a 100% success rate for all of our seven tape-outs.

Our total revenues increased from RMB1,308.1 million in 2017 to RMB2,705.3 million (US$393.5 million) in 2018, representing a year-on-year growth of 106.8%. During the same period, our net income decreased from RMB375.8 million to RMB122.4 million (US$17.8 million), representing a year-on-year decrease of 67.4%. Our adjusted net income, a non-GAAP measure defined as net income excluding share-based compensation, was



 

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RMB141.0 million (US$20.5 million) in 2018 as compared to RMB471.3 million in 2017. See “Summary Consolidated Financial and Operating Data—Non-GAAP Financial Measures.”

Our Competitive Strengths

We believe that the following strengths contribute to our success and differentiate us from our competitors:

 

   

We are a leading provider of supercomputing solutions.

 

   

We are able to achieve a fast time-to-market.

 

   

We were the first in the industry to deliver commercial edge computing AI chips on Risc-V architecture and self-developed neural-network accelerator with outstanding performance.

 

   

Our outstanding production track record and strong supply chain management ensure our product quality and production capability.

 

   

Our ability to make sustainable investments in AI technology.

 

   

We have a visionary management team, as well as a talented research and development team.

Our Growth Strategies

We intend to grow our business using the following key strategies:

 

   

Strengthen our leadership position in supercomputing solutions.

 

   

Continue to invest in high power efficiency IC design.

 

   

Continue to introduce new AI products.

 

   

Enhance our AI platform business model to build on our AI products.

 

   

Continue to enhance our supply chain management.

 

   

Continue to expand our overseas operations.

Our Challenges

Our ability to execute our strategies is subject to risks and uncertainties, including:

 

   

Fluctuation of the Bitcoin price.

 

   

Acceptance and regulation of Bitcoins and Bitcoin mining.

 

   

The significant revenue contribution from our Bitcoin mining machines.

 

   

Our ability to succeed in the AI market.

 

   

Constant technological changes in the industries we operate in.

 

   

Uncertainties in our research and development activities.

 

   

Our reliance on limited suppliers.

Our History and Corporate Structure

We are a Cayman Islands holding company and conduct our operations in China through our PRC subsidiaries. We first started our business developing Bitcoin-mining machines incorporating ASIC technology in 2013 through Beijing Canaan Creative Information Technology Co., Ltd., which was subsequently renamed Hangzhou Canaan Creative Information Technology Co., Limited, or Hangzhou Canaan, in September 2015. Empowered by the academic training and technical expertise of our co-founders, we have focused on the design of high performance, repeated computing ICs since our inception. As we grew further, Hangzhou Canaan went through a series of capital injections and became a holding company for our PRC operating subsidiaries.

With the growth of our business and in order to facilitate international capital investment in us, we underwent an offshore reorganization in the first quarter of 2018. In February 2018, Canaan Cayman Holdings



 

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Ltd. was incorporated under the laws of the Cayman Islands as an exempted company with limited liability. It was later renamed Canaan Inc. in April 2018. In order to mirror the shareholding structure of the then shareholders in Hangzhou Canaan, we issued and allotted our ordinary shares at par value to investment holding companies held by the then shareholders of Hangzhou Canaan in March 2018. Further, an intermediate holding company, Canaan Creative (HK) Holdings Limited, or Canaan HK, our wholly-owned subsidiary, was also established in Hong Kong in February 2018. In March 2018, Canaan HK acquired a 100% equity interest in Hangzhou Canaan and Canaan Inc. became our ultimate holding company.

The following diagram illustrates our corporate structure as of the date of this prospectus. It omits certain entities that are immaterial to our results of operations, business and financial condition. Unless otherwise indicated, equity interests depicted in this diagram are 100%-owned.

 

LOGO

Our Corporate Information

Our principal executive offices are located at 30/F, Dicara Silver Tower, 29 Jiefang East Road, Jianggan District, Hangzhou, People’s Republic of China. Our telephone number at this address is +86-571-8999-5063. Our registered office in the Cayman Islands is located at the offices of Sertus Chambers, Suite #5-204, 23 Lime Tree Bay Avenue, P.O. Box 2547, Grand Cayman, KY1-1104, Cayman Islands. Investors should submit any inquiries to the address and telephone number of our principal executive offices set forth above.

Our corporate website is www.canaan-creative.com, and the information contained on our website is not a part of this prospectus. Our agent for service of process in the United States is                     .



 

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Implications of Being an Emerging Growth Company

As a company with less than US$1.07 billion in revenue for the last fiscal year, we qualify as an “emerging growth company” pursuant to the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise not applicable generally to public companies. These provisions include an exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, related to the assessment of the effectiveness of the emerging growth company’s internal control over financial reporting. The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. We intend to avail ourselves of the extended transition period for complying with new or revised accounting standards provided under the JOBS Act. As a result, as we are an emerging growth company, we will not be subject to new or revised accounting standards at the same time that they become applicable to other public companies that are not emerging growth companies.

We will remain an emerging growth company until the earliest of (a) the last day of our fiscal year during which we have total annual gross revenues of at least US$1.07 billion; (b) the last day of our fiscal year following the fifth anniversary of the completion of this offering; (c) the date on which we have, during the previous three year period, issued more than US$1.0 billion in non-convertible debt; or (d) the date on which we are deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended, or the Exchange Act, which would occur if the market value of ADSs that are held by non-affiliates exceeds US$700 million as of the last business day of our most recently completed second fiscal quarter. Once we cease to be an emerging growth company, we will not be entitled to the exemptions provided in the JOBS Act discussed above.

Conventions That Apply to This Prospectus

Unless we indicate otherwise, references in this prospectus to:

 

   

“ADRs” are to American depositary receipts, which, if issued, evidence our ADSs;

 

   

“ADSs” are to our American depositary shares, each of which represents              ordinary shares;

 

   

“ASE” are to Advanced Semiconductor Engineering, Inc.;

 

   

“CAGR” are to compound annual growth rate;

 

   

“China” and the “PRC” are to the People’s Republic of China, excluding, for the purposes of this prospectus only, Taiwan, the Hong Kong Special Administrative Region and the Macao Special Administrative Region;

 

   

“ordinary shares” are to, prior to the completion of this offering, our ordinary shares, par value US$0.00000005 per share;

 

   

“RMB” or “Renminbi” are to the legal currency of China;

 

   

“SPIL” are to Silicon Precision Industries Co., Ltd.;

 

   

“TSMC” are to Taiwan Semiconductor Manufacturing Company Limited and its various subsidiaries and associates, including Global Unichip Corporation, as required by the context;

 

   

“US$,” “U.S. dollars,” or “dollars” are to the legal currency of the United States; and

 

   

“we,” “us,” “our company,” “our” and “Canaan” are to Canaan Inc. and its subsidiaries and consolidated affiliated entities, as the context requires; and depending on the context, references to “we” and “our” may also include the platform partners within our network.



 

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Our reporting currency is the Renminbi. This prospectus also contains translations of certain foreign currency amounts into U.S. dollars for the convenience of the reader. Unless otherwise stated, all translations of Renminbi into U.S. dollars were made at RMB6.8755 to US$1.00, the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on December 31, 2018. We make no representation that the Renminbi or U.S. dollars amounts referred to in this prospectus could have been or could be converted into U.S. dollars or Renminbi, as the case may be, at any particular rate or at all. On July 19, 2019, the noon buying rate for Renminbi was RMB6.8812 to US$1.00.

Except as otherwise indicated, all information in this prospectus assumes:

 

   

the filing and effectiveness of our [amended and restated] memorandum and articles of association, which will occur immediately prior to the completion of this offering; and

 

   

no exercise by the underwriters of their option to purchase up to an additional              ADSs representing              ordinary shares from us.

Glossary of Technical Terms

This glossary contains explanations of certain terms used in this prospectus in connection with our company and our business. Unless we indicate otherwise, references in this prospectus to:

 

   

“AI” are to artificial intelligence;

 

   

“ASICs” are to application-specific ICs, meaning ICs designed for a specific application;

 

   

“CPU” are to computing processing unit;

 

   

“GPU” are to graphic processing unit;

 

   

“edge computing” are to a method of optimizing cloud computing systems by performing data processing at the edge of the network, near the source of the data;

 

   

“FPGA” are to field programmable gate array, an integrated circuit designed to be configured by a customer or a designer after manufacturing;

 

   

“hash” are to a function used to map data of arbitrary size to data of fixed size and, in the context of Bitcoin mining, a function to solve the mining puzzle;

 

   

“hash rate” are to the processing power of the Bitcoin network and represents the number of computations that is processed by the network in a given time period;

 

   

“ICs” or “chips” are to integrated circuits;

 

   

“IoT” are to Internet-of-Things, the extension of internet connectivity into physical devices and everyday objects;

 

   

“ISO” are to the International Organization of Standardization;

 

   

“network computing power” are to the processing power of all the machines in the Bitcoin network;

 

   

“nm” are to nanometer;

 

   

“PMU” are to power management unit, which is a microcontroller that governs power functions;

 

   

“POW” are to proof-of-work;

 

   

“SaaS” are to software as a service, which is a software licensing and delivery model in which software is licensed on a subscription basis and is centrally hosted;



 

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“SoC” are to a chip that integrates all components of a computer or other electronic systems;

 

   

“tape-out” are to the final result of the design process for ICs when the graphic for the photomask of the IC is sent to the fabrication facility, and a successful tape-out means all the stages in the design and verification process of ICs have been completed;

 

   

“Thash” are to Terahash, the measuring unit of the processing power of the Bitcoin mining machine;

 

   

“Thash/s” or “TH/s”, “GH/s”, “Ehash/s” or “EH/s” are to the measuring unit of hash rate. 1 EH/s = 1,000,000 TH/s; 1 TH/s = 1,000 GH/s; and

 

   

“TPU” are to a tensor processing unit, which is an AI accelerator ASIC.



 

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THE OFFERING

 

ADSs Offered by Us

             ADSs

 

Public Offering Price

We estimate that the initial public offering price will be between US$             and US$             per ADS.

 

ADSs Outstanding Immediately After This Offering

            ADSs (or              ADSs if the underwriters exercise in full the over-allotment option).

 

Ordinary Shares Outstanding Immediately After This Offering

             ordinary shares (or              ordinary shares if the underwriters exercise in full the over-allotment option).

 

Over-Allotment Option

We have granted to the underwriters an option, exercisable for 30 days from the date of this prospectus, to purchase up to an aggregate of              additional ADSs at the initial public offering price, less underwriting discounts and commissions, solely for the purpose of covering over-allotments.

 

The ADSs

Each ADS represents              ordinary shares.

 

  The depositary will be the holder of the ordinary shares underlying the ADSs and you will have the rights provided in the deposit agreement among us, the depositary and holders and beneficial owners of ADSs from time to time.

 

  You may surrender your ADSs to the depositary to withdraw the ordinary shares underlying your ADSs. The depositary will charge you a fee for such an exchange.

 

  We may amend or terminate the deposit agreement for any reason without your consent. Any amendment that imposes or increases fees or charges or which materially prejudices any substantial existing right you have as an ADS holder will not become effective as to outstanding ADSs until 30 days after notice of the amendment is given to ADS holders. If an amendment becomes effective, you will be bound by the deposit agreement as amended if you continue to hold your ADSs.

 

  To better understand the terms of the ADSs, you should carefully read the section in this prospectus entitled “Description of American Depositary Shares.” We also encourage you to read the deposit agreement, which is an exhibit to the registration statement that includes this prospectus.

 

Ordinary Shares

See “Description of Share Capital”


 

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Use of Proceeds

We estimate that we will receive net proceeds of approximately US$             million from this offering, or approximately US$             million if the underwriters exercise their option to purchase additional ADSs from us in full, assuming an initial public offering price of US$             per ADS, the mid-point of the estimated range of the initial public offering price set forth on the cover of this prospectus, after deducting estimated underwriter discounts, commissions and estimated offering expenses payable by us. We plan to use the net proceeds we will receive from this offering to                     . See “Use of Proceeds” for more information.

 

Risk Factors

See “Risk Factors” and other information included in this prospectus for a discussion of the risks relating to investing in our ADSs. You should carefully consider these risks before deciding to invest in our ADSs.

 

[Directed ADS Program]

[At our request, the underwriters have reserved up to         % of the ADSs being offered by this prospectus for sale at the initial public offering price to our directors, officers, employees, business associates and related persons through a directed share program. We do not know if these persons will choose to purchase all or any portion of these reserved ADSs, but any purchases they do make will reduce the number of ADSs available to the general public. Any reserved ADSs not so purchased will be offered by the underwriters to the general public on the same terms as the other ADSs.]

 

Listing

We will apply to list our ADSs on the [New York Stock Exchange] [Nasdaq Global Market].

 

Proposed Trading Symbol

 

Depositary

 

Lock-up

We, [our executive officers, directors and certain option holders], have agreed with the underwriters not to sell, transfer or dispose of any ADSs, ordinary shares or similar securities for a period of          days after the date of this prospectus, subject to certain exceptions. See “Shares Eligible for Future Sale” and “Underwriting.”


 

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SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA

The following summary consolidated statements of operations data for the years ended December 31, 2017 and 2018 and the summary consolidated balance sheet data as of December 31, 2017 and 2018 have been derived from our audited consolidated financial statements included elsewhere in this prospectus.

Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP.

Our historical results are not necessarily indicative of results to be expected for any future period. The following summary consolidated financial data for the periods and as of the dates indicated are qualified by reference to, and should be read in conjunction with, our consolidated financial statements and related notes and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” both of which are included elsewhere in this prospectus.

Summary Consolidated Statements of Comprehensive Income:

 

     Year ended December 31,  
     2017     2018  
     RMB     RMB     US$  
     (in millions)  

Net revenues:

      

Products revenue

     1,303.1       2,698.6       392.5  

Service revenue

     4.7       6.0       0.9  

Other revenues

     0.3       0.7       0.1  
  

 

 

   

 

 

   

 

 

 

Total net revenues

     1,308.1       2,705.3       393.5  

Cost of revenues

     (703.7     (2,197.2     (319.6
  

 

 

   

 

 

   

 

 

 

Gross profit

     604.4       508.1       73.9  
  

 

 

   

 

 

   

 

 

 

Operating expenses:

      

Research and development expenses(1)

     (99.8     (189.7     (27.6

Sales and marketing expenses(1)

     (20.7     (38.7     (5.6

General and administrative expenses(1)

     (125.3     (146.7     (21.3
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     (245.8     (375.1     (54.6
  

 

 

   

 

 

   

 

 

 

Income from operations:

      

Interest income

     0.2       4.2       0.6  

Investment income

     5.6       3.2       0.5  

Interest expense and guarantee fee

     —         (53.1     (7.7

Foreign exchange losses, net

     (1.2     (1.2     (0.2

Value added tax refunds

     38.8       110.2       16.0  

Other (loss) income, net

     (1.1     3.8       0.6  
  

 

 

   

 

 

   

 

 

 

Income before income tax expenses

     401.0       200.2       29.1  

Income tax expense

     (25.2     (77.8     (11.3
  

 

 

   

 

 

   

 

 

 

Net income

     375.8       122.4       17.8  

Foreign currency translation adjustment, net of nil tax

     —         (65.2     (9.5
  

 

 

   

 

 

   

 

 

 

Total comprehensive income

     375.8       57.2       8.3  
  

 

 

   

 

 

   

 

 

 


 

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Note:

(1)

Share-based compensation expenses were allocated as follows:

 

     Year ended December 31,  
     2017      2018  
     RMB      RMB      US$  
     (in millions)  

Research and development expenses

     25.1        9.6        1.4  

Sales and marketing expenses

     0.1        1.1        0.2  

General and administrative expenses

     70.3        7.9        1.1  

Summary Consolidated Statements of Financial Position:

 

     As of December 31,  
     2017      2018  
   RMB      RMB      US$  
     (in millions)  

Cash and cash equivalents

     176.5        258.9        37.7  

Restricted cash

     —          286.3        41.6  

Accounts receivable, net

     1.3        23.7        3.4  

Inventories

     259.8        585.7        85.2  

Prepayments and other current assets

     636.4        186.7        27.2  

Income tax recoverable

     —          27.1        3.9  

Property, equipment and software

     18.4        27.9        4.1  

Total assets

     1,203.2        1,402.7        204.0  

Short-term loan

     —          1,049.0        152.6  

Contract liabilities

     202.5        6.9        1.0  

Accrued liabilities and other current liabilities

     69.2        58.0        8.4  

Total liabilities

     346.0        1,161.7        169.0  

Total shareholders’ equity

     857.2        241.0        35.0  

Total liabilities and shareholders’ equity

     1,203.2        1,402.7        204.0  

Summary Consolidated Statements of Cash Flow:

 

     Year ended December 31,  
         2017         2018  
     RMB     RMB     US$  
     (in millions)  

Net cash provided by (used in) operating activities

     91.2       (12.7     (1.9

Net cash (used in) provided by investing activities

     (86.8     84.0       12.2  

Net cash provided by financing activities

     150.0       295.2       42.9  

Net increase in cash and cash equivalents, restricted cash

     154.4       366.4       53.3  
  

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents, restricted cash

     (1.3     2.3       0.3  

Cash and cash equivalents, restricted cash at the beginning of year

     23.4       176.5       25.7  
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, restricted cash at the end of year

     176.5       545.2       79.3  
  

 

 

   

 

 

   

 

 

 


 

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Non­GAAP Financial Measures:

In evaluating our business, we consider and use adjusted net income as a supplemental measures to review and assess our operating performance. The presentation of this non-GAAP financial measure is not intended to be considered in isolation or as a substitute for financial information prepared and presented in accordance with U.S. GAAP. We define adjusted net income as net income excluding share­based compensation expense.

We believe that adjusted net income helps to identify underlying trends in our business that could otherwise be distorted by the effect of the expenses that we exclude in adjusted net income. We believe that adjusted net income provides useful information about our operating results, enhances the overall understanding of our past performance and future prospects and allows for greater visibility with respect to key metrics used by our management in its financial and operational decision-making.

The non-GAAP financial measure “adjusted net income” is not defined under U.S. GAAP, is not presented in accordance with U.S. GAAP and has limitations as an analytical tool. One of the key limitations of using adjusted net income is that it does not reflect all of the items of income and expense that affect our operations. Share-based compensation has been and may continue to be incurred in our business and is not reflected in the presentation of adjusted net income. Further, the non-GAAP financial measure “adjusted net income” may differ from the non-GAAP information used by other companies, including peer companies, and therefore their comparability may be limited.

We compensate for these limitations by reconciling the non-GAAP financial measure to the nearest U.S. GAAP performance measure, all of which should be considered when evaluating our performance. We encourage you to review our financial information in its entirety and not to rely on a single financial measure.

The table below sets forth a reconciliation of our net income to adjusted net income for the years indicated:

 

     Year ended December 31,  
     2017      2018  
     RMB      RMB      US$  
     (in millions)  

Net income

     375.8        122.4        17.8  

Add:

        

Share-based compensation expenses

     95.5        18.6        2.7  
  

 

 

    

 

 

    

 

 

 

Adjusted net income

     471.3        141.0        20.5  
  

 

 

    

 

 

    

 

 

 

Summary Operating Data:

The following table sets forth the sales volume and average selling prices generated by our different Bitcoin mining machines:

 

     Year ended December 31,  
     2017      2018  
     Volume      ASP      Volume      ASP  
     set      RMB      set      RMB  

A7 series(1)

     294,523        4,402        20,576        3,710  

A8 series(2)

     —          —          503,237        4,842  

A9 series(3)

     —          —          35,324        3,665  
  

 

 

       

 

 

    

Total

     294,523        4,402        559,137        4,726  
  

 

 

       

 

 

    


 

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Notes:

(1)

Mainly includes our A721, A741 and A761 Bitcoin mining machines.

(2)

Mainly includes our A821, A841 and A851 Bitcoin mining machines.

(3)

Mainly includes our A921 Bitcoin mining machine.

The following table sets forth the total computing power sold and average selling prices of our Bitcoin mining machines expressed in terms of computing power:

 

     Year ended December 31,  
     2017      2018  
     Total
Computing
Power Sold
     ASP per
Thash
     Total
Computing
Power Sold
     ASP per
Thash
 
     Thash/s      RMB      Thash/s      RMB  

A7 series(1)

     2,114,637        613        151,131        505  

A8 series(2)

     —          —          6,305,119        386  

A9 series(3)

     —          —          702,416        184  
  

 

 

       

 

 

    

Total

     2,114,637        613        7,158,666        369  
  

 

 

       

 

 

    

 

Notes:

(1)

Mainly includes our A721, A741 and A761 Bitcoin mining machines.

(2)

Mainly includes our A821, A841 and A851 Bitcoin mining machines.

(3)

Mainly includes our A921 Bitcoin mining machine.

The table below sets forth the sales cost, per unit costs and the selling cost in terms of computing power of our Bitcoin mining machines:

 

     Year ended December 31,  
     2017      2018  
     Cost(1)      Per unit cost      Cost per
Thash
     Cost(1)      Per unit cost      Cost per
Thash
 
     RMB in
millions
     RMB      RMB      RMB in
millions
     RMB      RMB  

A7 series(2)

     693.3        2,354        328        51.1        2,482        338  

A8 series(3)

     —          —          —          1,243.9        2,472        197  

A9 series(4)

     —          —          —          154.9        4,385        221  
  

 

 

          

 

 

       

Total

     693.3        2,354        328        1,449.9        2,593        203  
  

 

 

          

 

 

       

 

Notes:

(1)

Without taking into consideration the inventory and prepayment write down provision of nil and RMB786.0 million (US$114.3 million) in 2017 and 2018, respectively, as well as a realized inventory and prepayment write down of nil and RMB71.1 million (US$10.3 million).

(2)

Mainly includes our A721, A741 and A761 Bitcoin mining machines.

(3)

Mainly includes our A821, A841 and A851 Bitcoin mining machines.

(4)

Mainly includes our A921 Bitcoin mining machine.



 

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RISK FACTORS

You should consider carefully all of the information in this prospectus, including the risks and uncertainties described below and our consolidated financial statements and related notes, before making an investment in our ADSs. Any of the following risks and uncertainties could have a material adverse effect on our business, financial condition, results of operations and prospects. The market price of our ADSs could decline significantly as a result of any of these risks and uncertainties, and you may lose all or part of your investment.

Risks Relating to Our Business and Industry

Our results of operations have been and are expected to continue to be impacted by Bitcoin price fluctuation.

The demand for, and pricing of, our Bitcoin mining machines is determined primarily by the expected economic return of Bitcoin mining activities, which in turn is significantly affected by expectations with respect to the Bitcoin price, among other factors. The price of Bitcoin has experienced significant fluctuations over its short existence and may continue to fluctuate significantly in the future. Bitcoin prices ranged from approximately US$14,166 per coin as of December 31, 2017 to approximately US$3,792 per coin as of December 31, 2018, according to Blockchain.info. According to the same source, the Bitcoin price climbed to US$10,769 as of June 30, 2019. The decrease in the Bitcoin price during the second half of 2018 resulted in a material decrease in our sales volume and in the average selling price of our Bitcoin mining machines during the same period. We expect our results of operations to continue to be affected by the Bitcoin price, as 99.6% and 99.7% of our revenue were from sales of our Bitcoin mining machines and other Bitcoin mining machine parts and accessories in 2017 and 2018, respectively. Any future significant reductions in the price of Bitcoin will likely have a material and adverse effect on our results of operations and financial condition. We cannot assure you that the Bitcoin price will remain high enough to sustain the demand for our Bitcoin mining machines or that the Bitcoin price will not decline significantly in the future.

Various factors, mostly beyond our control, could impact the Bitcoin price. For example, the usage of Bitcoins in the retail and commercial marketplace is relatively low in comparison with the usage for speculation, which contributes to Bitcoin price volatility.

If the Bitcoin price or Bitcoin network transaction fees drop, the expected economic return of Bitcoin mining activities will diminish, thereby resulting in a decrease in demand for our Bitcoin mining machines. As a result, we may need to reduce the price of our Bitcoin mining machines. At the same time, if transaction fees increase to such an extent as to discourage users from using Bitcoins as a medium of exchange, it may decrease the transaction volume of the Bitcoin network and may affect the demand for our Bitcoin mining machines. In addition, any shortage of power supply due to government control measures or other reasons, and any increase in energy costs, would raise the costs of Bitcoin mining. This in turn could affect our customers’ expected economic return for mining activities and the demand for and pricing of our current Bitcoin mining machines.

Furthermore, fluctuations in Bitcoin price may affect the value of inventories as well as the provision we make to the inventory as we manage our inventories based on, among others, the sales forecast of our Bitcoin mining machines. As we generally increase our procurement volume and stock up finished goods for the launch of new products or we expect a surge of demand of Bitcoin mining machine, a significant drop in the Bitcoin price can lead to a lower expected sales price and excessive inventories, which in turn will lead to impairment losses with respect to such inventories. For example, in 2018, as a result of the significant drop in the Bitcoin price, we recorded an inventories and prepayments write down of RMB786.0 million (US$114.3 million), which in turn had a significant negative impact on our profitability. If the Bitcoin price drops significantly in the future, we may need to make similar write-downs again. To the extent we are able to sell such inventories above its carrying value, our gross profit may also be inflated by such write down.

The Bitcoin price drop in the second half of 2018 also caused our customers who purchased our Bitcoin mining products on credit to be less willing to make payment. We consider such portion of payment as implicit price concession and we retroactively adjusted our revenue based on such subsequent information. In 2018, we recognized such price concessions of RMB152.8 million (US$22.2 million).

 

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We derive a significant portion of our revenues from our Bitcoin mining machines. If the market for Bitcoin mining machines ceases to exist or diminishes significantly, our business and results of operations would be materially harmed.

Sales of our Bitcoin mining machines, which incorporate our proprietary ASICs, historically generated substantially all of our revenue, and are expected to continue to generate a significant portion of our revenue in the foreseeable future. In 2017 and 2018, sales of our Bitcoin mining machines and other Bitcoin mining machine parts and accessories accounted for 99.6% and 99.7% of our revenues, respectively. If the market for Bitcoin mining machines ceases to exist or diminishes significantly, we would experience a significant loss of sales, cancelation of orders, or loss of customers for our Bitcoin mining machines. Adverse factors that may affect the market for Bitcoin mining machines include:

 

   

Another cryptocurrency displaces Bitcoin as the mainstream cryptocurrency, thereby causing Bitcoin to lose value or become worthless, which could adversely affect the sustainability of our business;

 

   

Bitcoin fails to gain wide market acceptance and fails to become a generally accepted medium of exchange in the global economy due to certain inherent limitations to cryptocurrencies;

 

   

Over time, the reward for Bitcoin mining (in terms of the amount of Bitcoin awarded) will decline, which may reduce the incentive to mine Bitcoin. Specifically, the next halving event is designed to occur in 2020, and Bitcoins are expected to be fully mined out by the year 2140.

If we cannot maintain the scale and profitability of our Bitcoin mining machines and, at the same time, successfully expand our business in the AI market, our business, results of operations and ability to continue to grow will suffer. Furthermore, excess inventories, inventory markdowns, brand image deterioration and margin squeeze caused by declining economic returns for miners or pricing competition for our Bitcoin mining machines could all have a material and adverse impact on our business, financial condition and results of operations.

If we fail to succeed in the AI market or other new application markets we seek to penetrate into, our revenues, growth prospects and financial condition could be materially and adversely affected.

Until 2018, we have been offering a single line of Bitcoin mining machines, which historically accounted for substantially all of our total revenue. Up to June 30, 2019, we shipped more than 20,000 AI chips and development kits. Our future revenue growth will depend largely on our ability to successfully expand our business in the AI market and penetrate into new application markets. We cannot predict how or to what extent the demand for our products in the AI market will develop going forward. Furthermore, as ASICs may not develop into mainstream solutions for AI technologies and applications, we might not be able to capitalize on the growth in the market for AI technologies and applications with our ASICs. If the AI market does not develop as we currently anticipate and we are unable to penetrate into new application markets, our future revenue and profits could be materially and adversely affected.

We plan to work closely with our partners in product development to enhance our visibility in new market trends and meet customer demand by devoting more resources to research and development. We may also need to recruit more employees for research and development and product development, such as software engineers. We intend to continue to capitalize on market opportunities for introducing new product applications and conduct advance planning for our next-generation products in a timely manner. However, if we fail to penetrate into any of these or other new markets to which we devote our resources, we may not be able to generate returns on our investments and our financial condition could suffer.

The industries in which we operate are characterized by constant changes. If we fail to continuously innovate and to provide products that meet the expectations of our customers, we may be unable to attract new customers or retain existing customers, and hence our business and results of operations may be adversely affected.

The industries in which we operate are characterized by constant changes, including rapid technological evolution, continual shifts in customer demands, frequent introductions of new products and solutions and

 

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constant emergence of new industry standards and practices. Thus, our success will depend, in part, on our ability to respond to these changes in a cost-effective and timely manner. We need to anticipate the emergence of new technologies and assess their market acceptance. We also need to invest significant resources in research and development in order to keep our products competitive in the market.

However, research and development activities are inherently uncertain, and we might encounter practical difficulties in commercializing our research and development results, which could result in excessive research and development expenses or delays. Given the fast pace with which blockchain and AI technologies have been and will continue to be developed, we may not be able to timely upgrade our technologies in an efficient and cost-effective manner, or at all. In addition, new developments in AI, deep learning, IoT, computer vision, blockchain and cryptocurrency could render our products obsolete or unattractive. If we are unable to keep up with the technological developments and anticipate market trends, or if new technologies render our technologies or solutions obsolete, customers may no longer be attracted to our products. As a result, our business, results of operations and financial condition would be materially and adversely affected.

As our current mining machines are designed for Bitcoin mining, any limitation on the usage and adaptation of Bitcoin and any actual or perceived adverse development in the Bitcoin market, which is rapidly and continuously evolving, can impact our results of operations. As there is no wide consensus with respect to the value and application of Bitcoin, any future development may continue to affect the price of Bitcoin and hence affect the demand for our current Bitcoin mining machines. In addition, any event or rumor that generates negative publicity for the Bitcoin industry and market, such as allegations that Bitcoin is used for money laundering or other illicit activities, could result in harm to our reputation, which in turn may negatively affect our results of operations.

Decentralization, or the lack of control by a central authority, is a key reason that cryptocurrencies like Bitcoin have attracted many committed users. However, the decentralized nature of Bitcoin is subject to growing discussion and suspicion. Some claim that most of the actual services and businesses built within the Bitcoin ecosystem are in fact centralized since they are run by specific people, in specific locations, with specific computer systems, and that they are susceptible to specific regulations. Individuals, companies or groups, as well as Bitcoin exchanges that own vast amounts of Bitcoins, can affect the market price of Bitcoin. Furthermore, mining equipment production and mining pool locations are becoming centralized. Some argue that the decentralized nature of cryptocurrencies is a fundamental flaw rather than a strength. The suspicion about the decentralized nature of Bitcoin may cause our customers to lose confidence in the prospect of the Bitcoin industry. This in turn could adversely affect the market demand for our Bitcoin mining machines and our business. For more details, see “—If any person, institution or a pool of them acting in concert obtains control of more than 50% of the processing power active on the Bitcoin network, such person, institution or a pool of them could prevent new transactions from gaining confirmations, halt payments between users, and reverse previously completed transactions, which would erode user confidence in Bitcoin.”

We are subject to risks associated with legal, political or other conditions or developments regarding holding, using or mining of Bitcoins, which could negatively affect our business, results of operations and financial position.

Our customers are based globally. As such, changes in government policies, taxes, general economic and fiscal conditions, as well as political, diplomatic or social events, expose us to financial and business risks. In particular, changes in domestic or overseas policies and laws regarding holding, using and/or mining of Bitcoins could result in an adverse effect on our business operations and results of operations. Moreover, if any domestic or international jurisdiction where we operate or sell our Bitcoin mining machines prohibits or restricts Bitcoin mining activities, we may face legal and other liabilities and will experience a material loss of revenue.

There are significant uncertainties regarding future regulations pertaining to the holding, using or mining of Bitcoins, which may adversely affect our results of operations. While Bitcoin has gradually gained more market

 

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acceptance and attention, it is anonymous and may be used for black market transactions, money laundering, illegal activities or tax evasion. As a result, governments may seek to regulate, restrict, control or ban the mining, use and holding of Bitcoins. Our existing policies and procedures for the detection and prevention of money laundering and terrorism-funding activities through our business activities have only been adopted in recent years and may not completely eliminate instances in which we or our products may be used by other parties to engage in money laundering and other illegal or improper activities. We cannot assure you that there will not be a failure in detecting money laundering or other illegal or improper activities which may adversely affect our reputation, business, financial condition and results of operations.

With advances in technology, cryptocurrencies are likely to undergo significant changes in the future. It remains uncertain whether Bitcoin will be able to cope with, or benefit from, those changes. In addition, as Bitcoin mining employs sophisticated and high computing power devices that need to consume a lot of electricity to operate, future developments in the regulation of energy consumption, including possible restrictions on energy usage in the jurisdictions where we sell our products, may also affect our business operations and the demand for our current Bitcoin mining machines. There have been public backlashes surrounding the environmental impacts of Bitcoin mining, particularly the large consumption of electricity, and governments of various jurisdictions have responded. For example, in the United States, certain local governments of the state of Washington have discussed measures to address environmental impacts of Bitcoin-related operations, such as the high electricity consumption of Bitcoin mining activities.

A substantial majority of our revenues are generated from sales to customers in the PRC. Any adverse development in the regulatory environment in the PRC could have a negative impact on our business.

We primarily sell our Bitcoin mining machines to customers in the PRC. In 2017 and 2018, revenue from customers in the PRC accounted for 91.5% and 76.1%, respectively, of our total revenue. If there is any adverse development in the regulatory environment concerning Bitcoin mining or AI application in the PRC, our business, financial condition and results of operations will be materially and adversely affected and we will need to further strengthen our efforts in expanding our international sales. For example, pursuant to the Announcement on Requesting Public Comments on the Guidance Catalog for Industrial Structure Adjustment (2019 version, draft for comments), or the 2019 Draft NDRC Catalog, released by the National Development and Reform Commission of the PRC, or the NDRC, on April 8, 2019, cryptocurrency mining is classified as an eliminated industry along with industries such as steel manufacturing and coal mining. If the 2019 Draft NDRC Catalog is enacted as proposed, market entities will not be allowed to invest in or enter into the cryptocurrency mining business. If any entity refuses to eliminate such business on a timely basis, it may be ordered by the relevant government authorities to suspend production or close down. However, the 2019 Draft NDRC Catalog was released for consultation purposes, and there is uncertainty with respect to its actual content, the adoption timeline or the effective date of final rules and its implementation details. There is no assurance that we will be able to effectively respond to any changes in PRC industrial policies as well as their implementation and interpretation. To the extent we are not able to generate sufficient sales from overseas markets to offset any decrease in demand from our PRC customers, our business and results of operations will be negatively impacted. In particular, if the PRC government completely bans the mining, possession and use of Bitcoin, we will not be able to sell our products in the PRC, and we may not be able to generate sufficient sales overseas to make up for such loss of business in the PRC.

Changes in the Bitcoin algorithm or the mining mechanism may materially and adversely affect our business and results of operations.

Our ASICs for Bitcoin mining machines are designed for the POW mechanism which the Bitcoin network uses to validate Bitcoin transactions. Another cryptocurrency that uses the POW mechanism is known as “Bitcoin cash,” developed in mid-2017, which our current Bitcoin mining machines can also mine. Many people within the Bitcoin community believe that POW is a foundation within Bitcoin’s code that should not be changed. However, there have been debates on mechanism change to avoid the “de facto control” by a great

 

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majority of the network computing power. With the possibility of a change in rule or protocol of the Bitcoin network, if our Bitcoin mining machines cannot be modified to accommodate any such changes, our Bitcoin mining machines will not be able to meet customer demand, and the results of our operations will be significantly affected. For more details, see “—The administrators of the Bitcoin network’s source code could propose amendments to the Bitcoin network’s protocols and software that, if accepted and authorized by the Bitcoin network’s community, could adversely affect our business, results of operations and financial condition” and “—The acceptance of Bitcoin network software patches or upgrades by a significant, but not overwhelming, percentage of the users and miners in the Bitcoin network could result in a “fork” in the blockchain, resulting in the operation of two separate networks that cannot be merged. The existence of forked blockchains could erode user confidence in Bitcoin and adversely impact our business, results of operations and financial condition.”

Substantial increases in the supply of mining machines connected to the Bitcoin network would lead to an increase in network capacity, which in turn would increase mining difficulty. This development would negatively affect the economic returns of Bitcoin mining activities, which would decrease the demand for and/or pricing of our products.

The difficulty of Bitcoin mining, or the amount of computational resources required for a set amount of reward for recording a new block, directly affects the expected economic returns for Bitcoin miners, which in turn affects the demand for our Bitcoin mining machines. Bitcoin mining difficulty is a measure of how much computing power is required to record a new block and it is affected by the total amount of computing power in the Bitcoin network. The Bitcoin algorithm is designed so that one block is generated, on average, every ten minutes, no matter how much computing power is in the network. Thus, as more computing power joins the network, and assuming the rate of block creation does not change (remaining at one block generated every ten minutes), the amount of computing power required to generate each block and hence the mining difficulty increases. In other words, based on the current design of the Bitcoin network, Bitcoin mining difficulty would increase together with the total computing power available in the Bitcoin network, which is in turn affected by the number of Bitcoin mining machines in operation. From January 2017 to December 2018, Bitcoin mining difficulty increased by approximately 15 times, according to Blockchain.info. As a result, a strong growth in sales of our Bitcoin mining machines can contribute to further growth in the total computing power in the network, thereby driving up the difficulty of Bitcoin mining and resulting in downward pressure on the expected economic return of Bitcoin mining and the demand for, and pricing of, our products.

We may be unable to make the substantial research and development investments that are required to remain competitive in our business.

Advances in AI technology, Bitcoin mining technology and the semiconductor industry have led to increased demand for ICs of higher speed and power efficiency for solving computational problems of increasing complexity. We have broadened our product offerings to include AI applications, which are widely recognized to be a future growth driver for high-performance ASICs, according to Frost & Sullivan. We also plan to further diversify the application of our technology to other cryptocurrencies in the future. In 2017 and 2018, we incurred research and development expense of RMB99.8 million and RMB189.7 million, respectively. We are committed to investing in new product development in order to stay competitive in our markets. Driven by market demand, we intend to continue to broaden and enhance our product portfolio in order to deliver the most effective solutions to our customers. Nevertheless, if we are unable to generate enough revenue or raise enough capital to make adequate research and development investments going forward, our product development and relevant research and development initiatives may be restricted or delayed, or we may not be able to keep pace with the latest market trends and satisfy our customers’ needs, which could materially and adversely affect our results of operations. Furthermore, our substantial research and development expenditures may not yield the expected results that enable us to roll out new products, which in turn will harm our prospects and results of operations.

 

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We face intense competition and our competitors may employ aggressive pricing strategies, which can lead to a price reduction of our products and material adverse effect on our results of operations.

We operate in highly competitive industries for Bitcoin mining solutions and AI products, and we may look to enter into markets with very competitive landscapes. Our competitors include many well-known domestic and international players, and we face competitors that are larger than us and have advantages over us in terms of economies of scale and financial and other resources. We expect that competition in our markets will continue to be intense, as we compete not only with existing players that have been focusing on Bitcoin mining or AI, but also new entrants that include well-established players in the semiconductor industry, or players who have not been predisposed to this industry in the past. Some of these competitors may also have stronger brand names, greater access to capital, longer histories, longer relationships with their suppliers or customers and more resources than we do. Furthermore, these competitors may be able to adapt to changes in the industry more promptly and efficiently. Intense competition from existing and potential competitors could result in material price reductions in the products we sell or a decrease in our market share. Aggressive pricing strategies by our competitors and an abundant supply of Bitcoin mining machines or AI products in the market may cause us to reduce the prices of our products and also negatively affect the demand for our products or harm our profitability. If we fail to compete effectively and efficiently or fail to adapt to changes in the competitive landscape, our business, financial condition and results of operations may be materially and adversely affected.

Our Bitcoin mining machine business depends on supplies from a single third-party foundry, and any failure to obtain sufficient foundry capacity from this foundry would significantly delay the shipment of our products.

As a fabless IC design company, we do not own any IC fabrication facilities. TSMC has been our only third-party foundry partner for our Bitcoin mining machine business. In 2017 and 2018, the value of the ICs we purchased from TSMC accounted for 63.5% and 63.1%, respectively, of our total procurement for the respective periods. It is important for us to have a reliable relationship with TSMC and future foundry service providers to ensure adequate product supply to respond to customer demand.

We cannot guarantee that TSMC will be able to meet our manufacturing requirements. The ability of TSMC to provide us with foundry services is limited by its technology migration, available capacity and existing obligations. If TSMC fails to succeed in its technology migration, it will not be able to deliver to us qualified ICs, which will significantly affect our technological advancement and shipment of Bitcoin mining machines. This could in turn result in lost sales and have a material adverse effect on our relationships with our customers and on our business and financial condition. In addition, we do not have a guaranteed level of production capacity from TSMC. We do not have long-term contracts with them, and we source our supplies on a purchase order basis and prepay the purchase amount. As a result, we depend on TSMC to allocate to us a portion of its manufacturing capacity sufficient to meet our needs, to produce products of acceptable quality and at acceptable final test yields and to deliver those products to us on a timely basis and at acceptable prices. If TSMC raises its prices or is unable to meet our required capacity for any reason, such as shortages or delays in the shipment of semiconductor equipment or raw materials required to manufacture our ICs, or if our business relationships with TSMC deteriorate, we may not be able to obtain the required capacity and would have to seek alternative foundries, which may not be available on commercially reasonable terms, or at all. Moreover, it is possible that other customers of TSMC that are larger and/or better financed than we are, or that have long-term contracts with it, may receive preferential treatment in terms of capacity allocation or pricing. In addition, if we do not accurately forecast our capacity needs, TSMC may not have available capacity to meet our immediate needs or we may be required to pay higher costs to fulfill those needs, either of which could materially and adversely affect our business, operating results or financial condition.

In particular, the production of our ASICs may require advanced IC fabrication technologies, and foundries other than TSMC might not have sufficient production capacity for such technologies, if at all, to meet our requirements. This may expose us to risks associated with engaging new foundries. For example, using foundries with which we have not established relationships could expose us to potentially unfavorable pricing, unsatisfactory quality or insufficient capacity allocation.

 

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Other risks associated with our dependence on a single third-party foundry include limited control over delivery schedules and quality assurance, lack of capacity in periods of excess demand, unauthorized use of our intellectual property and limited ability to manage inventory and parts. In particular, although we have entered into confidentiality agreements with our third-party foundry for the protection of our intellectual property, it may not protect our intellectual property with the same degree of care as we use to protect our intellectual property. See “—If we fail to adequately protect our IP rights, our ability to compete effectively or to defend ourselves from litigation could be impaired, which could reduce our total revenue and increase our costs.” If we fail to properly manage any of these risks, our business and results of operations may be materially and adversely affected.

Moreover, if TSMC suffers any damage to its facilities, suspends manufacturing operations, loses benefits under material agreements, experiences power outages or computer virus attacks, lacks sufficient capacity to manufacture our products, encounters financial difficulties, is unable to secure necessary raw materials from its suppliers or suffers any other disruption or reduction in efficiency, we may encounter supply delays or disruptions. For example, in early August 2018, the operation of certain factories of TSMC in Taiwan was temporarily suspended as a result of a computer virus attack caused by an improper installment procedure administered by TSMC. The TSMC facilities affected by this computer virus included those that manufacture wafers for us, and TSMC’s operational suspension resulted in a delay in its shipment to us of 125 wafers for our 7nm ASICs for up to nine weeks.

Failure to maintain inventory levels in line with the approximate level of demand for our products could cause us to lose sales, expose us to increased inventory risks and subject us to increases in holding costs, risk of inventory obsolescence, increases in markdown allowances and write-offs, any of which could have a material adverse effect on our business, financial condition and results of operations.

To operate our business successfully and meet our customers’ demands and expectations, we must maintain a certain level of finished goods inventory to ensure immediate delivery when required. Furthermore, we are required to maintain an appropriate level of inventory of parts and components for our production. However, forecasts are inherently uncertain. If our forecasted demand is lower than actual demand, we may not be able to maintain an adequate inventory level of our finished goods or produce our products in a timely manner, and we may lose sales and market share to our competitors. On the other hand, we may also be exposed to increased inventory risks due to accumulated excess inventory of our products or raw materials, parts and components for our products. Excess inventory levels may lead to increases in inventory holding costs, risks of inventory obsolescence and provisions for write-downs. The carrying value of our inventories were RMB259.8 million and RMB585.7 million (US$85.2 million) as of December 31, 2017 and 2018, respectively.

The average selling prices of our products may decrease from time to time due to technological advancement and we may not be able to pass onto our suppliers such decreases, which may in turn adversely affect our profitability.

The IC design industry is characterized by rapid launches of new products, continuous technological advancements and changing market trends and customer preferences, all of which translate to a shorter life cycle and a gradual decrease in the average selling prices of products over time. For example, the average selling price per Thash for our Bitcoin mining machines decreased from RMB613 in 2017 to RMB369 in 2018. Because we compete in the environment of rapidly-evolving technology advancement and market trends and developments of the IC design industry, there are no assurances that we will be able to pass on any decrease in average selling prices of our products to our suppliers. In the event that average selling prices of our products unusually or significantly decrease and such decreases cannot be offset by a corresponding decrease in the prices of the principal components of our products, our gross profit margins may be materially and adversely affected, which in turn, may adversely affect our profitability.

 

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Our limited operating history and rapid revenue growth may make it difficult for us to forecast our business and assess the seasonality and volatility in our business.

As the markets for Bitcoin mining machines and AI applications are relatively young and still developing, we cannot forecast longer-term demand or order patterns for our products. Because of our limited operating history and historical data, as well as the limited visibility into future demand trends for our products, we may not be able to accurately forecast our future total revenue and budget our operating expenses accordingly. As most of our expenses are fixed in the short-term or incurred in advance of anticipated total revenue, we may not be able to adjust our expenses in a timely manner in order to offset any shortfall in revenue.

Our business is subject to the varying order patterns of the Bitcoin mining machine and AI products markets. In addition, many of the regions in which our products are purchased have varying holiday seasons that differ from traditional patterns observed by other semiconductor suppliers and these seasonal buying patterns can impact our sales. We have experienced fluctuations in orders during our limited operating history, and we expect such volatility to occur in the future. Our recent significant growth in revenue also makes it difficult to assess the impact of seasonal factors on our business. If we or any of our third-party manufacturing service providers are unable to increase production of new or existing products to meet any increases in demand due to seasonality or other factors, our total revenue would be adversely affected and our reputation with our customers may be damaged. Conversely, if we overestimate customer demand, we may reduce our orders or delay shipments of our products from units forecasted, and our total revenue in a particular period could be lower than expected.

We may be unable to execute our growth strategies or effectively maintain our rapid growth trends.

We have experienced rapid growth and significantly expanded our business in recent years. Our total net revenue grew by 106.8% from RMB1,308.1 million in 2017 to RMB2,705.3 million (US$393.5 million) in 2018. We may not be able to continue the trend of high revenue growth if we are not able to successfully execute our product development and diversification, geographic expansion and other growth plans. In addition, our rapid growth has placed and will continue to place significant demands on our management and our administrative, operational, research and development and financial resources.

To accomplish our growth strategies and manage the future growth of our operations, we will be required to enhance our research and development capabilities, improve our operational and financial systems, and expand, train and manage our growing employee base. Furthermore, we need to maintain and expand our relationships with our customers, suppliers, research institutions, third-party manufacturers and other third parties. Moreover, as we introduce new products or enter new markets, we may face new market, technological, operational and regulatory risks and challenges with which we are unfamiliar.

Our current and planned operations, personnel, systems, internal procedures and controls may not be adequate to support our future growth and expansion. In addition, the success of our growth strategies depends on a number of external factors, such as the growth of the semiconductor market and the demand for Bitcoin, the level of competition we face and evolving customer behavior and preferences. If we are unable to execute our growth strategies or manage our growth effectively, we may not be able to capture market opportunities or respond to competitive pressures, which may materially and adversely affect our business prospects and results of operations.

We rely on a limited number of third parties to package and test our products.

In addition to IC fabrication, we rely on a limited number of production partners, including Advanced Semiconductor Engineering, Inc., or ASE, STATS ChipPAC Korea Ltd., or STATS ChipPac, and Siliconware Precision Industries Co., Ltd., or SPIL, for the testing and packaging of our ASICs. Reliance on these third parties for the testing and packaging of our ASICs presents significant risks to us, including the following:

 

   

limited control over delivery schedules, quality assurance, final test yields and production costs;

 

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potential failure to obtain, or delay in obtaining, key process technologies;

 

   

failure by us to find an alternative supplier;

 

   

capacity shortages during periods of high demand;

 

   

shortages of materials;

 

   

unauthorized use of our IP;

 

   

limited warranties on ICs or products supplied to us; and

 

   

potential increases in prices.

The ability and willingness of our production partners to adequately and timely perform is largely beyond our control. If one or more of these production partners fails to perform its obligations in a timely manner or at satisfactory quality levels, our ability to bring products to market and our reputation could suffer. If these production partners fail to deliver quality products and components to us on time and at reasonable prices, we could face difficulties in fulfilling our customers’ orders, our total revenue could decline and our business, financial condition and results of operations would be adversely affected.

Bitcoin exchanges and wallets, and to a lesser extent, the Bitcoin network itself, may suffer from hacking and fraud risks, which may adversely erode user confidence in Bitcoin which would decrease the demand for our Bitcoin mining machines.

Bitcoin transactions are entirely digital and, as with any virtual system, are at risk from hackers, malware and operational glitches. Hackers can target Bitcoin exchanges and Bitcoin transactions, to gain access to thousands of accounts and digital wallets where Bitcoins are stored. Bitcoin transactions and accounts are not insured by any type of government program and all Bitcoin transactions are permanent because there is no third party or payment processor. Bitcoin has suffered from hacking and cyber-theft as such incidents have been reported by several cryptocurrency exchanges and miners, highlighting concerns about the security of Bitcoin and therefore affecting its demand and price. Also, the price and exchange of Bitcoin may be affected due to fraud risk. While Bitcoin uses private key encryption to verify owners and register transactions, fraudsters and scammers may attempt to sell false Bitcoins. All of the above may adversely affect the operation of the Bitcoin network which would erode user confidence in Bitcoin, which would negatively affect demand for our products.

We face risks associated with the expansion of our scale of operations globally, and if we are unable to effectively manage these risks, they could impair our ability to expand our business abroad.

As part of our growth strategy, we plan to further expand our sales outside of the PRC. As we continue to grow our business and expand our operations globally, we will continue to sell our products into new jurisdictions in which we have limited or no experience and in which our brands may be less recognized. The expansion exposes us to a number of risks, including:

 

   

we have a limited customer base and limited sales and relationships with international customers;

 

   

difficulty in managing multinational operations;

 

   

we may face competitors in the overseas markets who are more dominant and have stronger ties with customers and greater financial and other resources;

 

   

fluctuations in currency exchange rates;

 

   

challenges in providing customer services and support in these markets;

 

   

challenges in managing our international sales channels effectively;

 

   

unexpected transportation delays or interruptions or increases in international transportation costs;

 

 

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difficulties in and costs of exporting products overseas while complying with the different commercial, legal and regulatory requirements of the overseas markets in which we offer our products;

 

   

difficulty in ensuring that our customers comply with the sanctions imposed by the Office of Foreign Assets Control, or OFAC, on various foreign states, organizations and individuals;

 

   

inability to obtain, maintain or enforce intellectual property rights;

 

   

inability to effectively enforce contractual or legal rights or intellectual property rights in certain jurisdictions under which we operate;

 

   

changes in a specific country or region’s political or economic conditions or policies;

 

   

unanticipated changes in prevailing economic conditions and regulatory requirements; and

 

   

governmental policies favoring domestic companies in certain foreign markets or trade barriers including export requirements, tariffs, taxes and other restrictions and charges. In particular, there have been concerns over the exit of the United Kingdom from the European Union, a worldwide trend in favor of nationalism and protectionist trade policy and the ongoing trade dispute between the United States and China as well as other potential international trade disputes, all of which could cause turbulence in international markets. These government policies or trade barriers could increase the prices of our products and make us less competitive in such countries.

If we are unable to effectively manage these risks, our ability to expand our business abroad will be impaired, which could have a material and adverse effect on our business, financial condition, results of operations and prospects.

Shortages in, or increases in the prices of, the components of our products may adversely affect our business.

In addition to our proprietary ASICs, the components we use for our Bitcoin mining machines include PCB, other electronic components, fans and aluminum casings. The use of our Bitcoin mining machines also require certain ancillary equipment and components such as controllers, power adaptors and connectors. The production of our current Bitcoin mining machines depends on obtaining adequate supplies of these components on a timely basis and at competitive prices. We do not typically maintain large inventories of components, but rather we purchase them on a just-in-time basis from various third-party component manufacturers that satisfy our quality standards and meet our volume requirements. Given the long lead times that may be required to manufacture, assemble and deliver certain components and products, problems could arise in planning production and managing inventory levels that could seriously interrupt our operations, including the possibility of defective parts, an increase in component costs, delays in delivery schedules, and shortages of components. Furthermore, we may have to turn to less reputable suppliers if we cannot source adequate components from our regular suppliers. Under such circumstances, the quality of the components may suffer and could cause performance issues in our Bitcoin mining machines.

Shortages of components could result in reduced production or delays in production, as well as an increase in production costs, which may negatively affect our abilities to fulfill orders or make timely shipments to customers, as well as our customer relationships and profitability. Component shortages may also increase our costs of revenue because we may be required to pay higher prices for components in short supply, not being able to pass such costs to customers, and redesign or reconfigure products to accommodate substitute components.

We recorded negative operating cash flow in 2018. There can be no assurance that we will record positive operating cash flow in the future.

We recorded negative operating cash flow of RMB12.7 million (US$1.9 million) in 2018, which was primarily attributable to payments made to our suppliers and contract manufacturers. Although we strive to prudently manage our inventory purchases and prepayments to our suppliers, there is no assurance that we will generate positive cash flow from our operations in the future.

 

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A negative operating cash flow position could impair our ability to make necessary capital expenditures, constrain our operational flexibility and adversely affect our ability to expand our business and enhance our liquidity. For example, if we do not have sufficient net cash flow to fund our future liquidity, make prepayments to our vendors, pay our trade payables and repay our outstanding debt obligations when they become due, we may need to significantly increase external borrowings or secure other external financing. If adequate funds are not available from external borrowings, whether on satisfactory terms or at all, we may be forced to delay or abandon our development and expansion plans, and our business, prospects, financial condition and results of operations may be materially and adversely affected.

Our prepayments to suppliers may subject us to counterparty risk associated with such suppliers and negatively affect our liquidity and cash position.

We may incur net cash outflows at an early stage of our production because we are required to prepay our foundry service providers before the service is provided in order to secure the foundry service provider’s production capacity. As of December 31, 2017 and 2018, the outstanding balance of prepayments we made to our foundry service provider amounted to RMB606.0 million and RMB62.3 million (US$9.1 million), respectively. The amount of our prepayments can significantly increase at the beginning of our launch of advanced products in the future. We are subject to counterparty risk exposure to our suppliers. Any failure by our suppliers to perform their contractual obligations in a timely manner and/or in accordance with our requested quality may result in us not being able to fulfill customers’ orders accordingly. In such event, we may not be able to receive back the prepayments in a timely manner or in full, notwithstanding that our suppliers are obligated to return such prepayments upon meeting certain conditions. Furthermore, such prepayments also put cash pressure on us and if the cash outflows for the prepayments significantly exceed the cash inflows during any period, our future liquidity and cash position will be adversely affected.

If we experience difficulty in collecting our trade receivables, our liquidity, financial condition and results of operations would be negatively impacted.

We derive our revenues from the sale of products and are subject to counterparty risks such as our customer’s inability to pay. As of December 31, 2017 and 2018, our trade receivables amounted to RMB7.2 million and RMB27.5 million (US$4.0 million), respectively. There can be no assurance that we will be able to collect our trade receivables on a timely basis, and our trade receivable turnover days may increase, which in turn could materially and adversely affect our liquidity, financial condition and results of operations.

Failure at tape-out or failure to achieve the expected final test yields for our ASICs could negatively impact our operating results.

The tape-out process is a critical milestone in our business. A successful tape-out means all the stages in the design and verification process of our ASICs have been completed, and the product is ready to be sent for manufacturing. A tape-out is either a success or a failure, and in the latter case design modifications are needed. The tape-out process is very costly, and repeated failures can significantly increase our costs, lengthen our product development period and delay our product launch. While we have consistently achieved successful tape-out in the initial batch historically, we cannot assure you that we will be able to continue to have a high tape-out success rate in the future.

Once tape-out is successful, the ASIC design is sent for manufacturing, and the final test yield is a measurement of the production success rate. The final test yield is a function of both product design, which is developed by us, and process technology, which typically belongs to a third-party foundry, such as TSMC in our case. While we have historically achieved high final test yields, such as 96% in 2017 and 96% in 2018, we cannot assure you that we will be able to maintain such yields in the future. Low final test yields can result from either a product design deficiency or a process technology failure or a combination of both. As such, we may not

 

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be able to identify problems causing low final test yields until our product designs go to the manufacturing stage, which may substantially increase our per unit costs and delay the launch of new products.

For example, if TSMC experiences manufacturing inefficiencies or encounters disruptions, errors or difficulties during production, we may fail to achieve acceptable final test yields or experience product delivery delays. We cannot be certain that TSMC will be able to develop, obtain or successfully implement process technologies needed to manufacture future generations of our products on a timely basis. Moreover, during the periods in which foundries are implementing new process technologies, their manufacturing facilities may not be fully productive. A substantial delay in the technology transitions to smaller geometry process technologies could have a material and adverse effect on us, particularly if our competitors transition to such technologies before us.

In addition, resolution of yield problems requires cooperation among us, TSMC and package and test partners. We cannot assure you that the cooperation will be successful and that any yield problems can be fixed.

If any person, institution or a pool of them acting in concert obtains control of more than 50% of the processing power active on the Bitcoin network, such person, institution or a pool of them could prevent new transactions from gaining confirmations, halt payments between users, and reverse previously completed transactions, which would erode user confidence in Bitcoin.

If the award of Bitcoins for solving blocks and transaction fees for recording transactions are not sufficiently high to incentivize miners, miners may cease expending processing power to solve blocks. Miners ceasing operations would reduce the collective processing power on the Bitcoin network, which would adversely affect the confirmation process for transactions and make the Bitcoin network more vulnerable to any person, institution or a pool of them which has obtained over 50% control over the computing power on the Bitcoin network. In such event, such person, institution or a pool of them could prevent new transactions from gaining confirmation, halt payments between users, and reverse previously completed transactions. Such changes or any reduction in confidence in the confirmation process or processing power of the Bitcoin network may erode user confidence in Bitcoin, which would decrease the demand for our products.

The administrators of the Bitcoin network’s source code could propose amendments to the Bitcoin network’s protocols and software that, if accepted and authorized by the Bitcoin network’s community, could adversely affect our business, results of operations and financial condition.

The Bitcoin network is based on a cryptographic, algorithmic protocol that governs the end-user-to-end-user interactions between computers connected to the Bitcoin network. A loosely organized group can propose amendments to the Bitcoin network’s source code through one or more software upgrades that alter the protocols and software that govern the Bitcoin network and the properties of Bitcoins, including the irreversibility of transactions and limitations on the mining of new Bitcoins. To the extent that a significant majority of the users and miners on the Bitcoin network install such software upgrade(s), the Bitcoin network would be subject to new protocols and software that may render our products less desirable, which in turn may adversely affect our business, results of operations and financial condition. If less than a significant majority of the users and miners on the Bitcoin network install such software upgrade(s), the Bitcoin network could “fork.”

The acceptance of Bitcoin network software patches or upgrades by a significant, but not overwhelming, percentage of the users and miners in the Bitcoin network could result in a “fork” in the blockchain, resulting in the operation of two separate networks that cannot be merged. The existence of forked blockchains could erode user confidence in Bitcoin and could adversely impact our business, results of operations and financial condition.

Bitcoin is based on open source software and has no official developer or group of developers that formally controls the Bitcoin network. Any individual can download the Bitcoin network software and make any desired modifications, which are proposed to users and miners on the Bitcoin network through software downloads and upgrades. However, miners and users must consent to those software modifications by downloading the altered

 

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software or upgrade implementing the changes; otherwise, the changes do not become part of the Bitcoin network. Since the Bitcoin network’s inception, changes to the Bitcoin network have been accepted by the vast majority of users and miners, ensuring that the Bitcoin network remains a coherent economic system. However, a developer or group of developers could potentially propose a modification to the Bitcoin network that is not accepted by a vast majority of miners and users, but that is nonetheless accepted by a substantial population of participants in the Bitcoin network. In such a case, a fork in the blockchain could develop and two separate Bitcoin networks could result, one running the pre-modification software program and the other running the modified version. An example is the introduction of a cryptocurrency known as “Bitcoin cash” in mid-2017. This kind of split in the Bitcoin network could erode user confidence in the stability of the Bitcoin network, which could negatively affect the demand for our products.

AI technologies are constantly evolving, and any flaws in or misuse of AI, even if committed by other third parties, could have a negative impact on our business, reputation, brands and the general acceptance of AI solutions by society.

AI technologies are still in a preliminary stage of development and are constantly evolving. As with many disruptive innovations, AI presents risks and challenges that could affect user perception and its adoption. Any flaws in or insufficiencies of AI, and any inappropriate or premature usage thereof, whether actual or perceived, and whether by us or by other third parties, may dissuade prospective customers from adopting AI solutions, and may impair the general acceptance of AI by society. Moreover, AI is covered extensively, and in many instances critically, by various news media across the world. There is no assurance that our AI products will not be misused or applied in a way that is inconsistent with public expectations. Any misuse of our AI technologies, whether actual or perceived, and whether by us or by other third parties, could negatively impact our brands and reputation, and in turn our business, financial condition and results of operation.

Any failure of our products to meet the necessary quality standards could adversely affect our reputation, business and results of operation.

The quality of our products is critical to the success of our business and depends significantly on the effectiveness of our and our manufacturing service providers’ quality control systems. In our efforts to quickly meet new market trends and demand and adopt new technologies, our products may not have adequate time to go through our normal rigorous testing procedures and final inspection, which could result in instances where our products cannot reach the required performance standard, or our products are found to be defective. These instances could result in our customers suffering losses. Defects detected before product delivery to our customers may result in additional costs for remediation and rework. Defects detected after the delivery and installation of our products may result in our incurring further costs relating to inspection, installation, remediation or product return, which may result in damages to our reputation, loss of customers, government fines and disputes and litigation.

In addition, we outsourced to certain production partners a portion of our product manufacturing process, which require them to purchase parts and components from other third-party suppliers. Although we carry out quality inspections for the manufacturing process and the parts and components purchased, we cannot assure you that we will always be able to detect defects in the manufacturing process or the parts and components purchased. Any defect in such manufacturing process or parts and components purchased may lead to defects in our finished products, which may in turn increase our costs as well as damage our reputation and market share. We may not be able to procure contractual or other indemnities from the suppliers of the defective parts and components adequately, or at all. We may be subject to product liability claims and litigation for compensation which could result in substantial and unexpected expenditures and could materially and adversely affect our cash flow and operating results.

 

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Our Bitcoin mining machines use open source software and hardware as their basic controller system, which may subject us to certain risks.

We use open source software and hardware in our Bitcoin mining machines. For example, the AvalonMiner controller open source software needs to be installed on open source Raspberry Pi hardware, which serves as the basic controller system for the AvalonMiner, and we expect to continue to use Raspberry Pi and other open source software and hardware in the future. We may face claims from others claiming ownership of, or seeking to enforce the terms of, an open source license, including by demanding the release of the open source software, derivative works or our proprietary source code that was developed using such software. These claims could also result in litigation, requiring us to purchase a costly license or to devote additional research and development resources to change our technologies, either of which would have a negative effect on our business and operating results. In addition, if the license terms for the open source software we utilize change, we may be forced to re-engineer or discontinue our solutions or incur additional costs.

If we are unable to maintain or enhance our brand recognition, our business, financial condition and results of operations may be materially and adversely affected.

Maintaining and enhancing the recognition, image and acceptance of our brand are important to our ability to differentiate our products from and to compete effectively with our peers. Our brand image, however, could be jeopardized if we fail to maintain high product quality, pioneer and keep pace with evolving technology trends, or timely fulfill the orders for our products. If we fail to promote our brand or to maintain or enhance our brand recognition and awareness among our customers, or if we are subject to events or negative allegations affecting our brand image or the publicly perceived position of our brand, our business, operating results and financial condition could be adversely affected.

Power shortages, labor disputes and other factors may result in constraints on our production activities.

Historically, we have not experienced constraints on our production activities, including at our assembly plant, due to power shortages, labor disputes or other factors. However, there can be no assurance that our operations will not be affected by power shortages, labor disputes or other factors in the future, thereby causing material production disruptions and delays in our delivery schedule. In such event, our business, results of operations and financial condition could be materially and adversely affected.

If we fail to adequately protect our IP rights, our ability to compete effectively or to defend ourselves from litigation could be impaired, which could reduce our total revenue and increase our costs.

We rely primarily on a combination of protections provided by patent, IC layout and design rights, copyright, trademark and trade secret laws, as well as confidentiality, non-compete and non-disclosure agreements and other means for protecting our proprietary technologies and know-how. However, we cannot assure you that the strategies and steps we are taking are sufficient to protect our intellectual property rights or that, notwithstanding legal protection, others do not or will not infringe or misappropriate our intellectual property rights. If we fail to adequately protect our intellectual property rights, or if changes in laws diminish or remove the current legal protections available to them, the competitiveness of our products may be eroded and our business could suffer. As of the date of this prospectus we have registered a total of 49 patents in the PRC, including two inventions, 40 utility model patents and seven exterior design patent. As of the same date, we have registered 69 software copyrights and 23 IC layout-design right in the PRC. The rights granted to us under our patents, IC layout-design rights and copyrights, including prospective rights sought in our pending patent applications, may not be meaningful or provide us with any commercial advantage. In addition, they could be opposed, contested, circumvented or designed around by our competitors or be declared invalid or unenforceable in judicial or administrative proceedings. Any failure of our patents, IC layout-design rights and copyrights to adequately protect our technologies may allow our competitors to offer similar products or technologies. We may not be able to protect our IP rights in some countries where our products are sold or may be sold in the future.

 

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Even if IP rights are granted outside of the PRC, effective enforcement in those countries may not be available to us, primarily due to the relatively weak legal regime protecting IP rights in those countries and the difficulties to defend and enforce such rights. Accordingly, we may not be able to effectively protect our IP rights in those countries. Many companies have encountered substantial intellectual property infringement in countries where we sell or intend to sell our products.

Monitoring unauthorized use of our IP is difficult and costly. Unauthorized use of our IP may have occurred or may occur without our knowledge. Any failure by us to effectively protect our IP could reduce the value of our technologies and impair our ability to compete. We may in the future need to initiate infringement claims or litigation. Litigation can be expensive and time-consuming and may divert the efforts of our technical staff and managerial personnel, which could result in lower total revenue and higher expenses, whether or not such litigation results in a determination favorable to us.

We may face IP infringement claims or other related disputes, which could be time-consuming, costly to defend or settle and result in the loss of significant rights and lower sales.

As is typical in the semiconductor industry, we may be subject to infringement claims from time to time or otherwise become aware of potentially relevant patents or other IP rights held by other parties that may cover some of our technology, products and services. The semiconductor industry is characterized by companies that hold large numbers of patents and other IP rights and that vigorously pursue, protect and enforce these rights. Patent litigation has increased in recent years owing to increased assertions made by IP licensing entities and increasing competition and overlap of product functionality in our markets. Additionally, we have in the past entered and may continue in the future to enter into licensing agreements with third parties for the use of their proprietary technologies in the development of our products. As with any business relationship, we may face disputes and lawsuits related to those IP licensing agreements. As our operations continue to grow in size and scale, the likelihood of us becoming involved in IP related lawsuits and disputes to protect or defend our IP rights and the use of third-party IP rights will increase.

In addition, it is extremely difficult for us to monitor all of the patent applications that have been filed in the PRC, the United States or in other countries or regions and whether, if such pending patents are granted, such patents would have a material and adverse effect on our business if our product and service offering were to infringe upon them.

Other third parties may file claims against us or our customers alleging that our products, processes, or technologies infringe third-party patents or IP rights. Regardless of their merits or resolutions, such claims could be costly to defend or settle and could divert the efforts and attention of our management and technical personnel. In addition, some of our customer agreements in the future may require us to indemnify and defend our customers from third-party infringement claims and to pay damages in the case of adverse rulings. As such, claims of this sort also could harm our relationships with our customers and may deter future customers from doing business with us. We do not know whether we could prevail in any such proceeding given the complex technical issues and inherent uncertainties involved in IP litigation. If any pending or future proceedings result in an adverse outcome, we could be required to:

 

   

cease the manufacturing, use or sale of the infringing products, processes or technologies;

 

   

stop shipment to certain geographic areas;

 

   

pay substantial damages for infringement;

 

   

expend significant resources to develop non-infringing processes, technologies or products;

 

   

license technology from the third-party claiming infringement, which license may not be available on commercially reasonable terms, or at all;

 

   

cross-license our technology to a competitor in order to resolve an infringement claim, which could weaken our ability to compete with that competitor; or

 

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pay substantial damages to our customers to discontinue their use of or replace infringing products sold to them with non-infringing products.

Any of the foregoing results could have a material adverse effect on our business, financial condition and results of operations.

The loss of any member of our senior management team, or our failure to attract, train and retain qualified personnel, especially our design and technical personnel, could impair our ability to grow our business and effectively execute our business strategy.

Since our inception, the growth and expansion of our business operations have been dependent upon the business strategies and foresight of our senior management. Our future success depends, in large part, on the continued contributions of our senior management team, specifically Mr. Zhang and Mr. Li.

In addition, our future success depends on our ability to retain, attract and incentivize qualified personnel, including our management, sales, marketing, finance and especially research and development personnel. As the driver of our technological and product innovations, our research and development personnel represent a very significant asset of ours. As the technology in the semiconductor industry is advancing at a quick pace, there is an increasing need for skilled engineers. Many companies across the world are struggling to find suitable candidates for their research and development positions. The process of hiring employees with the combination of skills and characteristics required to implement our strategy can be extremely competitive and time-consuming. We cannot assure you that we will be able to attract adequate personnel as we continue to pursue our business strategies.

Moreover, we cannot assure you that we will be able to retain key existing employees. The loss of any of our co-founders, senior management or research and development team members could harm our ability to implement our business strategies and respond to the rapidly changing market conditions in which we operate, or could result in other operating risks. The loss of one or more of our key employees, especially our key design and technical personnel which includes our co-founders, or our inability to retain, attract and motivate qualified design and technical personnel, could have a material adverse effect on our business, financial condition and results of operations.

We may engage in acquisitions or strategic alliances that could disrupt our business, result in increased expenses, reduce our financial resources and cause dilution to our shareholders. We cannot assure you that such acquisitions or strategic alliances may be successfully implemented.

Although we have not engaged in acquisitions or strategic alliances in the past, we may look for potential acquisitions or strategic alliances in the future to expand our business. However, we may not be able to find suitable acquisition candidates, complete acquisitions on favorable terms, if at all, or integrate any acquired business, products or technologies into our operations. If we do complete acquisitions, they may be viewed negatively by customers or investors and they may not enable us to strengthen our competitive position or achieve our goals. In addition, any acquisitions that we make could lead to difficulties in integrating personnel, technologies and operations from the acquired businesses and in retaining and motivating key personnel from these businesses. Moreover, acquisitions may disrupt our ongoing operations, divert management from day-to-day responsibilities and increase our expenses. Future acquisitions may reduce our cash available for operations and other uses, and could result in increases in amortization expenses related to identifiable intangible assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt. We cannot predict the number, timing or size of future acquisitions, or the effect that any such acquisitions might have on our operating results.

 

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Changes in international trade policies and international barriers to trade may have an adverse effect on our business and expansion plans.

We have exported our products to a number of countries outside of the PRC and derive sales from exporting to those countries, and we intend to continue to sell our current and future products to countries outside of the PRC. Sales to the United States accounted for 10.5% of our total sales in 2018. Further, we rely on certain overseas suppliers, including suppliers in the United States, for the supply of certain equipment and tools, such as our electronic design automation, a development tool. Changes to trade policies, treaties and tariffs in or affecting the jurisdictions in which we operate and to which we sell our products, or the perception that these changes could occur, could adversely affect the financial and economic conditions in those jurisdictions, as well as our international sales, financial condition and results of operations.

In 2017 and 2018, the United States was the largest country outside of the PRC by sales contribution to which we sold our Bitcoin mining machines. The U.S. administration under President Donald Trump has advocated greater restrictions on trade generally and significant increases on tariffs on goods imported into the United States, particularly from China, and has recently taken steps toward restricting trade in certain goods. On June 15, 2018, the U.S. Trade Representative announced the imposition of an additional duty of 25% on approximately US$50 billion worth of Chinese imports, including those related to China’s “Made in China 2025” industrial policy. This list of products consists of two sets of U.S. tariff lines. The additional duty assessed on the first set, which includes photosensitive semiconductor devices, parts and accessories for measuring semiconductor devices, came into effect on July 6, 2018. These tariffs impact Chinese semiconductor companies that manufacture and export to the United States. The second set, which includes electronic integrated circuits, came into effect on August 23, 2018. On September 21, 2018, the U.S. Trade Representative further announced the imposition of additional duties on approximately US$200 billion worth of Chinese imports. The additional duties came into effect on September 24, 2018. The products that we exported to the United States were not included in the tariff lists for the above additional duties. Additionally, we plan to sell our AI products to domestic manufacturers who will then incorporate our AI products into final products such as smart appliances and smart toys. Therefore, while our AI products are not currently subject to these tariffs directly, the products of our customers that incorporate our AI products may be subject to these tariffs. We cannot assure you that future restrictions on trade and tariffs implemented by the United States will not affect our products, which would negatively affect our expansion plans as well as our financial condition and results of operations.

In response to the additional tariffs by the United States that came into effect on July 6, 2018, China has imposed retaliatory tariffs on various goods imported from the United States. In the event that China adopts further retaliatory measures against the United States or any adverse trade policies of other countries that affect the importation of equipment and tools that we require, we may not be able to find alternative suppliers on comparable terms, or at all, which may lead to an increase in our costs or significant delays in our product releases. In addition, such policy retaliations could result in further trade policy responses by the United States and other countries, which would cause an adverse effect on manufacturing levels, trade levels and industries in the jurisdictions in which we operate and to which we sell our products and may result in a material and adverse effect on our business and results of operations.

Our operations and those of our production partners and customers are vulnerable to natural disasters and other events beyond our control, the occurrence of which may have an adverse effect on the supply chain of our suppliers and on our facilities, personnel and results of operations.

Our business operations and those of our production partners and customers are faced with numerous risks and dangers, including capacity constraints, labor strikes, fire, natural disasters (e.g. earthquakes, typhoons), and environmental or occupational disasters. Any of these events could have a material adverse effect on our business.

We have one assembly plant and one warehouse in the PRC which could suffer significant business disruption due to earthquakes or other natural disasters. We are currently not covered by insurance against such

 

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business disruption. Similarly, the manufacturing facilities of our production partners and the mining facilities of our customers are principally located in Asia and their operations may be reduced or eliminated due to natural disasters. The risk of earthquakes in these geographic regions is significant due to the proximity of major earthquake fault lines, and Taiwan in particular, where our IC foundry supplier is located, is also subject to typhoons and other Pacific storms. In addition, some of our customers may place their Bitcoin mining facilities near streams within mountainous regions to take advantage of hydroelectric power, which causes them to be at risk of flooding. For example, a flood in Sichuan in June 2018 caused significant damage to certain Bitcoin mining facilities in the area and to the mining equipment at these facilities.

Our business could also be adversely affected by epidemics or outbreaks such as avian flu, or H1N1, also known as swine flu. An outbreak of avian flu or H1N1 in the human population, or another similar health crisis, could adversely affect the economies and financial markets of entire regions, particularly in Asia. Moreover, any related disruptions to transportation or the free movement of persons could hamper our operations and force us to close our offices temporarily.

The occurrence of any of the foregoing or other natural or man-made disasters could cause damage or disruption to us, our employees, operations, markets and customers, which could result in significant delays in deliveries or substantial shortages of our products and could adversely affect our business, financial condition, results of operations or prospects.

Cyber-security incidents, including data security breaches or computer viruses, could harm our business by disrupting our delivery of services, damaging our reputation or exposing us to liability.

We receive, process, store and transmit, often electronically, the data of our customers and others, much of which is confidential. Unauthorized access to our computer systems or stored data could result in the theft, including cyber-theft, or improper disclosure of confidential information, and the deletion or modification of records could cause interruptions in our operations. These cyber-security risks increase when we transmit information from one location to another, including over the Internet or other electronic networks. Despite the security measures we have implemented, our facilities, systems and procedures, and those of our third-party service providers, may be vulnerable to security breaches, acts of vandalism, software viruses, misplaced or lost data, programming or human errors or other similar events which may disrupt our delivery of services or expose the confidential information of our customers and others. Any security breach involving the misappropriation, loss or other unauthorized disclosure or use of confidential information of our customers or others, whether by us or a third party, could (i) subject us to civil and criminal penalties, (ii) have a negative impact on our reputation, or (iii) expose us to liability to our customers, third parties or government authorities. We are not aware of such breaches to date. Any of these developments could have a material adverse effect on our business, financial condition and results of operations.

Preferential tax treatment currently available to us in the PRC could be discontinued or reduced.

As an enterprise selling self-developed software, Hangzhou Canaan Creative Information Technology Co., Limited, or Hangzhou Canaan, a subsidiary of ours, received VAT tax refunds of RMB38.8 million and RMB110.2 million (US$16.0 million) in 2017 and 2018, respectively. We cannot assure you that we will continue to qualify for the VAT tax refund, or that the policies providing for the VAT tax refund will continue to be effective.

Additionally, Hangzhou Canaan is accredited as a software enterprise, and was therefore entitled to preferential tax treatment in 2017, paying no income taxes. In 2018, Hangzhou Canaan as a key software enterprise will be subject to a preferential enterprise income tax rate, or EIT rate, of 10.0%. Following our accreditation as a key software enterprise falling within the State’s planning lay-out or high-tech enterprise, we will independently determine whether we meet the conditions required for EIT preferences annually. Canaan Creative, a subsidiary of ours, was certified as a High-tech Enterprise in Beijing, and has also been entitled to an EIT rate of 15.0% since 2016. Under the PRC Enterprise Income Tax Law ( LOGO ), or the

 

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PRC EIT Law and its relevant regulations, PRC companies are typically subject to an income tax rate of 25% under the PRC EIT Law. Meanwhile, we shall, in accordance with the requirements of the tax authority and other relevant authorities, retain and submit our financial statements together with details of our research and development activities and other technological innovation activities for future reference to enjoy the preferential tax treatment. As advised by our PRC Legal Adviser, if we fail to provide materials retained for future reference, we will not be entitled to enjoy the preferential tax treatment, as well as other benefits conferred under the accreditations.

We require various approvals, licenses, permits and certifications to operate our business. Any failure to obtain or renew any of these approvals, licenses, permits or certifications could materially and adversely affect our business and results of operations.

In accordance with the laws and regulations in the jurisdictions in which we operate, we are required to maintain various approvals, licenses, permits and certifications in order to operate our business. Complying with such laws and regulations may require substantial expense, and any non-compliance may expose us to liability. In the event of non-compliance, we may have to incur significant expenses and divert substantial management time to rectify the incidents. In the future, if we fail to obtain all the necessary approvals, licenses, permits and certifications, we may be subject to fines or the suspension of operations at the production facilities and research and development facilities that do not have all the requisite approvals, licenses, permits and certifications, which could materially and adversely affect our business and results of operations. See “Regulation” for further details on the requisite approvals, licenses, permits and certifications necessary for our business operations. We may also experience adverse publicity arising from non-compliance with government regulations, which would negatively impact our reputation.

We cannot assure you that we will be able to fulfill all the conditions necessary to obtain the required government approvals, or that relevant government officials will always, if ever, exercise their discretion in our favor, or that we will be able to adapt to any new laws, regulations and policies. There may also be delays on the part of government authorities in reviewing our applications and granting approvals, whether due to the lack of human resources or the imposition of new rules, regulations, government policies or their implementation, interpretation and enforcement. If we are unable to obtain, or experience material delays in obtaining, necessary government approvals, our operations may be substantially disrupted, which could materially and adversely affect our business, financial condition and results of operations.

Our assembly plant is located on property whose owner has not obtained the approval of relevant authorities, and we may be ordered to relocate from that property.

Our assembly plant for Bitcoin mining machines in Hebei province with a gross floor area of 7,538.5 square meters was constructed by our landlord without the approval of housing use planning authorities. As advised by our PRC Counsel, such buildings may be considered to be in violation of relevant zoning laws and the government may order the demolition or relocation of such building.

If we are evicted from such property, we may need to find alternative properties and relocate our assembly plant. Unless we are able to make timely alternative arrangements for relocating our assembly plant, we may not be able to fulfill purchase orders received, which may have a material and adverse effect on our business, results of operations and financial condition.

Our founders have had and will continue to have substantial influence over us. The interests of our founders may not be aligned with the interests of other shareholders.

After the completion of this offering, our founders, namely Mr. Zhang and Mr. Li, will indirectly beneficially own                     % of the issued ordinary shares (assuming the underwriters do not exercise their

 

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option to purchase additional ADSs) and continue to have substantial control over our issued share capital. Our founders will therefore have substantial influence over the business and operations of our company, including decisions regarding mergers, consolidations and sales of all or substantially all of its assets, the election of directors and other significant corporate actions.

However, the interests of our founders may differ from the interests of other shareholders. This concentration of ownership may discourage, delay or prevent a change in control of our company, which could negatively affect the market price of the ordinary shares. We may not be able to enter into transactions that could be beneficial to our company without our founders’ consent. Alternatively, we may, with our principal shareholders’ vote, enter into transactions despite objections from minority shareholders.

We may be involved in legal and other disputes from time to time arising out of our operations, including disputes with our raw material or component suppliers, production partners, customers or employees.

We may from time to time be involved in disputes with various parties arising out of our operations, including raw material or electronic components suppliers, production partners, customers or employees. These disputes may lead to protests or legal or other proceedings and may result in damage to our reputation, substantial costs and diversion of resources and management’s attention from our core business activities. In addition, we may encounter compliance issues with regulatory bodies in the course of our operations, in respect of which we may face administrative proceedings or unfavorable decisions that may result in liabilities and cause delays to our production and delivery. We may be involved in other proceedings or disputes in the future that may have a material adverse effect on our business, financial condition, results of operations or cash flows.

Our insurance coverage is limited and may not be adequate to cover potential losses and liabilities. A significant uninsured loss or a loss in excess of our insurance coverage could have a material adverse effect on our results of operations and financial condition.

The insurance products available to us are limited, and the property, transit, public liability and director and officer insurance policies we have obtained may not cover all risks associated with our business. The occurrence of certain incidents including severe weather, earthquake, fire, war, power outages, flooding and the consequences resulting from them may not be covered by our insurance policies adequately, or at all. If we were subject to substantial liabilities that were not covered by our insurance, we could incur costs and losses that could materially and adversely affect our results of operations and financial condition.

We may need additional capital but may not be able to obtain it in a timely manner and on favorable terms or at all.

Our operations may require additional capital or financing from time to time in order to achieve further growth. We did not have outstanding borrowings as of December 31, 2017 and we had outstanding borrowings of RMB1,049.0 million (US$152.6 million) as of December 31, 2018 incurred primarily in connection with our reorganization. We may require additional cash resources due to the future growth and development of our business. Our future capital requirements may be substantial as we seek to expand our operations, diversify our product offering, and pursue acquisitions and equity investments. If our cash resources are insufficient to satisfy our cash requirements, we may seek to issue additional equity or debt securities or obtain new or expanded credit facilities or enter into additional factoring arrangements.

Our ability to obtain external financing in the future is subject to a variety of uncertainties, including our future financial condition, results of operations and cash flows and the liquidity of international capital and lending markets. In addition, our loan agreements may contain financial covenants that restrict our ability to incur additional indebtedness or to distribute dividends. Any indebtedness that we may incur in the future may also contain operating and financial covenants that could further restrict our operations. There can be no assurance that financing will be available in a timely manner or in amounts or on terms acceptable to us, or at all.

 

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A large amount of bank borrowings and other debt may result in a significant increase in interest expense while at the same time exposing us to increased interest rate risks. Equity financings could result in dilution to our shareholders, and the securities issued in future financings may have rights, preferences and privileges that are senior to those of our ordinary shares or ADSs. Any failure to raise needed funds on terms favorable to us, or at all, could severely restrict our liquidity as well as have a material adverse effect on our business, financial condition and results of operations.

We rely on third-party logistics service providers to deliver our products. Disruption in logistics may prevent us from meeting customer demand and our business, financial condition and results of operations may suffer as a result.

We engage independent third-party logistics service providers to deliver the ICs from our production partners to our assembly plant and our products from our warehouses to our customers. Disputes with or termination of our contractual relationships with one or more of our logistics service providers could result in delayed delivery of products or increased costs. There can be no assurance that we can continue or extend relationships with our current logistics service providers on terms acceptable to us, or that we will be able to establish relationships with new logistics service providers to ensure accurate, timely and cost-efficient delivery services. If we are unable to maintain or develop good relationships with our preferred logistics service providers, it may inhibit our ability to offer products in sufficient quantities, on a timely basis, or at prices acceptable to our consumers. If there is any breakdown in our relationships with our preferred logistics service providers, we cannot assure you that no interruptions in our product delivery would occur or that they would not materially and adversely affect our business, prospects and results of operations.

As we do not have any direct control over these logistics service providers, we cannot guarantee their quality of service. In addition, services provided by these logistics service providers could be interrupted by unforeseen events beyond our control, such as poor handling provided by these logistics service providers, natural disasters, pandemics, adverse weather conditions, riots and labor strikes. If there is any delay in delivery, damage to products or any other issue, we may lose customers and sales and our brand image may be tarnished.

Bitcoin mining activities are energy-intensive, which may restrict the geographic locations of miners and have a negative environmental impact.

Bitcoin mining activities are inherently energy-intensive and electricity costs account for a significant portion of the overall mining costs. The availability and cost of electricity will restrict the geographic locations of mining activities. Any shortage of electricity supply or increase in electricity cost in a jurisdiction may negatively impact the viability and the expected economic return for Bitcoin mining activities in that jurisdiction, which may in turn decrease the sales of our Bitcoin mining machines in that jurisdiction.

In addition, the significant consumption of electricity may have a negative environmental impact, including contribution to climate change, which may give rise to public opinion against allowing the use of electricity for Bitcoin mining activities or government measures restricting or prohibiting the use of electricity for Bitcoin mining activities. Any such development in the jurisdictions where we sell our Bitcoin mining machines could have a material and adverse effect on our business, financial condition and results of operations.

Our business operation and international expansion is subject to geopolitical risks.

Our business operation and international expansion is subject to geopolitical risks. We rely on our production partners in Taiwan, including TSMC, ASE and SPIL, for the fabrication, testing and packaging of our ASICs. Any significant deterioration in the cross-strait relationship may have a negative impact on the ability of our production partners in Taiwan to fulfill their contractual obligations and ship the ASICs to us, which could have a material and adverse effect on our business, financial condition and results of operations.

 

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In addition, there might be significant changes to United States trade policies, treaties and tariffs, including trade policies and tariffs regarding the PRC. China may respond by imposing retaliatory trade measures against the United States. In 2017 and 2018, the United States was the largest country outside the PRC by sales contribution to which we sold our Bitcoin mining machines. Further, we rely on suppliers in the United States for the supply of certain equipment and tools, such as our electronic design automation, a development tool. If the United States restricts or prohibits the importation of ASICs or related products from China, our international expansion may be negatively affected. If China imposes retaliatory trade measures that affect the importation of the equipment and tools we require, we may face difficulty in our production. In both cases, our business, financial condition and results of operations could be materially and adversely affected.

We may be subject to fines and other administrative penalties resulting from the operation of our business, which could materially and adversely affect our business, financial condition and results of operation.

We are subject to regulation by the PRC government authorities. These relevant regulatory authorities have broad powers to adopt regulations and other requirements affecting or restricting our operations, including tax policies. Moreover, these relevant regulatory authorities possess significant powers to enforce applicable regulatory requirements in the event of our non-compliance, including the imposition of fines, sanctions or the revocation of licenses or permits to operate our business. For example, we were notified by the Beijing City Haidian District Zhongguancun Customs that we owe a value-added tax, or VAT, amounting to not more than RMB830,000. We expect the relevant government authority to require us to pay the outstanding VAT plus a late-payment fee, as well as an administrative fine of up to two times the outstanding VAT. However, we cannot determine the exact amount of the administrative fine for the late payment of VAT as of the date of this prospectus. We cannot assure you that we will not face similar or other administrative fines or penalties concerning our operations or our subsidiaries, which could have a material adverse impact on our results of operation.

Any global systemic economic and financial crisis could negatively affect our business, results of operations, and financial condition.

Any prolonged slowdown in the Chinese or global economy may have a negative impact on our business, results of operations and financial condition. The global financial markets have experienced significant disruptions since 2008 and the United States, Europe and other economies have experienced periods of recession. The recovery from the lows of 2008 and 2009 has been uneven and there are new challenges, including the escalation of the European sovereign debt crisis from 2011 and the slowdown of the PRC’s economic growth since 2012, which may continue. There is considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies adopted by the central banks and financial authorities of some of the world’s leading economies, including the United States and the PRC. There have also been concerns over unrest in Ukraine, the Middle East and Africa, which have resulted in volatility in financial and other markets. There have also been concerns over the United Kingdom leaving the European Union as well as the significant potential changes to United States trade policies, treaties and tariffs, including trade policies and tariffs regarding the PRC. There have also been concerns about the economic effect of the tensions in the relationship between the PRC and surrounding Asian countries. There were and could be in the future a number of domino effects from such turmoil on our business, including significant decreases in orders from our customers; insolvency of key suppliers resulting in product delays; inability of customers to obtain credit to finance purchases of our products and/or customer insolvencies; and counterparty failures negatively impacting our operations. Any systemic economic or financial crisis could cause revenues for the semiconductor industry as a whole to decline dramatically and could materially and adversely affect our results of operations.

If counterfeit products are sold under our brand names and trademarks, our reputation and financial results could be materially and adversely affected.

Third-party merchants and dealers are separately responsible for sourcing counterfeit products that are sold under our brand names and trademarks. Counterfeit products may be defective or inferior in quality as compared

 

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to authentic products. If our customers are not satisfied by counterfeit products sold under our brand names and trademarks, we may be subject to reputational damage. We believe our brand and reputation are important to our success and our competitive position. The discovery of counterfeit products sold under our brand names and trademarks may severally damage our reputation and cause customers to refrain from making future purchases from us, which would materially and adversely affect our business operations and financial results.

Risks Relating to Doing Business in the PRC

Economic, political and social conditions as well as governmental policies in the PRC could adversely affect our business, prospects, financial condition and financial results.

A majority of our business operations is currently conducted in the PRC and we derive a majority of our revenue from the PRC. The PRC economy differs from the economies of most developed countries in many aspects, including:

 

   

political structure;

 

   

level of government involvement and control;

 

   

growth rate and level of development;

 

   

level and control of capital investment and reinvestment;

 

   

control of foreign exchange; and

 

   

allocation of resources.

The PRC economy has been transitioning from a centrally planned economy to a more market-oriented economy for approximately four decades as the PRC government has implemented economic reform measures to utilize market forces in the development of the PRC economy. We cannot predict whether changes in the economic, political and social conditions of the PRC and in its laws, regulations and policies will have any adverse effect on our current or future business, financial condition or results of operations.

More specifically, many of the economic reforms carried out by the PRC government are unprecedented or experimental and are expected to be refined and improved over time. This refining and adjustment process may not necessarily have a positive effect on our operations and business development. These actions, as well as other actions and policies of the government of the PRC, could cause a decrease in the overall level of economic activity in the PRC and the surrounding regions and, in turn, have an adverse impact on our business and financial condition.

Changes to and uncertainties in the legal system of the PRC may have a material adverse impact on our business, financial condition and results of operations. Legal protections available to you under the legal system of the PRC may be limited.

The PRC is still in the process of developing a comprehensive statutory framework. Since 1979, the PRC government has established a commercial law system, and significant progress has been made in promulgating laws and regulations relating to economic affairs and matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. However, many of these laws and regulations are relatively new, and the implementation and interpretation of these laws and regulations remain uncertain in many areas. It may be difficult to obtain swift and equitable enforcement or to obtain enforcement of a judgment by a court of another jurisdiction. Consequently, developments and changes in the PRC laws and regulations, including their interpretation and enforcement, may have a material and adverse effect on our business, financial condition and results of operations. Furthermore, the legal protections available to you under the PRC legal system may be limited.

 

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You may experience difficulties enforcing judgments against us and our management in the PRC.

Our PRC Legal Adviser has advised us that the recognition and enforcement of foreign judgments are governed by the PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based either on treaties between the PRC and the country where the judgment is made or on reciprocity between jurisdictions, provided that the foreign judgments do not violate the basic principles of laws of the PRC or its sovereignty, security or social and public interest.

PRC regulations relating to the establishment of offshore special purpose vehicles by PRC residents may subject our PRC-resident beneficial owners or our PRC subsidiaries to liability or penalties, limit our ability to make capital contributions into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us, or otherwise adversely affect our financial position.

Under several regulations promulgated by the State Administration of Foreign Exchange of the People’s Republic of China, or SAFE, PRC residents and PRC corporate entities are required to register with and obtain approval from local branches of SAFE or designated qualified foreign exchange banks in China in connection with their direct or indirect offshore investment activities. In addition, any PRC resident who is a direct or indirect shareholder of an offshore company is required to update the previously filed registration with the local branch of SAFE, with respect to any material change involving that offshore company, such as an increase or decrease in capital, transfer or swap of shares, merger or division. These regulations apply to all direct and indirect shareholders and beneficial owners of our company who are PRC residents, or PRC-Resident Shareholders, and may apply to any offshore acquisitions that we make in the future. To the best of our knowledge, as of the date of this prospectus, each of our principal shareholders who is required to make the foreign exchange registration under SAFE Circular 37 had completed such registration. However, we may not at all times be fully aware or informed of the identities of all the PRC residents holding direct or indirect interests in our company, and we cannot assure you that all of our shareholders and beneficial owners who are PRC residents will comply with these foreign exchange regulations.

If any PRC-Resident Shareholder fails to make the required registration or update a previously filed registration, our PRC subsidiaries may be prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to us, and we may also be prohibited from injecting additional capital into our PRC subsidiaries. Moreover, failure to comply with the various foreign exchange registration requirements described above could result in liability on the related PRC-Resident shareholder or our PRC subsidiaries under the PRC laws for evasion of applicable foreign exchange restrictions.

Our corporate structure may restrict our ability to receive dividends from, and transfer funds to, our PRC operating subsidiaries, which could restrict our ability to act in response to changing market conditions in a timely manner.

We are a Cayman Islands holding company and a certain portion of our operations are conducted through our operating subsidiaries. The ability of our operating subsidiaries to make dividend and other payments to us may be restricted by factors that include changes in applicable foreign exchange and other laws and regulations.

In particular, under the PRC law, each of our PRC operating subsidiaries may only pay dividends after 10% of its net profit has been set aside as reserve funds, unless such reserves have reached at least 50% of its registered capital. In addition, the profit available for distribution from our PRC operating subsidiaries is determined in accordance with generally accepted accounting principles in the PRC. This calculation may differ if it were performed in accordance with U.S. GAAP. As a result, we may not have sufficient distributions from our PRC operating subsidiaries to enable necessary profit distributions to our shareholders in the future, which would be based upon our financial statements prepared under U.S. GAAP.

Distributions by our PRC operating subsidiaries to us other than as dividends may be subject to governmental approval and taxation. Any transfer of funds from our company to our PRC operating subsidiaries,

 

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either as a shareholder loan or as an increase in registered capital, is subject to registration or approval of PRC governmental authorities, including the relevant administration of foreign exchange and/or the relevant examining and approval authority. These limitations on the free flow of funds between us and our PRC subsidiaries could restrict our ability to act in response to changing market conditions in a timely manner.

Dividends payable by us to our foreign investors and gains on the sale of our ADSs may become subject to withholding taxes under the PRC tax laws.

Under the EIT Law and EIT Implementation Rules, our foreign corporate shareholders may be subject to a 10% income tax upon any gains realized from the transfer of their ADSs and dividends distributable to such foreign corporate shareholder, if such income is regarded as income from “sources within the PRC.” According to the EIT Implementation Rules, whether income generated from transferring equity investments is to be regarded as sources within the PRC or from foreign territory shall depend upon the locations in which the enterprises accepting the equity investment are located. However, it is unclear whether income received by our shareholders will be deemed to be income from sources within the PRC and whether there will be any exemption or reduction in taxation for our foreign corporate shareholders due to the promulgation of the EIT Law. If our foreign corporate shareholders are required to pay PRC income tax on the transfers of our ADSs that they hold or on the gains on the sale of our ADSs by them, the value of our foreign corporate shareholders’ investments in our ADSs may be materially and adversely affected.

We may be classified as a “resident enterprise” for PRC enterprise income tax purposes, which could result in unfavorable tax consequences to us and our non-PRC shareholders.

The EIT Law provides that enterprises established outside of the PRC whose “de facto management bodies” are located in the PRC are considered “resident enterprises” and are generally subject to the uniform 25% enterprise income tax rate on their worldwide income. In addition, a circular issued by the State Administration of Taxation on April 22, 2009 regarding the standards used to classify certain Chinese-invested enterprises controlled by Chinese enterprises or Chinese group enterprises and established outside of the PRC as “resident enterprises” clarified that dividends and other income paid by such “resident enterprises” will be considered to be PRC source income, subject to PRC withholding tax, currently at a rate of 10%, when recognized by non-PRC enterprise shareholders. This circular also subjects such “resident enterprises” to various reporting requirements with the PRC tax authorities. Under the implementation regulations to the enterprise income tax, a “de facto management body” is defined as a body that has material and overall management and control over the manufacturing and business operations, personnel and human resources, finances and properties of an enterprise. In addition, the circular mentioned above sets out criteria for determining whether “de facto management bodies” are located in the PRC for overseas incorporated, domestically controlled enterprises. However, as this circular only applies to enterprises established outside of the PRC that are controlled by PRC enterprises or groups of PRC enterprises, it remains unclear how the tax authorities will determine the location of “de facto management bodies” for overseas incorporated enterprises that are controlled by individual PRC residents like us and some of our subsidiaries. Therefore, although substantially all of our management is currently located in the PRC, it remains unclear whether the PRC tax authorities would require or permit our overseas registered entities to be treated as PRC resident enterprises. We do not currently consider our company to be a PRC resident enterprise. However, if the PRC tax authorities disagree with our assessment and determine that we are a “resident enterprise” we may be subject to enterprise income tax at a rate of 25% on our worldwide income and dividends paid by us to our non-PRC shareholders as well as capital gains recognized by them with respect to the sale of our ADSs may be subject to a PRC withholding tax.

This will have an impact on our effective tax rate, a material adverse effect on our net income and results of operations, and may require us to withhold tax on our non-PRC shareholders.

 

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Government control of foreign currency conversion may affect the value of your investment.

The PRC government imposes controls on the convertibility of Renminbi into foreign currencies and, in certain cases, the remittance of currency out of the PRC. Under existing PRC foreign exchange regulations, payments of certain current account items can be made in foreign currencies without prior approval from the local branch of the SAFE by complying with certain procedural requirements. However, approval from appropriate government authorities is required where Renminbi is to be converted into foreign currency and remitted out of the PRC to pay capital expenses such as the repayment of bank loans denominated in foreign currencies. The restrictions on foreign exchange transactions under capital accounts could also affect the ability of our subsidiaries in the PRC to obtain foreign exchange through debt or equity financing, including by means of loans or capital contributions from us. The PRC government may also at its discretion restrict access in the future to foreign currencies for current account transactions.

Risks Relating to Our ADSs and this Offering

An active trading market for our ordinary shares or our ADSs may not develop and the trading price for our ADSs may fluctuate significantly.

We will apply to list our ADSs on the [New York Stock Exchange] [Nasdaq Global Market]. We have no current intention to seek a listing for our ordinary shares on any stock exchange. Prior to the completion of this offering, there has been no public market for our ADSs or our ordinary shares. If an active public market for our ADSs does not develop following the completion of this offering, the market price and liquidity of our ADSs may be materially and adversely affected.

The initial public offering price for our ADSs will be determined by negotiation between us and the underwriters based upon several factors, and we can provide no assurance that the trading price of our ADSs after this offering will not fall below the initial public offering price. As a result, investors in our securities may experience a significant decrease in the value of their ADSs.

The trading price of our ADSs is likely to be volatile, which could result in substantial losses to investors.

The trading price of our ADSs is likely to be volatile and could fluctuate widely due to factors beyond our control. This may happen because of broad market and industry factors, including the performance and fluctuation of the market prices of other companies with business operations located mainly in China that have listed their securities in the United States. The securities of some of these companies, including internet-based companies, have experienced significant volatility since their initial public offerings, including, in some cases, substantial price declines in their trading prices. The trading performances of other PRC companies’ securities after their offerings may affect the attitudes of investors toward PRC companies listed in the United States in general and consequently may impact the trading performance of our ADSs, regardless of our actual operating performance.

In addition to market and industry factors, the price and trading volume of our ADSs may be highly volatile due to factors specific to our own operations, including the following:

 

   

variations in our revenues, earnings and cash flow;

 

   

announcements of new investments, acquisitions, strategic partnerships or joint ventures by us or our competitors;

 

   

announcements of new offerings, solutions and expansions by us or our competitors;

 

   

changes in financial estimates by securities analysts;

 

   

detrimental adverse publicity about us, our services or our industry;

 

   

additions or departures of key personnel;

 

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the release of lockup or other transfer restrictions on our outstanding equity securities or sales of additional equity securities; and

 

   

potential litigation or regulatory investigations.

Any of these factors may result in large and sudden changes in the volume and price at which our ADSs will trade.

In the past, shareholders of public companies have often brought securities class action suits against those companies following periods of instability in the market price of their securities. If we were involved in a class action suit, it could divert a significant amount of our management’s attention and other resources from our business and operations and require us to incur significant expenses to defend the suit, which could harm our results of operations. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and results of operations.

If securities or industry analysts do not publish research or reports about our business, or if they adversely change their recommendations regarding our ADSs, the market price for our ADSs and trading volume could decline.

The trading market for our ADSs will be influenced by research or reports that industry or securities analysts publish about our business. If one or more analysts who cover us downgrade our ADSs, the market price for our ADSs would likely decline. If one or more of these analysts cease to cover us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which could, in turn, cause the market price or trading volume for our ADSs to decline.

The sale or availability for sale of substantial amounts of our ADSs could adversely affect their market price.

Sales of substantial amounts of our ADSs in the public market after the completion of this offering, or the perception that these sales could occur, could adversely affect the market price of our ADSs and could materially impair our ability to raise capital through equity offerings in the future. The ADSs sold in this offering will be freely tradable without restriction or further registration under the Securities Act of 1933, as amended, or the Securities Act, and shares held by our existing shareholders may also be sold in the public market in the future subject to the restrictions in Rule 144 and Rule 701 under the Securities Act and the applicable lock-up agreements. There will be              ADSs (equivalent to              ordinary shares) outstanding immediately after this offering, or              ADSs (equivalent to              ordinary shares) if the underwriters exercise their option to purchase additional ADSs in full. In connection with this offering, we and [our officers, directors and certain option holders] have agreed not to sell any ordinary shares or ADSs for              days after the date of this prospectus without the prior written consent of the underwriters, subject to certain exceptions. However, the underwriters may release these securities from these restrictions at any time, subject to applicable regulations of the Financial Industry Regulatory Authority, Inc. We cannot predict what effect, if any, market sales of securities held by our significant shareholders or any other shareholder or the availability of these securities for future sale will have on the market price of our ADSs. See “Underwriting” and “Shares Eligible for Future Sale” for a more detailed description of the restrictions on selling our securities after this offering.

Because we do not expect to pay dividends in the foreseeable future after this offering, you must rely on price appreciation of our ADSs for a return on your investment.

We currently intend to retain most, if not all, of our available funds and any future earnings after this offering to fund the development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, you should not rely on an investment in our ADSs as a source for any future dividend income.

 

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Our board of directors has discretion as to whether to distribute dividends, subject to certain requirements of Cayman Islands law. Under Cayman Islands law, a Cayman Islands company may pay a dividend out of either profit or share premium account, provided that in no circumstances may a dividend be paid if this would result in the company being unable to pay its debts as they fall due in the ordinary course of business. Even if our board of directors decides to declare and pay dividends, the timing, amount and form of future dividends, if any, will depend on our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors. Accordingly, the return on your investment in our ADSs will likely depend entirely upon any future price appreciation of our ADSs. There is no guarantee that our ADSs will appreciate in value after this offering or even maintain the price at which you purchased the ADSs. You may not realize a return on your investment in our ADSs, and you may even lose your entire investment in our ADSs.

Because the initial public offering price is substantially higher than the pro forma net tangible book value per share, you will experience immediate and substantial dilution.

If you purchase ADSs in this offering, you will pay more for each ADS than the corresponding amount paid by existing shareholders for their ordinary shares. As a result, you will experience immediate and substantial dilution of approximately US$             per ADS (assuming that no outstanding options to acquire ordinary shares are exercised). This number represents the difference between (1) our pro forma net tangible book value per ADS of US$             as of December 31, 2017, after giving effect to this offering and (2) the assumed initial public offering price of US$             per ADS, the midpoint of the estimated initial public offering price range set forth on the front cover of this prospectus. See “Dilution” for a more complete description of how the value of your investment in our ADSs will be diluted upon the completion of this offering.

We have not determined a specific use for a portion of the net proceeds from this offering, and we may use these proceeds in ways with which you may not agree.

We have not determined a specific use for a portion of the net proceeds of this offering, and our management will have considerable discretion in deciding how to apply these proceeds. You will not have the opportunity to assess whether the proceeds are being used appropriately before you make your investment decision. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. We cannot assure you that the net proceeds will be used in a manner that will improve our results of operations or increase our ADS price, or that these net proceeds will be placed only in investments that generate income or appreciate in value.

Our post-offering memorandum and articles of association contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our ordinary shares and ADSs.

We will adopt an amended and restated memorandum and articles of association that will become effective immediately prior to the completion of this offering. Our new memorandum and articles of association will contain certain provisions that limit the ability of others to acquire control of our company or cause us to engage in change-of-control transactions, including a provision that grants authority to our board of directors to establish and issue from time to time one or more series of preferred shares without action by our shareholders and to determine, with respect to any series of preferred shares, the terms and rights of that series. These provisions could have the effect of depriving our shareholders and ADSs holders of the opportunity to sell their shares or ADSs at a premium over the prevailing market price by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transactions.

You may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited because we are incorporated under Cayman Islands law.

We are an exempted company incorporated under the laws of the Cayman Islands. Our corporate affairs are governed by our memorandum and articles of association, the Companies Law of the Cayman Islands, as

 

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amended and the common law of the Cayman Islands. The rights of shareholders to take action against our directors, actions by our minority shareholders and the fiduciary duties of our directors to us under the Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from the common law of England, the decisions of whose courts are of persuasive authority, but are not binding, on a court in the Cayman Islands. The rights of our shareholders and the fiduciary duties of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands have a less developed body of securities laws than the United States. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States.

Shareholders of Cayman Islands exempted companies like us have no general rights under Cayman Islands law to inspect corporate records (other than the memorandum and articles of association) or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our articles of association to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obligated to make them available to our shareholders. This may make it more difficult for you to obtain the information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

Certain corporate governance practices in the Cayman Islands, which is our home country, differ significantly from requirements for companies incorporated in other jurisdictions such as the United States. We may follow the home country practice for certain corporate governance practices after the closing of this offering which may differ from the requirements of the New York Stock Exchange or Nasdaq Global Market. If we choose to follow the home country practice, our shareholders may be afforded fewer protection than they otherwise would under rules and regulations applicable to U.S. domestic issuers.

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would as public shareholders of a company incorporated in the United States. For a discussion of significant differences between the provisions of the Companies Law of the Cayman Islands and the laws applicable to companies incorporated in the United States and their shareholders, see “Description of Share Capital—Differences in Corporate Law.”

Certain judgments obtained against us by our shareholders may not be enforceable.

We are a Cayman Islands exempted company and all of our assets are located outside of the United States. All of our current operations are conducted in China. In addition, all of our current directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons are located outside the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under the U.S. federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforcement of Civil Liabilities.”

Our auditor, like other independent registered public accounting firms operating in China, is not permitted to be subject to inspection by Public Company Accounting Oversight Board, and consequently investors may be deprived of the benefits of such inspection.

Our auditor, the independent registered public accounting firm that issued the audit report included elsewhere in this registration statement, as an auditor of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board (United States), or PCAOB, is subject to laws in the United States pursuant to which the PCAOB conducts regular inspections to assess its compliance with applicable professional standards. Our auditor is located in, and organized under the laws of, the PRC, which is a jurisdiction where the PCAOB, has been unable to conduct inspections without the approval of the Chinese authorities. In May 2013, PCAOB announced that it had entered into a Memorandum of

 

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Understanding on Enforcement Cooperation with the CSRC and the PRC Ministry of Finance, which establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations undertaken by PCAOB, the CSRC or the PRC Ministry of Finance in the United States and the PRC, respectively. PCAOB continues to be in discussions with the China Securities Regulatory Commission, or CSRC, and the PRC Ministry of Finance to permit joint inspections in China of audit firms that are registered with PCAOB and audit Chinese companies that trade on U.S. exchanges.

On December 7, 2018, the SEC and the PCAOB issued a joint statement highlighting continued challenges faced by the U.S. regulators in their oversight of financial statement audits of U.S.-listed companies with significant operations in China. However, it remains unclear what further actions, if any, the SEC and PCAOB will take to address the problem.

This lack of PCAOB inspections in China prevents the PCAOB from fully evaluating audits and quality control procedures of our independent registered public accounting firm. As a result, we and investors in our ordinary shares are deprived of the benefits of such PCAOB inspections. The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our independent registered public accounting firm’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections, which could cause investors and potential investors in our stock to lose confidence in our audit procedures and reported financial information and the quality of our financial statements.

Proceedings instituted by the SEC against “big four” PRC-based accounting firms, including our independent registered public accounting firm, could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act.

Starting in 2011 “big four” PRC-based accounting firms, including our independent registered public accounting firm, were affected by a conflict between U.S. and Chinese law. Specifically, for certain U.S.-listed companies operating and audited in mainland China, the SEC and the PCAOB sought to obtain from the Chinese firms access to their audit work papers and related documents. The firms were, however, advised and directed that under Chinese law, they could not respond directly to the U.S. regulators on those requests, and that requests by foreign regulators for access to such papers in China had to be channeled through the CSRC.

In late 2012, this impasse led the SEC to commence administrative proceedings under Rule 102(e) of its Rules of Practice and also under the Sarbanes-Oxley Act of 2002 against the Chinese accounting firms, including our independent registered public accounting firm. A first instance trial of the proceedings in July 2013 in the SEC’s internal administrative court resulted in an adverse judgment against the firms. The administrative law judge proposed penalties on the firms including a temporary suspension of their right to practice before the SEC, although that proposed penalty did not take effect pending review by the Commissioners of the SEC. On February 6, 2015, before a review by the Commissioner had taken place, the firms reached a settlement with the SEC. Under the settlement, the SEC accepted that future requests by the SEC for the production of documents will normally be made to the CSRC. The firms were to receive matching Section 106 requests, and were required to abide by a detailed set of procedures with respect to such requests, which in substance require them to facilitate production via the CSRC. If they failed to meet specified criteria, the SEC retained authority to impose a variety of additional remedial measures on the firms depending on the nature of the failure.

Under the terms of the settlement, the underlying proceeding against the four China-based accounting firms was deemed dismissed with prejudice four years after entry of the settlement. The four-year mark occurred on February 6, 2019. While we cannot predict if the SEC will further challenge the four China-based accounting firms’ compliance with U.S. law in connection with U.S. regulatory requests for audit work papers or if the results of such a challenge would result in the SEC imposing penalties such as suspensions. If additional remedial measures are imposed on the “big four” PRC-based accounting firms, including our independent registered public accounting firm, we could be unable to timely file future financial statements in compliance with the requirements of the Exchange Act.

In the event the “big four” PRC-based accounting firms become subject to additional legal challenges by the SEC or PCAOB, depending upon the final outcome, listed companies in the United States with major PRC

 

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operations may find it difficult or impossible to retain auditors in respect of their operations in China, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act, including possible delisting. Moreover, any negative news about any such future proceedings against these audit firms may cause investor uncertainty regarding China-based, U.S.-listed companies and the market price of our common stock may be adversely affected.

If our independent registered public accounting firm was denied, even temporarily, the ability to practice before the SEC and we were unable to timely find another registered public accounting firm to audit and issue an opinion on our financial statements, our financial statements could be determined not to be in compliance with the requirements of the Exchange Act. Such a determination could ultimately lead to the delisting of the ADSs from the [New York Stock Exchange] [Nasdaq Global Market] or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of the ADSs in the United States.

We are an emerging growth company within the meaning of the Securities Act and may take advantage of certain reduced reporting requirements.

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from requirements applicable to other public companies that are not emerging growth companies including, most significantly, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 for so long as we are an emerging growth company until the fifth anniversary from the date of our initial listing.

The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. We intend to avail ourselves of the extended transition period.

We are a foreign private issuer within the meaning of the rules under the Exchange Act, and as such we are exempt from certain provisions applicable to United States domestic public companies.

Because we are a foreign private issuer under the Exchange Act, we are exempt from certain provisions of the securities laws and regulations in the United States that apply to U.S. domestic issuers, including:

 

   

the rules under the Exchange Act requiring the filing of quarterly reports on Form 10-Q or current reports on Form 8-K with the SEC;

 

   

the sections of the Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered under the Exchange Act;

 

   

the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability for insiders who profit from trades made in a short period of time; and

 

   

the selective disclosure rules by issuers of material nonpublic information under Regulation FD.

We will be required to file an annual report on Form 20-F within four months of the end of each fiscal year. In addition, we intend to publish our results on a quarterly basis through press releases, distributed pursuant to the rules and regulations of the [New York Stock Exchange] [Nasdaq Global Market]. Press releases relating to financial results and material events will also be furnished to the SEC on Form 6-K. However, the information we are required to file with or furnish to the SEC will be less extensive and less timely than that required to be filed with the SEC by U.S. domestic issuers. As a result, you may not be afforded the same protections or information that would be made available to you were you investing in a U.S. domestic issuer.

The voting rights of holders of ADSs are limited by the terms of the deposit agreement, and you may not be able to exercise your right to vote your ordinary shares.

As a holder of our ADSs, you will only be able to exercise the voting rights with respect to the underlying ordinary shares represented by your ADSs in accordance with the provisions of the deposit agreement. Under the deposit agreement, you must vote by giving voting instructions to the depositary. Upon receipt of your voting instructions, the depositary will vote the underlying ordinary shares represented by your ADSs in accordance with these instructions. You will not be able to directly exercise your right to vote with respect to the underlying ordinary shares represented by your ADSs unless you withdraw such ordinary shares. Under our amended and

 

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restated memorandum and articles of association that will become effective immediately prior to the completion of this offering, the minimum notice period required for convening a general meeting is ten days. When a general meeting is convened, you may not receive sufficient advance notice to withdraw the underlying ordinary shares represented by your ADSs to allow you to vote with respect to any specific matter. If we ask for your instructions, the depositary will notify you of the upcoming vote and will arrange to deliver our voting materials to you. We cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote the underlying ordinary shares represented by your ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for their manner of carrying out your voting instructions. This means that you may not be able to exercise your right to vote and you may have no legal remedy if the underlying ordinary shares represented by your ADSs are not voted as you requested.

The depositary for our ADSs will give us a discretionary proxy to vote our ordinary shares underlying your ADSs if you do not vote at shareholders’ meetings, except in limited circumstances, which could adversely affect your interests.

Under the deposit agreement for the ADSs, if you do not vote, the depositary will give us a discretionary proxy to vote our ordinary shares underlying your ADSs at shareholders’ meetings unless:

 

   

we have failed to timely provide the depositary with notice of the meeting and related voting materials;

 

   

we have instructed the depositary that we do not wish a discretionary proxy to be given;

 

   

we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting;

 

   

a matter to be voted on at the meeting would have a material adverse impact on shareholders; or

 

   

the voting at the meeting is to be made on a show of hands.

The effect of this discretionary proxy is that if you do not vote at shareholders’ meetings, you cannot prevent the underlying ordinary shares represented by your ADSs from being voted, except under the circumstances described above. This may make it more difficult for shareholders to influence the management of our company. Holders of our ordinary shares are not subject to this discretionary proxy.

You, as holders of ADSs, may have fewer rights than holders of our ordinary shares and must act through the depositary to exercise those rights.

Holders of ADSs do not have the same rights as our registered shareholders. As a holder of our ADSs, you will not have any direct right to attend general meetings of our shareholders or to cast any votes at such meetings. You will only be able to exercise the voting rights that are carried by the underlying ordinary shares represented by your ADSs indirectly in accordance with the provisions of the deposit agreement. Under the deposit agreement, you may vote only by giving voting instructions to the depositary. Upon receipt of your voting instructions, the depositary will try, as far as is practicable, to vote the underlying ordinary shares represented by your ADSs in accordance with your instructions. If we ask for your instructions, then upon receipt of your voting instructions, the depositary will try to vote the underlying ordinary shares represented by your ADSs in accordance with these instructions. If we do not instruct the depositary to ask for your instructions, the depositary may still vote in accordance with instructions you give, but it is not required to do so. You will not be able to directly exercise your right to vote with respect to the underlying ordinary shares represented by your ADSs unless you withdraw such ordinary shares and become the registered holder of such shares prior to the record date for the general meeting.

Under our post-offering articles of association that will become effective prior to the completion of this offering, the minimum notice period required to convene a general meeting is              days. When a general meeting is convened, you may not receive sufficient advance notice of the meeting to withdraw the underlying ordinary shares represented by your ADSs and become the registered holder of such shares to allow you to attend the general meeting and to vote directly with respect to any specific matter or resolution to be considered and voted upon at the general meeting. In addition, under our post-offering articles of association that will become effective prior to the completion of this offering, for the purposes of determining those shareholders who are entitled to attend and vote at any general meeting, our directors may close our register of members and/or fix in

 

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advance a record date for such meeting, and such closure of our register of members or the setting of such a record date may prevent you from withdrawing the underlying ordinary shares represented by your ADSs and becoming the registered holder of such shares prior to the record date, so that you would not be able to attend the general meeting or to vote directly. If we ask for your instructions, the depositary will notify you of the upcoming vote and will arrange to deliver our voting materials to you. We have agreed to give the depositary at least              days’ prior notice of shareholder meetings. Nevertheless, we cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote the underlying ordinary shares represented by your ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for their manner of carrying out your voting instructions. This means that you may not be able to exercise your right to direct how the shares underlying your ADSs are voted, and you may have no legal remedy if the underlying ordinary shares represented by your ADSs are not voted as you requested.

Rights to pursue claims against the depositary as a holder of ADSs are limited by the terms of the deposit agreement and the deposit agreement may be amended or terminated without consent of the holders of ADSs.

Under the deposit agreement, any action or proceeding against or involving the depositary, arising out of or based upon the deposit agreement or the transactions contemplated thereby or by virtue of owning the ADSs may only be instituted in a state or federal court in New York, New York, and holders of the ADSs will have irrevocably waived any objection which they may have to the laying of venue of any such proceeding, and irrevocably submitted to the exclusive jurisdiction of such courts in any such action or proceeding. Notwithstanding the foregoing, the depositary may, in its sole discretion, elect to institute any action, controversy, claim or dispute directly or indirectly based on, arising out of or relating to the deposit agreement or the ADRs or the transactions contemplated thereby in any competent court in the Cayman Islands, Hong Kong, China and/or the United States, or, by having such disputes referred to and finally resolved by an arbitration either in New York, New York or in Hong Kong, subject to certain exceptions solely related to the aspects of such claims that are related to U.S. federal securities law, in which case the resolution of such aspects may, at the option of such registered holder of the ADSs, remain in state or federal court in New York, New York. Also, we may amend or terminate the deposit agreement without consent of the holders of ADSs. If holders of ADSs continue to hold their ADSs after an amendment to the deposit agreement, they agree to be bound by the deposit agreement as amended. See “Description of American Depositary Shares” for more information.

You may experience dilution of your holdings due to the inability to participate in rights offerings.

We may, from time to time, distribute rights to our shareholders, including rights to acquire securities. Under the deposit agreement, the depositary will not distribute rights to holders of ADSs unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the Securities Act with respect to all holders of ADSs, or are registered under the provisions of the Securities Act. The depositary may, but is not required to, attempt to sell these undistributed rights to third parties, and may allow the rights to lapse. We may be unable to establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration statement with respect to these rights or underlying securities or to endeavor to have a registration statement declared effective. Accordingly, holders of ADSs may be unable to participate in our rights offerings and may experience dilution of their holdings as a result.

There are limits on our obligations and liability, as well as limits to the obligations and liability of the depositary, to ADR holders and holders of ADSs.

The deposit agreement expressly limits our obligations and liability, as well as the obligations and liability of the depositary, to ADR holders and holders of ADSs. For example, neither we nor the depositary will be labile if we or the depositary exercises or fails to exercise discretion under the deposit agreement or the ADRs including, without limitation, any failure to determine that any distribution or action may be lawful or reasonably practicable. In addition, neither the depositary nor its agents have any obligation to appear in, prosecute or defend any action, suit or other proceedings in respect of any deposited securities or the ADRs. See “Description of American Depositary Shares” for more information.

 

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You may be subject to limitations on the transfer of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems it expedient in connection with the performance of its duties. The depositary may close its books from time to time for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, and on weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of our ADSs generally when our share register or the books of the depositary are closed, or at any time if we or the depositary thinks it is advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

We have identified two material weaknesses in our internal controls as of December 31, 2018, and if we fail to maintain an effective system of internal controls, our ability to accurately and timely report our financial results or prevent fraud may be adversely affected, and investor confidence and the market price of our ADSs may be adversely affected.

Prior to this offering, we have been a private company with limited accounting personnel and other resources with which to address our internal controls. In the course of preparing our consolidated financial statements, we and our independent registered public accounting firm identified two material weaknesses in our internal controls. A material weakness is a deficiency, or combination of deficiencies, in internal controls, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses identified are related to (i) our lack of competent financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting and compliance requirements, and (ii) our lack of documented financial closing policies and procedures, specifically those related to the period end expenses cut-off and accruals.

We have begun and will continue to implement measures to address the material weaknesses. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Internal Control over Financial Reporting.” However, the implementation of those measures may not fully remediate the material weaknesses in a timely manner. In the future, we may determine that we have additional material weaknesses or other deficiencies, or our independent registered public accounting firm may disagree with our management’s assessment of the effectiveness of our internal controls. Our failure to correct these material weaknesses or our failure to discover and address any other material weaknesses could result in inaccuracies in our financial statements and impair our ability to comply with the applicable financial reporting requirements and related regulatory filings on a timely basis. Moreover, ineffective internal control over financial reporting could significantly hinder our ability to prevent fraud.

We will incur increased costs as a result of being a public company, particularly after we cease to qualify as an “emerging growth company.”

Upon the completion of this offering, we will become a public company and expect to incur significant legal, accounting and other expenses that we did not incur as a subsidiary of a listed company. The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and the [New York Stock Exchange] [Nasdaq Global Market], impose various requirements on the corporate governance practices of public companies.

We expect these rules and regulations to increase our legal and financial compliance costs and to make some corporate activities more time-consuming and costly. After we are no longer an “emerging growth company,” we expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and the other rules and regulations of the SEC. For example, as a result of becoming a public company, we will need to increase the number of independent directors and adopt policies regarding internal controls and disclosure controls and procedures. We also expect that operating as a public company will make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits

 

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and coverage or to incur substantially higher costs to obtain the same or similar coverage. In addition, we will incur additional costs associated with our public company reporting requirements. It may also be more difficult for us to find qualified persons to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these rules and regulations, and we cannot predict or estimate with any degree of certainty the amount of additional costs we may incur or the timing of such costs.

As an exempted company incorporated in the Cayman Islands, we are permitted to adopt certain home country practices in relation to corporate governance matters that differ significantly from the requirements of the [NYSE Listed Company Manual and Nasdaq Stock Market Rules]; these practices may afford fewer protection to shareholders than they would enjoy if we complied fully with the [NYSE Listed Company Manual or Nasdaq Stock Market Rules].

As a Cayman Islands exempted company listed on the [New York Stock Exchange] [Nasdaq Global Market], we are subject to the [NYSE corporate governance listing standards] [Nasdaq Stock Market Rules]. However, [New York Stock Exchange] [Nasdaq Global Market] rules permit a foreign private issuer like us to follow the corporate governance practices of its home country. Certain corporate governance practices in the Cayman Islands, which is our home country, may differ significantly from the [NYSE Listed Company Manual and the Nasdaq Stock Market Rules]. For instance, we are not required to: (i) have a majority of the board be independent; (ii) have a compensation committee or a nominating and corporate governance committee consisting entirely of independent directors; or (iii) have regularly scheduled executive sessions with only independent directors each year. We intend to rely on some of these exemptions. As a result, you may not be provided with the benefits of certain corporate governance requirements of the [New York Stock Exchange or the NASDAQ Global Market]. We may also follow the home country practice for certain corporate governance practices after the closing of this offering which may differ from the requirements of the [New York Stock Exchange or Nasdaq Global Market]. If we choose to follow the home country practice, our shareholders may be afforded fewer protection than they would otherwise enjoy under the [NYSE Listed Company Manual] [Nasdaq Stock Market Rules] applicable to U.S. domestic issuers.

We may become a passive foreign investment company, or PFIC, which could result in adverse U.S. tax consequences to U.S. investors.

Based on the past and projected composition of our income and assets, and the valuation of our assets, including goodwill (which we have determined based on the expected price of our ADSs in this offering), we do not expect to be a passive foreign investment company, or a PFIC, in the current taxable year or in the foreseeable future, although there can be no assurance in this regard.

In general, we will be a PFIC for any taxable year in which:

 

   

at least 75% of our gross income is passive income, or

 

   

at least 50% of the value (determined based on a quarterly average) of our assets is attributable to assets that produce or are held for the production of passive income.

The determination of whether we are a PFIC is made annually. Accordingly, it is possible that we may become a PFIC in the current or any future taxable year due to changes in our asset or income composition. The composition of our assets and income may be affected by how, and how quickly, we use our liquid assets and the cash raised in this offering. Because we have valued our goodwill based on the expected market value of our ADSs, a decrease in the price of our ADSs may also result in our becoming a PFIC.

If we are a PFIC for any taxable year during which you hold our ADSs or ordinary shares, our PFIC status could result in adverse United States federal income tax consequences to you if you are a United States Holder, as defined under “Taxation—Certain United States Federal Income Tax Considerations.” For example, if we are or become a PFIC, you may become subject to increased tax liabilities under United States federal income tax laws and regulations, and will become subject to burdensome reporting requirements. See “Taxation—Certain United States Federal Income Tax Considerations—Passive Foreign Investment Company.” There can be no assurance that we will not be a PFIC for the current or any future taxable year.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve risks and uncertainties, including statements based on our current expectations, assumptions, estimates and projections about us and our industry. The forward-looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Industry Overview,” “Business” and “Regulation” in this prospectus. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. In some cases, these forward-looking statements can be identified by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “potential,” “continue,” “is/are likely to” or other similar expressions. The forward-looking statements included in this prospectus relate to, among others:

 

   

our goals and growth strategies;

 

   

our future business development, financial condition and results of operations;

 

   

trends in the Bitcoin and AI industries in the PRC and globally;

 

   

competition in our industry;

 

   

fluctuations in general economic and business conditions in China and other regions where we operate;

 

   

the regulatory environment in which we and companies integral to our ecosystem operate;

 

   

our proposed use of proceeds from this offering; and

 

   

assumptions underlying or related to any of the foregoing.

This prospectus also contains market data relating to the IC industry in China, including our market position and the size and growth rates of the markets in which we participate, that are based on industry publications and reports. Statistical data in these publications and reports also include projections based on a number of assumptions. The IC industry in China may not grow at the rates projected by market data, or at all. The failure of these markets to grow at the projected rates may have a material adverse effect on our business and the market price of our ADSs. If any one or more of the assumptions underlying the market data turns out to be incorrect, actual results may differ from the projections based on these assumptions. In addition, projections, assumptions and estimates of our future performance and the future performance of the industry in which we operate is necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors” and elsewhere in this prospectus. You should not place undue reliance on these forward-looking statements.

The forward-looking statements made in this prospectus relate only to events or information as of the date on which the statements are made in this prospectus. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this prospectus and the documents that we have referred to in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately US$            million, or approximately US$            million if the underwriters exercise their option to purchase additional ADSs in full, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us and based upon an assumed initial offering price of US$            per ADS (the mid-point of the estimated range of initial public offering price shown on the front cover page of this prospectus). A US$1.00 increase (decrease) in the assumed initial public offering price of US$ per            ADS would increase (decrease) the net proceeds to us from this offering by US$            million, after deducting the estimated underwriting discounts and commissions and estimated aggregate offering expenses payable by us and assuming no change to the number of ADSs offered by us as set forth on the front cover page of this prospectus.

We plan to use the net proceeds we will receive from this offering as follows:

 

   

approximately US$            million for             ;

 

   

approximately US$            million for             ;

 

   

approximately US$            million for             ; and

 

   

the balance of the net proceeds for general corporate purposes.

The foregoing represents our intentions as of the date of this prospectus with respect to the use and allocation of the net proceeds of this offering based upon our present plans and business conditions, but our management will have significant flexibility and discretion in applying the net proceeds of the offering.

The occurrence of unforeseen events or changed business conditions may result in application of the proceeds of this offering in a manner other than as described in this prospectus.

To the extent that the net proceeds we receive from this offering are not immediately applied for the above purposes, we intend to invest our net proceeds in short-term, interest bearing, debt instruments or bank deposits.

In utilizing the proceeds of this offering, we, as an offshore holding company, are permitted under PRC laws and regulations to provide funding to our PRC subsidiaries only through loans or capital contributions. Subject to satisfaction of applicable government registration and approval requirements, we may extend inter-company loans to our PRC subsidiaries or make additional capital contributions to our PRC subsidiaries to fund their capital expenditures or working capital. We cannot assure you that we will be able to obtain these government registrations or approvals on a timely basis, if at all.

 

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DIVIDEND POLICY

Since our inception, we have not declared or paid any dividends on our ordinary shares. We do not have any present plan to pay any dividends on our ordinary shares or ADSs in the foreseeable future. We intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

Our board of directors has complete discretion on whether to distribute dividends, subject to certain requirements of Cayman Islands law, namely that our company may only pay dividends out of profits or share premium, and provided always that in no circumstances may a dividend be paid if this would result in our company being unable to pay its debts as they fall due in the ordinary course of business. In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our board of directors. Even if our board of directors decides to pay dividends on our ordinary shares, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors our board of directors may deem relevant.

Any future determination to pay dividends will be made at the discretion of our board of directors and may be based on a number of factors, including our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant. If we pay any dividends, we will pay our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.” Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.

We are a holding company incorporated in the Cayman Islands. In order for us to distribute any dividends to our shareholders and ADS holders, we rely on dividends distributed by our subsidiaries in the PRC and other jurisdictions. Distributions from our subsidiaries to us may be subject to various local taxes, such as withholding tax. In addition, regulations in the PRC currently permit the payment of dividends of a PRC company only out of accumulated distributable after-tax profits as determined in accordance with its articles of association and the accounting standards and regulations in China. See “Risk Factors—Risks Relating to Doing Business in the PRC—Our corporate structure may restrict our ability to receive dividends from, and transfer funds to, our PRC operating subsidiaries, which could restrict our ability to act in response to changing market conditions in a timely manner.”

 

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CAPITALIZATION

The following table sets forth our capitalization as of December 31, 2018 presented on:

 

   

an actual basis; and

 

   

a pro forma basis as adjusted to reflect the issuance and sale of the ordinary shares in the form of ADSs by us in this offering at an assumed initial public offering price of US$            per ADS, the mid-point of the estimated range of the initial public offering price shown on the front cover page of this prospectus, after deducting underwriting discounts and commissions and estimated offering expenses payable by us and assuming no exercise of the underwriters’ over-allotment option.

The pro forma as adjusted information below is illustrative only and our capitalization following the completion of this offering is subject to adjustment based on the initial public offering price of our ADSs and other terms of this offering determined at pricing. You should read this table in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

     As of December 31, 2018  
     Actual     Pro Forma
as Adjusted
 
     RMB     US$     RMB      US$  
     (in millions)  

Shareholders’ equity:

         

Ordinary shares

     1             

Subscription receivable from shareholders

     (1           

Treasury stocks

                 

Additional paid-in capital

     154,970       22,539       

Statutory reserves

     97,307       14,153       

Accumulated other comprehensive loss

     (65,230     (9,487     

Retained earnings

     53,931       7,844       
  

 

 

   

 

 

   

 

 

    

 

 

 

Total shareholders’ equity

     240,978       35,049       
  

 

 

   

 

 

   

 

 

    

 

 

 

Total capitalization

     240,978       35,049       

 

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DILUTION

If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per ordinary share is substantially in excess of the book value per ordinary share attributable to the existing shareholders for our presently outstanding ordinary shares.

Our net tangible book value as of December 31, 2018 was approximately RMB            million (US$            million), or RMB            (US$            ) per ordinary share as of that date, and US$            per ADS. Net tangible book value represents the amount of our total consolidated assets, less the amount of our intangible assets, goodwill and total consolidated liabilities. Dilution is determined by subtracting net tangible book value per ordinary share, after giving effect to the issuance and sale by us of                ordinary shares in the form of ADSs in this offering at an assumed initial public offering price of US$            per ADS (the mid-point of the estimated initial public offering price range shown on the front cover page of this prospectus) after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us.

Without taking into account any other changes in net tangible book value after December 31, 2018, other than to give effect to the issuance and sale by us of            ordinary shares in the form of ADSs in this offering at an assumed initial public offering price of US$            per ADS (the mid-point of the estimated initial public offering price range shown on the front cover page of this prospectus) after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of December 31, 2018 would have been US$            million, or US$            per outstanding ordinary share and US$            per ADS. This represents an immediate increase in net tangible book value of US$            per ordinary share and US$            per ADS to the existing shareholders and an immediate dilution in net tangible book value of US$            per ordinary share and US$            per ADS to investors purchasing ADSs in this offering.

The following table illustrates such dilution:

 

     Per ordinary share      Per ADS  

Actual net tangible book value per share as of December 31, 2018

   US$                    US$                

Pro forma as adjusted net tangible book value per share after giving effect to this offering

   US$                    US$                

Assumed initial public offering price

   US$                    US$                

Dilution in net tangible book value per share to new investors in the offering

   US$                    US$                

The amount of dilution in net tangible book value to new investors in this offering set forth above is determined after giving effect to this offering from the public offering price per ordinary share.

A US$1.00 increase (decrease) in the assumed public offering price of US$            per ADS (the mid-point of the estimated initial public offering price range shown on the front cover page of this prospectus) would increase (decrease) our pro forma net tangible book value after giving effect to the offering by US$            million, the pro forma net tangible book value per ordinary share and per ADS after giving effect to this offering by US$            per ordinary share and US$            per ADS and the dilution in pro forma net tangible book value per ordinary share and per ADS to new investors in this offering by US$            per ordinary share and US$            per ADS, assuming no change to the number of ADS offered by us as set forth on the front cover page of this prospectus, and after deducting underwriting discounts and commissions and other offering expenses.

The following table summarizes, on a pro forma basis as of December 31, 2018, the differences between existing shareholders and new investors with respect to the number of ordinary shares (in the form of ADSs

 

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or shares) purchased from us, the total consideration paid and the average price per ordinary share and per ADS paid before deducting the underwriting discounts and commissions and estimated offering expenses. The total number of ordinary shares does not include ordinary shares underlying the ADSs issuable upon the exercise of the option to purchase additional ADSs granted to the underwriters.

 

     Ordinary Shares
Purchased
    Total Consideration     Average
Price per
Ordinary
Share
     Average
Price per
ADS
 
     Number      Percent     Amount      Percent  
     (in millions of US$, except number of shares and percentages)  

Existing shareholders

                         US$          US$        US$    

New investors

                         US$          US$        US$    

Total

                         100   US$          100   US$        US$    

If the underwriters were to fully exercise the over-allotment option to purchase              additional ADSs from us, the percentage of our ordinary shares held by existing shareholders would be         %, and the percentage of our ordinary shares held by new investors would be         %.

The pro forma information discussed above is illustrative only. Our net tangible book value following the completion of this offering is subject to adjustment based on the actual initial public offering price of our ADSs and other terms of this offering determined at pricing.

 

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ENFORCEMENT OF CIVIL LIABILITIES

We are incorporated under the laws of the Cayman Islands as an exempted company with limited liability. We are incorporated in the Cayman Islands because of certain benefits associated with being a Cayman Islands company, such as political and economic stability, an effective judicial system, a favorable tax system, the absence of foreign exchange control or currency restrictions and the availability of professional and support services. However, the Cayman Islands has a less developed body of securities laws as compared to the United States and provides protections for investors to a lesser extent. In addition, Cayman Islands companies may not have standing to sue before the federal courts of the United States.

Most of our operations are conducted in China, and most of our assets are located in China. In addition, most of our directors and officers are residents of jurisdictions other than the United States and all or a substantial portion of their assets are located outside the United States. As a result, it may be difficult for investors to effect service of process within the United States upon us or these persons, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States. It may also be difficult for you to enforce in United States courts judgments obtained in United States courts based on the civil liability provisions of the United States federal securities laws against us and our officers and directors.

We have appointed              as our agent to receive service of process with respect to any action brought against us in the U.S. District Court for the Southern District of New York under the federal securities laws of the U.S. or of any state in the U.S. or any action brought against us in the Supreme Court of the State of New York in the County of New York under the securities laws of the State of New York.

Maples and Calder (Hong Kong) LLP, our counsel as to Cayman Islands law, has advised us that there is uncertainty as to whether the courts of the Cayman Islands would (1) recognize or enforce judgments of U.S. courts obtained against us or our directors or officers that are predicated upon the civil liability provisions of the federal securities laws of the United States or the securities laws of any state in the United States, or (2) entertain original actions brought in the Cayman Islands against us or our directors or officers that are predicated upon the federal securities laws of the United States or the securities laws of any state in the United States.

In addition, Maples and Calder (Hong Kong) LLP has advised us that although there is no statutory enforcement in the Cayman Islands of judgments obtained in the federal or state courts of the United States (and the Cayman Islands are not a party to any treaties for the reciprocal enforcement or recognition of such judgments), a judgment obtained in such jurisdiction will be recognized and enforced in the courts of the Cayman Islands at common law, without any re-examination of the merits of the underlying dispute, by an action commenced on the foreign judgment debt in the Grand Court of the Cayman Islands, provided such judgment (i) is given by a foreign court of competent jurisdiction, (ii) imposes on the judgment debtor a liability to pay a liquidated sum for which the judgment has been given, (iii) is final and conclusive, (iv) is not in respect of taxes, a fine or a penalty, and (v) was not obtained in a manner and is not of a kind the enforcement of which is contrary to natural justice or the public policy of the Cayman Islands.

Our PRC Counsel has advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedure Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedure Law based either on treaties between China and the country where the judgment is made or on principles of reciprocity between jurisdictions. Our PRC Counsel has advised us further that under PRC law, courts in the PRC will not recognize or enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC law or national sovereignty, security or social public interest. As there existed no treaty or other form of reciprocity between China and the United States governing the recognition and enforcement of judgments as of the date of this prospectus, including those predicated upon the liability provisions of the United States federal securities laws,

 

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there is uncertainty whether and on what basis a PRC court would enforce judgments rendered by United States courts. In addition, because there is no treaty or other form of reciprocity between the Cayman Islands and China governing the recognition and enforcement of judgments as of the date of this prospectus, there is further uncertainty as to whether and on what basis a PRC court would enforce judgments rendered by a Cayman Islands court.

 

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OUR HISTORY AND CORPORATE STRUCTURE

Our History

We are a Cayman Islands holding company and conduct our operations in China through our PRC subsidiaries. We first started our business developing Bitcoin-mining machines incorporating ASIC technology in 2013 through Beijing Canaan Creative Information Technology Co., Ltd. which was subsequently renamed Hangzhou Canaan Creative Information Technology Co., Limited, or Hangzhou Canaan, in September 2015. Empowered by the academic training and technical expertise of our co-founders, we have focused on the design of high performance, repeated computing ICs since our inception. As we grew further, Hangzhou Canaan went through a series of capital injections and became a holding company for our PRC operating subsidiaries.

With the growth of our business and in order to facilitate international capital investment in us, we underwent an offshore reorganization in the first quarter of 2018. In February 2018, Canaan Cayman Holdings Ltd. was incorporated under the laws of the Cayman Islands as an exempted company with limited liability. It was later renamed Canaan Inc. in April 2018. In order to mirror the shareholding structure of the then shareholders in Hangzhou Canaan, we issued and allotted our ordinary shares at par value to investment holding companies held by the then shareholders of Hangzhou Canaan in March 2018. Further, an intermediate holding company, Canaan Creative (HK) Holdings Limited, or Canaan HK, our wholly-owned subsidiary, was also established in Hong Kong in February 2018. In March 2018, Canaan HK acquired a 100% equity interest in Hangzhou Canaan and Canaan Inc. became our ultimate holding company. In June 2018, we completed a one-for-2,000 shares subdivision, and the number of total issued and outstanding ordinary shares became 2,000,000,000. Accordingly, our authorized share capital of US$50,000 is divided into 1,000,000,000,000 ordinary shares of US$0.00000005 each.

In August 2017 and May 2018, we sought listing on China’s National Equities Exchange Quotations Co., Ltd. and The Stock Exchange of Hong Kong Limited, respectively, both of which were subsequently suspended.

Our principal executive offices are located at 30/F, Dicara Silver Tower, 29 Jiefang East Road, Jianggan District, Hangzhou, People’s Republic of China. Our telephone number at this address is +86-571-8999-5063. Our registered office in the Cayman Islands is located at the offices of Sertus Chambers, Suite #5-204, 23 Lime Tree Bay Avenue, P.O. Box 2547, Grand Cayman, KY1-1104, Cayman Islands. Investors should submit any inquiries to the address and telephone number of our principal executive offices set forth above.

 

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Our Corporate Structure

The following diagram illustrates our corporate structure as of the date of this prospectus. It omits certain entities that are immaterial to our results of operations, business and financial condition. Unless otherwise indicated, equity interests depicted in this diagram are 100%-owned.

 

 

LOGO

 

 

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SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA

The following selected consolidated statements of operations data for the years ended December 31, 2017 and 2018 and the selected consolidated balance sheet data as of December 31, 2018 have been derived from our audited consolidated financial statements included elsewhere in this prospectus.

Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP.

Our historical results are not necessarily indicative of results to be expected for any future period. The following selected consolidated financial data for the periods and as of the dates indicated are qualified by reference to and should be read in conjunction with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” both of which are included elsewhere in this prospectus.

Consolidated Statements of Comprehensive Income:

 

     Year ended December 31,  
     2017     2018  
     RMB     RMB     US$  
     (in millions)  

Net revenues:

      

Products revenue

     1,303.1       2,698.6       392.5  

Service revenue

     4.7       6.0       0.9  

Other revenues

     0.3       0.7       0.1  
  

 

 

   

 

 

   

 

 

 

Total net revenues

     1,308.1       2,705.3       393.5  

Cost of revenues

     (703.7     (2,197.2     (319.6
  

 

 

   

 

 

   

 

 

 

Gross profit

     604.4       508.1       73.9  
  

 

 

   

 

 

   

 

 

 

Operating expenses:

      

Research and development expenses

     (99.8     (189.7     (27.6

Sales and marketing expenses

     (20.7     (38.7     (5.6

General and administrative expenses

     (125.3     (146.7     (21.3
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     (245.8     (375.1     (54.6
  

 

 

   

 

 

   

 

 

 

Income from operations:

      

Interest income

     0.2       4.2       0.6  

Investment income

     5.6       3.2       0.5  

Interest expense and guarantee fee

     —         (53.1     (7.7

Foreign exchange losses, net

     (1.2     (1.2     (0.2

Value added tax refunds

     38.8       110.2       16.0  

Other (loss) income, net

     (1.1     3.8       0.6  
  

 

 

   

 

 

   

 

 

 

Income before income tax expenses

     401.0       200.2       29.1  

Income tax expense

     (25.2     (77.8     (11.3
  

 

 

   

 

 

   

 

 

 

Net income

     375.8       122.4       17.8  

Foreign currency translation adjustment, net of nil tax

     —         (65.2     (9.5
  

 

 

   

 

 

   

 

 

 

Total comprehensive income

     375.8       57.2       8.3  
  

 

 

   

 

 

   

 

 

 

 

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Consolidated Statements of Financial Positions:

 

     As of December 31,  
     2017      2018  
   RMB      RMB      US$  
     (in millions)  

Cash and cash equivalents

     176.5        258.9        37.7  

Restricted cash

     —          286.3        41.6  

Accounts receivable, net

     1.3        23.7        3.4  

Inventories

     259.8        585.7        85.2  

Prepayments and other current assets

     636.4        186.7        27.2  

Income tax recoverable

     —          27.1        3.9  

Property, equipment and software

     18.4        27.9        4.1  

Total assets

     1,203.2        1,402.7        204.0  

Short-term loan

     —          1,049.0        152.6  

Contract liabilities

     202.5        6.9        1.0  

Accrued liabilities and other current liabilities

     69.2        58.0        8.4  

Total liabilities

     346.0        1,161.7        169.0  

Total shareholders’ equity

     857.2        241.0        35.0  

Total liabilities and shareholders’ equity

     1,203.2        1,402.7        204.0  

Consolidated Statements of Cash Flow:

 

     Year ended December 31,  
     2017     2018  
     RMB     RMB     US$  
     (in millions)  

Net cash provided by (used in) operating activities

     91.2       (12.7     (1.9

Net cash (used in) provided by investing activities

     (86.8     84.0       12.2  

Net cash provided by financing activities

     150.0       295.2       42.9  

Net increase in cash and cash equivalents, restricted cash

     154.4       366.4       53.3  
  

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents, restricted cash

     (1.3     2.3       0.3  

Cash and cash equivalents, restricted cash at the beginning of year

     23.4       176.5       25.7  
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, restricted cash at the end of year

     176.5       545.2       79.3  
  

 

 

   

 

 

   

 

 

 

Non­GAAP Financial Measures:

In evaluating our business, we consider and use adjusted net income as a supplemental measures to review and assess our operating performance. The presentation of this non-GAAP financial measure is not intended to be considered in isolation or as a substitute for financial information prepared and presented in accordance with U.S. GAAP. We define adjusted net income as net income excluding share­based compensation expense.

We believe that adjusted net income helps to identify underlying trends in our business that could otherwise be distorted by the effect of the expenses that we exclude in adjusted net income. We believe that adjusted net income provides useful information about our operating results, enhances the overall understanding of our past performance and future prospects and allows for greater visibility with respect to key metrics used by our management in its financial and operational decision-making.

 

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The non-GAAP financial measure “adjusted net income” is not defined under U.S. GAAP, is not presented in accordance with U.S. GAAP and has limitations as an analytical tool. One of the key limitations of using adjusted net income is that it does not reflect all of the items of income and expense that affect our operations. Share-based compensation has been and may continue to be incurred in our business and is not reflected in the presentation of adjusted net income. Further, the non-GAAP financial measure “adjusted net income” may differ from the non-GAAP information used by other companies, including peer companies, and therefore their comparability may be limited.

We compensate for these limitations by reconciling the non-GAAP financial measure to the nearest U.S. GAAP performance measure, all of which should be considered when evaluating our performance. We encourage you to review our financial information in its entirety and not to rely on a single financial measure.

The table below sets forth a reconciliation of our net income to adjusted net income for the years indicated:

 

     Year ended December 31,  
     2017      2018  
     RMB      RMB      US$  
     (in millions)  

Net income

     375.8        122.4        17.8  

Add:

        

Share-based compensation expenses

     95.5        18.6        2.7  
  

 

 

    

 

 

    

 

 

 

Adjusted net income

     471.3        141.0        20.5  
  

 

 

    

 

 

    

 

 

 

Selected Operating Data:

The following table sets forth the sales volume and average selling prices generated by our different Bitcoin mining machines:

 

     Year ended December 31,  
     2017      2018  
     Volume      ASP      Volume      ASP  
     set      RMB      set      RMB  

A7 series(1)

     294,523        4,402        20,576        3,710  

A8 series(2)

     —          —          503,237        4,842  

A9 series(3)

     —          —          35,324        3,665  
  

 

 

       

 

 

    

Total

     294,523        4,402        559,137        4,726  
  

 

 

       

 

 

    

 

Notes:

(1)

Mainly includes our A721, A741 and A761 Bitcoin mining machines.

(2)

Mainly includes our A821, A841 and A851 Bitcoin mining machines.

(3)

Mainly includes our A921 Bitcoin mining machine.

 

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The following table sets forth the total computing power sold and average selling prices of our Bitcoin mining machines expressed in terms of computing power:

 

     Year ended December 31,  
     2017      2018  
     Total
Computing
Power Sold
     ASP per
Thash
     Total
Computing
Power Sold
     ASP per
Thash
 
     Thash/s      RMB      Thash/s      RMB  

A7 series(1)

     2,114,637        613        151,131        505  

A8 series(2)

     —          —          6,305,119        386  

A9 series(3)

     —          —          702,416        184  
  

 

 

       

 

 

    

Total

     2,114,637        613        7,158,666        369  
  

 

 

       

 

 

    

 

Notes:

(1)

Mainly includes our A721, A741 and A761 Bitcoin mining machines.

(2)

Mainly includes our A821, A841 and A851 Bitcoin mining machines.

(3)

Mainly includes our A921 Bitcoin mining machine.

The table below sets forth the sales cost, the per unit costs and the selling cost in terms of computing power of our Bitcoin mining machines:

 

     Year ended December 31,  
     2017      2018  
     Cost(1)      Per unit cost      Cost per
Thash
     Cost(1)      Per unit cost      Cost per
Thash
 
     RMB in
millions
     RMB      RMB      RMB in
millions
     RMB      RMB  

A7 series(2)

     693.3        2,354        328        51.1        2,482        338  

A8 series(3)

     —          —          —          1,243.9        2,472        197  

A9 series(4)

     —          —          —          154.9        4,385        221  
  

 

 

          

 

 

       

Total

     693.3        2,354        328        1,449.9        2,593        203  
  

 

 

          

 

 

       

 

Notes:

(1)

Without taking into consideration the inventory and prepayment write down provision of nil and RMB786.0 million (US$114.3 million) in 2017 and 2018, respectively, as well as a realized inventory and prepayment write down of nil and RMB71.1 million (US$10.3 million).

(2)

Mainly includes our A721, A741 and A761 Bitcoin mining machines.

(3)

Mainly includes our A821, A841 and A851 Bitcoin mining machines.

(4)

Mainly includes our A921 Bitcoin mining machine.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the section entitled “Selected Consolidated Financial and Operating Data” and our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

We provide supercomputing solutions through our proprietary high performance computing ASICs. Our visionary management team has a clear strategy to commercialize supercomputing technology. In January 2013, Mr. Nangeng Zhang, our chairman and chief executive officer, and his team, invented and delivered one of the first Bitcoin mining machines incorporating ASIC technology. Our founders and management team have a clear strategy to commercialize supercomputing technology. We initially dedicated our research and development efforts to ASIC applications for Bitcoin mining, which rapidly built up our know-how of ASIC design. Such experience provides us with a solid foundation in terms of both technology and capital resources, which better prepares us for further research and development involving AI chips. We were the second largest designer and manufacturer of Bitcoin mining machines globally in terms of computing power sold in the six months ended June 30, 2019, according to Frost & Sullivan. During the same period, our Bitcoin mining machines sold accounted for 21.9% of the combined computing power of all the Bitcoin mining machines sold in the global market, according to Frost & Sullivan. We were the first in the industry to deliver commercial edge computing AI chips based on Risc-V architecture and self-developed neural-network accelerator with outstanding performance in September 2018. As we are a fabless IC designer, the ICs that we design are manufactured, packaged and tested by industry-leading suppliers, including TSMC, STATS ChipPac, ASE and SPIL.

We have developed significant advantages in our business and technological capabilities, including the following:

 

   

Our mastery of the whole IC design process;

 

   

Our years of accumulated engineering experience in applying theoretical research to the mass production of new products, producing over 100 million chips in 2017 and 2018;

 

   

Our ability to achieve a fast time-to-market with our products and our successful early monetization of the ASIC design in blockchain applications have provided us with an early advantage with respect to both technology and capital reserve to pursue our strategic initiatives;

 

   

Our breakthroughs in various technological fields to improve ASIC performance, such as low voltage and high power efficiency operations and high computing density, all of which are crucial features for ASICs for blockchain and AI solutions;

 

   

Our ownership of most of the intellectual property we employ, and our accumulation of valuable know-how and multiple generations of proprietary silicon data through our years of ASIC design experience;

 

   

Our ability to provide a holistic AI solution to our customers, including AI chips, algorithm development and optimization, hardware module, end-product and software services; and

 

   

Our close and trusted partnerships with leading global suppliers, which have enabled us to achieve high-quality, high yield rate and stable production, with a 100% success rate for all of our seven tape-outs.

Key Factors Affecting Our Results of Operations

Our results of operations have been, and are expected to continue to be, affected by a number of factors, which primarily include the following:

 

   

fluctuation of the Bitcoin price;

 

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acceptance and development of blockchain technology applications, especially Bitcoin;

 

   

development of AI technology, especially edge computing;

 

   

the performance and cost of our products;

 

   

production capacity;

 

   

investment in research and development; and

 

   

the regulatory environment.

Fluctuation of the Bitcoin Price

The demand and pricing for our Bitcoin mining machines are significantly affected by the Bitcoin price, the most significant factor affecting the expected returns generated by Bitcoin mining activities. In addition, other factors such as power efficiency of mining machines and transaction fees also have an inverse relationship with the expected economic return of Bitcoin mining, while factors such as network computing power, price of mining machines and other operating costs such as electricity costs typically have a converse relationship with the expected return on Bitcoin mining activities.

In general, our financial performance, particularly our revenue and gross margin, would fluctuate in response to the factors below:

 

   

Bitcoin miners’ purchasing behavior are primarily driven by the expectation about future Bitcoin price, as well as the expected economic returns of Bitcoin mining based on a series of abovementioned factors, which impact the demand and selling price of our Bitcoin mining machines.

 

   

As the Bitcoin price fluctuates, we will adjust our selling price of Bitcoin mining machines to match Bitcoin miners’ typical target payback cycle of 150 to 300 days.

 

   

Although our technology upgrade for new generation of our Bitcoin mining machine will reduce the average production cost for our Bitcoin mining machine in general, a sudden decrease of Bitcoin price may lead to stagnant demand and decrease of selling price for our products, which further lead to inventories and prepayments write-down that impact our gross margin.

Historically, a strong increase in the Bitcoin price in late 2017 drove the significant increase in both the demand for and the average selling price of our Bitcoin mining machines in the first half of 2018. As the Bitcoin price dropped in 2018, manufacturers of Bitcoin mining machines began to experience a lower demand and average selling price of Bitcoin mining machines, thereby leading to lower revenue and a larger amount of inventory, as well as the elimination of certain weaker players in the market. Furthermore, due to the decrease of Bitcoin price during second half of 2018, we made a total provision of RMB786.0 million (US$114.3 million) during the year and recorded a gross margin of 18.8%, compared with gross margin of 46.2% in 2017. The Bitcoin price drop in the second half of 2018 also caused our customers who purchased our Bitcoin mining products on credit to be less willing to make payment. We consider such portion of payment as implicit price concession and we retroactively adjusted our revenue based on such subsequent information. We recognized such price concessions of RMB152.8 million (US$22.2 million), while we did not recognize any such price concession in 2017. All of these led to a significant decrease in our gross margin and net income in 2018.

Going forward, if the Bitcoin price fluctuates significantly, we expect to experience a significant corresponding fluctuation in both sales volume and average selling prices of our Bitcoin mining machines, as well as a significant inventory and prepayment write down that erodes our profitability in the case of a significant Bitcoin price drop. See “Risk Factors—Risks Relating to Our Business and Industry—Our results of operations have been and are expected to continue to be impacted by Bitcoin price fluctuation.”

 

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Acceptance and Development of Blockchain Technology Applications, Especially Bitcoin

Our current blockchain product is designed for Bitcoin mining. In recent years, the cumulative number of global Bitcoin mining transactions has rapidly increased, and the total revenue generated by Bitcoin mining, which includes new Bitcoins awarded for blocks created as well as Bitcoins charged for transactions verified, has rapidly increased at a CAGR of 152.8% from US$21.1 million in 2012 to US$5,508.6 million in 2018, according to Frost & Sullivan. Driven by such trends, the market size of ASIC-based Bitcoin hardware has grown from RMB1.1 billion in 2014 to RMB21.4 billion in 2018, representing a CAGR of 110.0%. Our net revenues derived from sales of Bitcoin mining machines and Bitcoin mining machine parts were RMB1,303.1 million in 2017, whereas such revenues were RMB2,698.3 million (US$392.5 million) in 2018. Any adverse development in blockchain technology and the cryptocurrency markets, and in the Bitcoin market in particular, can significantly impact our results of operations. The Bitcoin market can also be affected by the following factors, among others: (i) different views regarding the decentralized nature of cryptocurrencies, (ii) acceptance of cryptocurrencies as an investment instrument as well as a currency for payment, (iii) competing cryptocurrencies to Bitcoin, and (iv) changes in the Bitcoin algorithm and the mechanism of mining. See “Risk Factors—Risks Relating to Our Business and Industry—We derive a significant portion of our revenues from our Bitcoin mining machines. If the market for Bitcoin mining machines ceases to exist or diminishes significantly, our business and results of operations would be materially harmed,” “—Changes in the Bitcoin algorithm or the mining mechanism may materially and adversely affect our business and results of operations” and “—The industries in which we operate are characterized by constant changes. If we fail to continuously innovate and to provide products that meet the expectations of our customers, we may be unable to attract new customers or retain existing customers, and hence our business and results of operations may be adversely affected.

Development of AI Technology, Especially Edge Computing

In addition to our Bitcoin mining machines, we have also developed ASICs for AI applications and have continued to make investments in the edge computing area. Net revenues derived from the sale of our AI products was RMB275.2 thousand in 2018. The development of AI technology, especially as it relates to edge computing, and the acceptance of ASICs for AI applications is crucial to our future success in diversifying our product offering. According to Frost & Sullivan, the global AI chips market is expected to reach approximately RMB221.6 billion by the end of 2023, representing a CAGR of 45.1% from RMB34.4 billion in 2018. ASICs in the processing chips market are expected to experience the fastest growth at a CAGR of 15.8% from US$31.7 billion in 2018 to US$66.1 billion in 2023. However, if any adverse development in AI technology arises or if ASICs for AI applications are not widely accepted, our results of operations and prospects may be negatively impacted.

Performance and Cost of Our Products

The pricing of and demand for our Bitcoin mining machines and our AI chips are closely related to their performance. In general, more advanced process technologies, such as the new 7nm process technology used in our Bitcoin mining machines, can accommodate designs that produce ASICs with higher power efficiency. The introduction of new process and design technologies also enables us to gradually lower the production costs of ASICs with comparable computing power. However, the application of such process technologies also commands high initial setup costs, particularly when the new production techniques first become available, which translates to higher per unit costs. As a result, our new generation ASICs using the most advanced process technologies will need to achieve strong sales in order to justify the initial setup costs of the new production techniques and maintain our profitability. At the same time, as the most advanced production capabilities of IC foundries ramp up, the initial high unit cost for IC fabrication may also decrease, which will likely translate to lower fabrication costs and a positive effect on our business, results of operations and financial condition.

Production Capacity

As a fabless IC design company, we outsource the fabrication process of our ICs to third-party foundry partners, and we outsource the testing and packaging process to third-party testing and packaging partners. We

 

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work closely with a limited number of such production partners. For example, we currently rely on one third-party foundry, and we cannot guarantee that it will be able to meet our manufacturing requirements or capacity or that it will not raise its prices. See “Risk Factors—Risks Relating to Our Business and Industry—Our Bitcoin mining machine business depends on supplies from a single third-party foundry, and any failure to obtain sufficient foundry capacity from this foundry would significantly delay the shipment of our products.” As a result, our ability to quickly respond to market demand and meet production timelines, as well as to price our products competitively, is highly dependent on our third-party production partners. If our production partners are unable to meet our production capacity requirements or deliver products that meet our quality standards on a timely basis, our results of operations will be adversely affected.

We may also incur significant cash outflow at the early stages of our production process because we are required to make prepayments to some of our third-party production partners to secure their production capacity beforehand, which may affect our liquidity position. In addition, any failure by our third-party production partners to perform their obligations in a timely manner may subject us to counterparty risk and make it difficult or impossible for us to fulfill our customers’ orders, which would harm our reputation and negatively affect our business, results of operations and financial condition.

Investment in Research and Development

We are a fabless IC design company. Our ability to design high quality ASICs largely depends on our continued investment in research and development, and our results of operations are affected by related expenses. Historically, we have invested substantially in research and development to build and enhance our competitive edge, and we need to continue to devote resources to research and development activities in order to (i) design and develop new or enhanced ASICs for Bitcoin mining applications, (ii) design and develop new or enhanced ASICs for AI applications, and (iii) expand our product offering and penetrate into new application markets, particularly into markets for ASIC applications that require high performance and strong computing power. In addition, as the tape-out process is extremely costly, our historical 100% successful tape-out rate has contributed to lower research and development expenses. We cannot assure you that we can continue to have a high successful tape-out rate. Unsuccessful tape-outs will significantly increase our research and development expenses. Our ability to design and develop new or enhanced ASICs for Bitcoin mining and AI applications and ASICs for other applications with market potential as well as maintain a high tape-out rate will have a material effect on our business, results of operations, financial condition and profitability.

Regulatory Environment

Our customers are primarily based in the PRC, and we expect a growing portion of our revenues to be derived from sales outside of the PRC. As such, we need to make efforts and incur costs to ensure that we are compliant with the existing laws and regulations relating to our business in the various jurisdictions that are material to our business and operations, and to comply with new laws and regulations or changes under existing laws and regulations that may arise in the future. Our ability to anticipate and respond to potential changes in government policies and regulations will have a significant impact on our business operations in such countries and our overall results of operations. See “Risk Factors—Risks Relating to Our Business and Industry—We are subject to risks associated with legal, political or other conditions or developments regarding holding, using or mining of Bitcoins, which could negatively affect our business, results of operation and financial position.”

Critical Accounting Policies, Judgments and Estimates

We prepare our financial statements in accordance with U.S. GAAP, which requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenues and expenses during the reporting periods. We continually evaluate these judgments and estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the

 

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future based on available information and assumptions that we believe to be reasonable, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors that should be considered when reviewing our financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements. You should read the following description of critical accounting policies, judgments and estimates in conjunction with our consolidated financial statements and other disclosures included in this prospectus.

Revenue Recognition

We have adopted the new revenue standard, ASC 606, Revenue from Contracts with Customers (Topic 606) for all periods presented. Consistent with the criteria of Topic 606, we recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services.

Products revenue

We generate revenue primarily from the sale of bitcoin mining machines directly to customers such as businesses or individuals engaged in Bitcoin mining activities. Our sales arrangements usually require a full prepayment before the delivery of products. Occasionally, we grant credit periods ranging from three to six months to some long-standing customers in China. We expect to accept a lower amount of consideration (as compared to fixed and promised consideration that is set out in the sales contracts) from our credit sales customers and hence provide implicit price concessions to these customers.

Revenues from product sales are recorded at the net sales price (transaction price), which includes an estimation of variable consideration which primarily results from implicit price concessions on credit sales. The amount of variable consideration is included in the transaction price to the extent it is not constrained and it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period. If the consideration promised in a contract includes a variable amount, we estimate the amount to which we expect to receive. Actual amounts of consideration ultimately received may differ from the estimates. If actual results in the future vary from our estimates, we will adjust these estimates, which would affect revenue and earnings in the period such variances are known. With respect to the determination of variable consideration resulting from the amount of implicit price concessions, since the Bitcoin market price is volatile and unpredictable and changes in the Bitcoin price will greatly affect the implicit price concession to be provided by us to our credit sales customers, we use all the subsequent hindsight information to adjust the estimated variable consideration for the periods presented as there was limited historical data to better determine an estimate. Prospectively, our policy will take into account any historical data in determining the implicit price concessions at the time of revenue recognition. During the years ended December 31, 2017 and 2018, we recognized price concessions provided to our customers in the amounts of nil and RMB152.8 million (US$22.2 million), respectively.

We recognize products revenue at a point in time based on management’s evaluation of when the control of the products have been passed to customers. The transfer of control is considered complete when products have been picked up by or shipped to our customers.

We offer a standard product warranty of no longer than six months that the product will operate under normal use. At the time revenue is recognized, an estimate of future warranty costs is recorded as a component of cost of revenues. The reserves established are regularly monitored based upon historical experience and any actual claims charged against the reserve. The amount of total warranty costs incurred was immaterial for the years ended December 31, 2017 and 2018, respectively.

 

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Services revenue

We also generate a small portion of revenue from our maintenance services under separate contracts. Revenue from the maintenance service to the customer is recognized when the related services have been rendered to the customer.

Inventories

Inventories, consisting of finished goods, work in process, raw materials and goods in transit, which are purchased from contract manufacturers and component suppliers. Inventories are stated at the lower of cost and net realizable value. Cost of inventory is determined using the weighted average cost method. Adjustments are recorded to write down the cost of inventory to the estimated net realizable value due to slow-moving and obsolete inventory, which is dependent upon factors such as historical and forecasted consumer demand, and promotional environment. We take ownership, risks and rewards of the products purchased.

In accordance with ASC 855-10-55-1(b), we consider all data available, including future demand and subsequent changes in product prices, that may provide additional information about the valuation of inventories at the balance sheet date.

Share-based Compensation

We grant restricted shares and share options to eligible employees and account for share-based compensation in accordance with ASC 718, Compensation—Stock Compensation.

Employees’ share-based compensation awards are measured at the grant date fair value of the awards and recognized as expenses (a) immediately at the grant date if no vesting conditions are required; or (b) for share-based awards granted with only service conditions, using the graded vesting method, net of estimated forfeitures, over the vesting period; or (c) for share-based awards granted with service conditions and the occurrence of an initial public offering as a performance condition, cumulative share-based compensation expenses for the options that have satisfied the service condition should be recorded upon the completion of the initial public offering, using the graded vesting method, or (d) for share-based awards with service conditions and other performance conditions, using the graded vesting method, net of estimated pre-vesting forfeitures, over the vesting period.

A change in any of the terms or conditions of share-based awards is accounted for as a modification of the awards. We calculate incremental compensation expense of a modification as the excess of the fair value of the modified awards over the fair value of the original awards immediately before its terms are modified at the modification date. For vested awards, we recognize incremental compensation cost in the period when the modification occurs. For awards not being fully vested, we recognize the sum of the incremental compensation expense and the remaining unrecognized compensation expense for the original awards over the remaining requisite service period after modification.

Share-based compensation in relation to the restricted shares is measured based on the fair market value of our ordinary shares at the grant date of the award. Prior to the listing, estimates of the fair value of our ordinary shares involve significant assumptions that might not be observable in the market, and a number of complex and subjective variables, including discount rate, and subjective judgments regarding our projected financial and operating results, our unique business risks, the liquidity of our ordinary shares and our operating history and prospects at the time the grants are made. Share-based compensation in relation to the share options is estimated using the Binomial Option Pricing Model. The determination of the fair value of share options is affected by the share price of our ordinary shares as well as the assumptions regarding a number of complex and subjective variables, including the expected share price volatility, risk-free interest rate, exercise multiple and expected dividend yield. The fair value of these awards was determined with assistance from an independent valuation firm.

 

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Components of Results of Operations

Revenue

We derive our revenue primarily from sales of Bitcoin mining machines.

The following table sets forth a breakdown of our revenue by services, each expressed in the absolute amount and as a percentage of our total revenue, for the periods indicated:

 

     Year ended December 31,  
     2017      2018  
     RMB      %      RMB      US$      %  
     (in millions, except for percentages)  

Products revenue

     1,303.1        99.6        2,698.6        392.5        99.8  

Blockchain products(1)

     1,303.1        99.6        2,698.3        392.5        99.7  

AI products

     —          —          0.3        0.0        0.0  

Service revenue

     4.7        0.4        6.0        0.9        0.2  

Other revenues

     0.3        0.0        0.7        0.1        0.0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     1,308.1        100.0        2,705.3        393.5        100.0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Note:

(1)

Substantially all of our blockchain products revenue is attributable to sales of Bitcoin mining machines, with the remainder consisting of other Bitcoin mining machine parts and accessories.

Our net revenue is primary affected by the number of Bitcoin mining machines sold and their average selling price. The average unit selling price of our Bitcoin mining machines is primarily affected by the Bitcoin price. The following table sets forth the sales volume and average selling prices generated by our different Bitcoin mining machines:

 

     Year ended December 31,  
     2017      2018  
     Revenue      Volume      ASP      Revenue      Volume      ASP  
     RMB in
millions
     set      RMB      RMB in
millions
     set      RMB  

A7 series(1)

     1,296.5        294,523        4,402        76.3        20,576        3,710  

A8 series(2)

     —          —          —          2,436.8        503,237        4,842  

A9 series(3)

     —          —          —          129.5        35,324        3,665  
  

 

 

    

 

 

       

 

 

    

 

 

    

Total

     1,296.5        294,523        4,402        2,642.5        559,137        4,726  
  

 

 

    

 

 

       

 

 

    

 

 

    

 

Notes:

(1)

Mainly includes our A721, A741 and A761 Bitcoin mining machines.

(2)

Mainly includes our A821, A841 and A851 Bitcoin mining machines.

(3)

Mainly includes our A921 Bitcoin mining machine.

The average selling price of our products is primarily affected by the Bitcoin price. The Bitcoin price hike in late 2017 resulted in strong demand and higher average selling prices for our A7 and A8 series products in the first half of 2018. In 2018, a drop in the Bitcoin price reversed the trends, especially with respect to the average selling prices. As a result, our A9 series products released after the Bitcoin price drop had a lower average selling price as compared with our A7 and A8 series products that were sold throughout 2018 despite the much stronger computing power. We typically price our Bitcoin mining machine based on their computing power. In addition, we typically reduce the price of the previous generation of Bitcoin mining machines when we introduce a new generation of Bitcoin mining machines. Also, the selling price of our Bitcoin mining machines is closely related to their performance in terms of computing power.

 

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The following table sets forth the total computing power sold and average selling prices of our Bitcoin mining machines expressed in terms of computing power:

 

     Year ended December 31,  
     2017      2018  
     Revenue      Total
Computing
Power Sold
     ASP per
Thash
     Revenue      Total
Computing
Power Sold
     ASP per
Thash
 
     RMB in
millions
     Thash/s      RMB      RMB in
millions
     Thash/s      RMB  

A7 series(1)

     1,296.5        2,114,637        613        76.3        151,131        505  

A8 series(2)

     —          —          —          2,436.8        6,305,119        386  

A9 series(3)

     —          —          —          129.5        702,416        184  
  

 

 

    

 

 

       

 

 

    

 

 

    

Total

     1,296.5        2,114,637        613        2,642.5        7,158,666        369  
  

 

 

    

 

 

       

 

 

    

 

 

    

 

 

Notes:

(1)

Mainly includes our A721, A741 and A761 Bitcoin mining machines.

(2)

Mainly includes our A821, A841 and A851 Bitcoin mining machines.

(3)

Mainly includes our A921 Bitcoin mining machine.

In general, the average selling price of our Bitcoin mining machines in terms of computing power decreased as a result of the overall technology advancement that led to a lower unit cost and the fact that we typically decrease the price of our previous generation of Bitcoin mining machines as we introduce the new generation of Bitcoin mining machines. The drop in 2018 was also largely attributable to a Bitcoin price drop.

Cost of revenues

Our cost of revenues consists of product costs, including costs of raw materials, costs of contract manufacturers for production, shipping and handling costs, manufacturing and tooling equipment depreciation, warehousing costs as well as slow-moving and obsolete inventory and prepayment write-downs and tax surcharges. The following table sets forth a breakdown of our cost of revenue, expressed as an absolute amount and as a percentage of our total cost of revenue, for the years indicated.

 

     For the year ended December 31,  
     2017      2018  
     RMB      %      RMB     USD     %  
     (in millions, except for percentages)  

Cost of revenue excluding the impact of write-downs

     703.7        100.0        1,482.3       215.6       67.5  

Inventory and prepayment write-down

     —          —          786.0       114.3       35.8  

Realized inventory and prepayment write-down

     —          —          (71.1     (10.3     (3.2
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total cost of revenue

     703.7        100.0        2,197.2       319.6       100.0  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Historically, the relative weight of the components of our cost of revenue remained relatively stable without taking into consideration the inventory and prepayment write down provision. As we employ a fabless model, costs of contract manufacturing and raw materials is the largest component of our cost of revenue. Going forward, as we continue our fabless model, we do not expect any major changes to the relative weight of the components of our cost of revenue without taking into consideration the inventory and prepayment write down provision.

We make inventory and prepayment write downs when we determine that we are unlikely to sell our inventory at or above their cost. The amount to be written down is the difference between the cost of our

 

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inventory and the estimated realizable value of our inventory, which is significantly affected by the Bitcoin price. In the second half of 2018, in view of the Bitcoin price drop, the prevailing market demand of our Bitcoin mining machines and the prevailing retail price of our Bitcoin mining machine, we determined that under such conditions it was unlikely that we would be able to sell those Bitcoin mining machines at or above their cost. As a result, based on our estimation of market conditions with reference to the Bitcoin price, we recorded an inventory and prepayment write down of RMB786.0 million (US$114.3 million). Going forward, if we are able to sell such inventories above their cost, the cost of sales for those machines will be net of such write down, which in turn will have the effect of increasing our gross profit for the period.

Our cost of revenue increased as an absolute amount during the periods indicated primarily due to the increase in the sales volume of our Bitcoin mining machines. The table below sets forth the per unit costs of our Bitcoin mining machines:

 

     For the year ended December 31,  
     2017      2018  
     Cost(1)      Volume      Per unit cost      Cost(1)      Volume      Per unit cost  
     RMB in
millions
     set      RMB      RMB in
millions
     set      RMB  

A7 series(2)

     693.3        294,523        2,354        51.1        20,576        2,482  

A8 series(3)

     —          —          —          1,243.9        503,237        2,472  

A9 series(4)

     —          —          —          154.9        35,324        4,385  
  

 

 

    

 

 

       

 

 

    

 

 

    

Total

     693.3        294,523        2,354        1,449.9        559,137        2,593  
  

 

 

    

 

 

       

 

 

    

 

 

    

 

 

Notes:

(1)

Without taking into consideration the inventory and prepayment write down provision of nil and RMB786.0 million (US$114.3 million) in 2017 and 2018, respectively, as well as a realized inventory and prepayment write down of nil and RMB71.1 million (US$10.3 million).

(2)

Mainly includes our A721, A741 and A761 Bitcoin mining machines.

(3)

Mainly includes our A821, A841 and A851 Bitcoin mining machines.

(4)

Mainly includes our A921 Bitcoin mining machine.

The following table sets out the sales cost and average selling cost of our Bitcoin mining machines expressed in terms of computing power:

 

     Year ended December 31,  
     2017      2018  
     Cost(1)      Total
Computing
Power Sold
     Cost per
Thash
     Cost      Total
Computing
Power Sold
     Cost per
Thash
 
     RMB in
millions
     Thash/s      RMB      RMB in
millions
     Thash/s      RMB  

A7 series(2)

     693.3        2,114,637        328        51.1        151,131        338  

A8 series(3)

     —          —          —          1,243.9        6,305,119        197  

A9 series(4)

     —          —          —          154.9        702,416        221  
  

 

 

    

 

 

       

 

 

    

 

 

    

Total

     693.3        2,114,637        328        1,449.9        7,158,666        203  
  

 

 

    

 

 

       

 

 

    

 

 

    

 

 

Notes:

(1)

Without taking into consideration the inventory and prepayment write down provision of nil and RMB786.0 million (US$114.3 million) in 2017 and 2018, respectively, as well as a realized inventory and prepayment write down of nil and RMB71.1 million (US$10.3 million).

(2)

Mainly includes our A721, A741 and A761 Bitcoin mining machines.

 

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(3)

Mainly includes our A821, A841 and A851 Bitcoin mining machines.

(4)

Mainly includes our A921 Bitcoin mining machine.

In general, we tend to incur higher per-unit production costs for our Bitcoin mining machines using newly implemented process technologies early in their life cycle due to the initial set up costs. We were also able to optimize our design as a same generation of processing technology matures, which can lead to a lower per Thash cost for newer products. The number of ASICs installed in each unit of our Bitcoin mining machines also affects the per unit production costs for our Bitcoin mining machines. The cost of other parts and accessories can also affect our production costs. As a result, (i) our A7 series products sold in 2018 had more ASICs and were bundled with power adapters and had higher per unit costs as compared with 2017, (ii) our A8 series products that employ improved design for 16nm processing technology and a larger number of ASICs have lower per unit production costs and significantly lower per Thash production costs as compared with our A7 series products which also employ 16nm ASICs and have a lower number of ASICs installed, and (iii) our A9 series products that employ 7nm ASICs with much stronger computing power have significantly higher per unit production costs and higher per Thash production costs as compared with our A8 series products due to significantly higher set-up cost and related expenses from employing new technology.

Gross profit and gross profit margin

Our gross profit and gross profit margin are primarily affected by Bitcoin prices, which have a significant effect on the average selling price of our products, and, to a lesser extent, the average per unit production costs of our Bitcoin mining machines. In 2017 and 2018, our gross profit was RMB604.4 million and RMB508.1 million (US$73.9 million), respectively. Our overall gross profit margin was 46.2% and 18.8%, respectively, in the same years. A strong increase in the Bitcoin price in late 2017 drove the significant increase in both the demand and average selling price of our Bitcoin mining machines in the first half of 2018. As the Bitcoin price dropped in 2018, we began to experience a much lower demand and average selling price of our Bitcoin mining machines, thereby leading to lower revenue and a large amount of inventory. Furthermore, we made an inventory and prepayment write down of RMB786.0 million (US$114.3 million) in response to the stagnant demand for our products and the decreased Bitcoin price, which resulted in a significant increase in our cost of sales and therefore lower gross margin. Going forward, if we are able to sell such inventories above their cost, the cost of sales for those machines will be net of such write down, which in turn will have the effect of increasing our gross profit for the period.

Operating expenses

Our operating expenses include research and development expenses, selling and marketing expenses and general and administrative expenses. The following table sets forth components of our operating expenses, both in absolute amount and as a percentage of our total revenue, for the periods presented:

 

     Year ended December 31,  
     2017      2018  
     RMB      %      RMB      US$      %  
     (in millions, except for percentages)  

Research and development expenses

     99.8        7.6        189.7        27.6        7.0  

Share-based compensation expense included in research and development expenses

     25.1        1.9        9.6        1.4        0.4  

Selling and marketing expenses

     20.7        1.6        38.7        5.6        1.4  

Share-based compensation expense included in selling and marketing expenses

     0.1        0.0        1.1        0.2        0.0  

General and administrative expenses

     125.3        9.6        146.7        21.3        5.4  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Share-based compensation expense included in general and administrative expenses

     70.3        5.4        7.9        1.1        0.3  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     245.8        18.8        375.1        54.6        13.9  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Research and development expenses. Research and development expenses primarily consist of salary and welfare for research and development personnel (including share-based compensation), consulting and contractor expenses, testing and tooling materials and other expenses associated with research and development. Substantially all of our research and development expenses are related to developing new products and services and improving existing products and services.

Selling and marketing expenses. Sales and marketing expenses consist primarily of salary and welfare for sales and marketing personnel (including share-based compensation), promotion and marketing expenses and other expenses associated with sales and marketing.

General and administrative expenses. General and administrative expenses consist primarily of salary and welfare for general and administrative personnel (including share-based compensation), rental expenses and depreciation, allowance for doubtful receivables, entertainment expense, general office expense and professional service fees.

Taxation

Cayman Islands

The Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty. There are no other taxes likely to be material to us levied by the government of the Cayman Islands except for stamp duties which may be applicable to instruments executed in, or after execution, brought within the jurisdiction of the Cayman Islands. In addition, the Cayman Islands does not impose withholding tax on dividend payments.

Hong Kong

Our subsidiary incorporated in Hong Kong is subject to Hong Kong profit tax at a rate of 16.5%. No Hong Kong profit tax has been levied as we did not have an assessable profit that was earned in or derived from the Hong Kong subsidiary during the periods presented. Hong Kong does not impose a withholding tax on dividends.

PRC

In March 2007, the National People’s Congress of China enacted the Enterprise Income Tax Law, which became effective on January 1, 2008 and amended on February 24, 2017. The Enterprise Income Tax Law provides that enterprises organized under the laws of jurisdictions outside China with their “de facto management bodies” located within China may be considered PRC resident enterprises and therefore subject to the PRC EIT at the rate of 25% on their worldwide income. The Implementing Rules of the Enterprise Income Tax Law further define the term “de facto management body” as the management body that exercises substantial and overall management and control over the business, personnel, accounts and properties of an enterprise.

While we do not currently consider our company or any of our overseas subsidiaries to be a PRC resident enterprise, there is a risk that the PRC tax authorities may deem our company or any of our overseas subsidiaries to be a PRC resident enterprise since a substantial majority of the members of our management team as well as the management team of our overseas subsidiaries are located in China, in which case we or the applicable overseas subsidiaries, as the case may be, would be subject to the PRC EIT at the rate of 25% on worldwide income. If the PRC tax authorities determine that our Cayman Islands holding company is a “resident enterprise” for PRC EIT purposes, a number of unfavorable PRC tax consequences could follow.

Under the Enterprise Income Tax Law and its implementation regulations issued by the State Council, a 10% PRC withholding tax is applicable to dividends paid to investors that are nonresident enterprises, which do not have an establishment or place of business in the PRC or which have such establishment or place of business but the dividends are not effectively connected with such establishment or place of business, to the extent such dividends are derived from sources within the PRC.

 

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In addition, any gain realized on the transfer of shares by such investors is also subject to PRC tax at a rate of 10%, if such gain is regarded as income derived from sources within the PRC. If we are deemed to be a PRC resident enterprise, dividends paid on our ordinary shares or ADSs, and any gain realized from the transfer of our ordinary shares or ADSs, may be treated as income derived from sources within the PRC and may as a result be subject to PRC taxation.

Furthermore, if we are deemed to be a PRC resident enterprise, dividends paid to individual investors who are non-PRC residents and any gain realized on the transfer of ADSs or ordinary shares by such investors may be subject to PRC tax at a current rate of 20% (which in the case of dividends may be withheld at source). Any PRC tax liability may be reduced under applicable tax treaties or tax arrangements between China and other jurisdictions. If we or any of our subsidiaries established outside China are considered to be a PRC resident enterprise, it is unclear whether holders of our ADSs or ordinary shares would be able to claim the benefit of income tax treaties or agreements entered into between China and other countries or areas.

In April 2018, the Ministry of Finance, or MOF, and State Administration of Taxation, or SAT, jointly promulgated the Circular of the MOF and the SAT on Adjustment of Value-Added Tax Rates, or Circular 32, according to which (i) for VAT taxable sales or imports of goods originally subject to VAT rates of 17% and 11% respectively, such tax rates were adjusted to 16% and 10%, respectively; and (ii) for exported goods originally subject to a tax rate of 17% and an export tax refund rate of 17%, the export tax refund rate was adjusted to 16%. Circular 32 became effective on May 1, 2018 and superseded existing provisions which were inconsistent with Circular 32.

Pursuant to the Announcement on Relevant Policies for Deepening Value-Added Tax Reform, which was promulgated by MOF, SAT and the General Administration of Customs on March 20, 2019, where (i) for VAT taxable sales or imports of goods originally subject to VAT rates of 16%, such tax rates shall be adjusted to 13%; (ii) for exported goods originally subject to a tax rate of 16% and an export tax refund rate of 16%, the export tax refund rate shall be adjusted to 13%.

We are also subject to VAT at a rate of approximately 6% on the services and solutions we provide to our customers, less any deductible VAT we have already paid or borne. We are also subject to surcharges on VAT payments in accordance with PRC law.

Internal Control over Financial Reporting

Prior to this offering, we have been a private company with limited accounting personnel and other resources with which to address our internal controls and procedures, and we were never required to evaluate our internal controls within a specified period. As a result, we may experience difficulty in meeting these reporting requirements in a timely manner. Our management has not completed an assessment of the effectiveness of our internal control over financial reporting, and our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. However, in the course of preparing and auditing our consolidated financial statements for the years ended December 31, 2017 and 2018, we and our independent registered public accounting firm identified two material weaknesses in our internal control over financial reporting as of December 31, 2018. In accordance with reporting requirements set forth by the SEC, a “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our company’s annual or interim consolidated financial statements will not be prevented or detected on a timely basis.

The material weaknesses identified are related to (i) our lack of competent financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting and compliance requirements, and (ii) our lack of documented financial closing policies and procedures, specifically those related to the period end expenses cut-off and accruals.

 

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We plan to take initiatives to improve our internal control over financial reporting to address the material weaknesses that have been identified, including:

 

   

hiring additional qualified accounting and reporting personnel who are equipped with the relevant U.S. GAAP and SEC reporting experiences and qualifications to strengthen our financial reporting function and to set up a financial and system control framework;

 

   

implementing regular and continuous U.S. GAAP accounting and financial reporting training programs for our accounting and financial reporting personnel;

 

   

enhancing our internal audit function as well as engaging an external consulting firm to assist us with assessing our Sarbanes-Oxley compliance readiness and improving overall internal controls; and

 

   

formalizing and standardizing our financial reporting control procedures and policies to improve the quality and accuracy of the period end financial closing process.

However, we cannot assure you that we will complete the implementation of these measures in a timely manner. See “Risk Factors—Risks Relating to Our Business and Industry—We have identified two material weaknesses in our internal controls as of December 31, 2018, and if we fail to maintain an effective system of internal controls, our ability to accurately and timely report our financial results or prevent fraud may be adversely affected, and investor confidence and the market price of our ADSs may be adversely affected.”

As a company with less than US$1.07 billion in revenue for our last fiscal year, we qualify as an “emerging growth company” pursuant to the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include an exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002, related to the assessment of the effectiveness of the emerging growth company’s internal control over financial reporting.

 

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Results of Operations

The following table sets forth a summary of our consolidated results of operations for the periods indicated. This information should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. The operating results in any period are not necessarily indicative of the results that may be expected for any future period.

 

     Year ended December 31,  
     2017     2018  
     RMB     % of revenue     RMB     US$     % of revenue  
     (in millions)  

Net revenues:

          

Products revenue

     1,303.1       99.6       2,698.6       392.5       99.8  

Service revenue

     4.7       0.4       6.0       0.9       0.2  

Other revenues

     0.3       0.0       0.7       0.1       0.0  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

     1,308.1       100.0       2,705.3       393.5       100.0  

Cost of revenues

     (703.7     (53.8     (2,197.2     (319.6     (81.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     604.4       46.2       508.1       73.9       18.8  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

          

Research and development expenses

     (99.8     (7.6     (189.7     (27.6     (7.0

Sales and marketing expenses

     (20.7     (1.6     (38.7     (5.6     (1.4

General and administrative expenses

     (125.3     (9.6     (146.7     (21.3     (5.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     (245.8     (18.8     (375.1     (54.6     (13.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other income from operations:

          

Interest income

     0.2       0       4.2       0.6       0.2  

Investment income

     5.6       0.4       3.2       0.5       0.1  

Interest expense and guarantee fee

     —         0       (53.1     (7.7     (2.0

Foreign exchange losses, net

     (1.2     (0.1     (1.2     (0.2     (0

Value added tax refunds

     38.8       3.0       110.2       16.0       4.1  

Other (loss) income, net

     (1.1     (0.1     3.8       0.6       0.1  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax expenses

     401.0       30.7       200.2       29.1       7.4  

Income tax expense

     (25.2     (1.9     (77.8     (11.3     (2.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     375.8       28.7       122.4       17.8       4.5  

Foreign currency translation adjustment, net of tax

     —         0       (65.2     (9.5     (2.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income

     375.8       28.7       57.2       8.3       2.1  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

Revenue. Our revenue increased by 106.8% to RMB2,705.3 million (US$393.5 million) in 2018 from RMB1,308.1 million in 2017, primarily due to the increase in the sales volume of our Bitcoin mining machines from 294,523 sets in 2017 to 559,137 sets in 2018, which in turn was the result of a Bitcoin price hike in late 2017, partially offset by a Bitcoin price drop in the second half of 2018.

Cost of revenue. Our cost of revenue increased by 212.2% to RMB2,197.2 million (US$319.6 million) in 2018 from RMB703.7 million in 2017, primarily due to an increase in the sales volume of our Bitcoin mining

 

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machines from 294,523 sets in 2017 to 559,137 sets in 2018, as well as the provision for inventories and prepayments write down in the amount of RMB786.0 million (US$114.3 million) in 2018.

Gross profit. As a result of the foregoing, our gross profit decreased by 15.9% to RMB508.1 million (US$73.9 million) in 2018 from RMB604.4 million in 2017. Our overall gross profit margin decreased significantly from 46.2% in 2017 to 18.8% in 2018, primarily due to a Bitcoin price drop in the second half of 2018, which resulted in lower average selling prices in the second half of 2018 and an inventories and prepayments write down of RMB786.0 million (US$114.3 million) in response to the stagnant demand for our products driven by the decrease in the Bitcoin price.

Operating expenses. Our total operating expenses increased by 52.6% to RMB375.1 million (US$54.6 million) in 2018 from RMB245.8 million in 2017, primarily due to the increase in our research and development expenses and selling and marking expenses.

 

   

Research and development expenses. Our research and development expenses increased by 90.1% to RMB189.7 million (US$27.6 million) in 2018 from RMB99.8 million in 2017, primarily due to the expansion of our research and development projects. Our research and development expenses as a percentage of our revenues decreased to 7.6% in 2018 from 7.0% in 2017.

 

   

Selling and marketing expenses. Our selling and marketing expenses increased by 86.9% to RMB38.7 million (US$5.6 million) in 2018 from RMB20.7 million in 2017, primarily due to the increase in the scale of our operations. Our selling and marketing expenses as a percentage of our revenues remained relatively stable.

 

   

General and administrative expenses. Our general and administrative expenses increased by 17.1% to RMB146.7 million (US$21.3 million) in 2018 from RMB125.3 million in 2017, primarily due to the increase in the scale of our operations as well as the expenses incurred in connection with our preparing for an initial public offering in 2018 in the amount to RMB44.0 million (US$6.4 million), while, in 2017, we incurred higher share-based compensation expenses of RMB70.3 million. Our general and administrative expenses as a percentage of our revenues decreased to 5.4% in 2018 from 9.6% in 2017 due to economies of scale.

Investment income. Our investment income decreased by 43.5% to RMB3.2 million (US$0.5 million) in 2018 from RMB5.6 million in 2017, primarily due to the decrease in the purchase of investment products.

Interest income. Our interest income increased significantly to RMB4.2 million (US$0.6 million) in 2018 from RMB0.2 million in 2017, due to the interest from a security deposit associated with a bank loan in 2018.

Interest expense and guarantee fee. We recorded interest expense and guarantee fee of RMB53.1 million (US$7.7 million) in 2018 primarily in connection with an offshore bank loan and a guarantee fee to the relevant bank for the purpose of securing such offshore loan in connection with our restructuring in 2018.

Foreign exchange gain/(losses), net. Our foreign exchange losses decreased by 0.8% to RMB1.2 million (US$0.2 million) in 2018 from RMB1.2 million in 2017 as a result of the recording of our non-RMB denominated assets and liabilities.

Value added tax refunds. Our VAT refunds increased significantly to RMB110.2 million (US$16.0 million) in 2018 from RMB38.8 million primarily from the increase of sales by Hangzhou Canaan, which was accredited as a software enterprise and enjoyed a VAT refund scheme. Under the tax refund scheme, the VAT payable by a software enterprise is capped, and any amount beyond the cap will be refunded. We expect Hangzhou Canaan to continue to enjoy the tax refund as long as it remains an accredited software enterprise.

Other (loss) income, net. Our other income was RMB3.8 million (US$0.6 million) in 2018 primary from government grants and our other loss was RMB1.1 million in 2017 primarily from a net loss on disposal of property, equipment and software which was offset by government grants.

 

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Income before income tax expenses. As a result of the foregoing, our income before income tax expenses decreased by 50.1% to RMB200.2 million (US$29.1 million) in 2018 from RMB401.0 million in 2017.

Income tax expenses. Our income tax expenses increased significantly to RMB77.8 million (US$11.3 million) in 2018 from RMB25.2 million in 2017, primarily due to (i) the expiration of a tax-free period from our software enterprise accreditation in 2018 and (ii) a higher taxable income for PRC taxation purposes despite our lower net income in 2018, as the significant inventories and prepayments write down is not deductible for PRC taxation purposes.

Net income. As a result of the foregoing, our net income decreased by 67.4% to RMB122.4 million (US$17.8 million) in 2018 from RMB375.8 million in 2017, and our net margin decreased from 28.7% in 2017 to 4.5% in 2018.

Foreign currency translation adjustment, net of tax. We recorded RMB65.2 million (US$9.5 million) of foreign currency translation adjustment, net of tax in 2018 as a result of the translation of the financial statements of our Hong Kong subsidiary whose functional currency is U.S. dollars.

Liquidity and Capital Resources

Our primary source of liquidity historically has been cash generated from our business operations, bank loans and equity contributions from our shareholders, which have historically been sufficient to meet our working capital and capital expenditure requirements.

As of December 31, 2018, we had aggregate cash and cash equivalents, restricted cash of RMB545.2 million (US$79.3 million).

In 2018, we entered into certain short-term loan agreements with various banks with an aggregate principal amount of RMB500.0 million and interest rates ranging from 4.35% to 6.09% per annum. As of December 31, 2018, the aggregate outstanding principal amount under these agreements was RMB250.0 million bearing interest rates ranging from 4.35% to 5.22%.

On April 25, 2018, Canaan HK entered into a facility agreement with China Merchants Bank Co., Ltd., Hong Kong Branch, or CMB HK, as facility agent and CMB International Financial Limited, or CMBI Finance, as security agent, amounting to HK$930 million. Canaan HK drew down HK$921 million under this facility. The maturity of the facility agreement was the earlier of 12 months following closing and the completion of our initial public offering. The interest rate is the Hong Kong InterBank Offered Rate plus 1.3% per annum. In addition, Hangzhou Canaan and Canaan HK paid a guarantee fee of 1% per annum and 0.75% per quarter to secure the borrowing, respectively. Canaan HK repaid the outstanding loans in March 2019.

The weighted average interest rate for all of our borrowings in 2018 was approximately 7.14% per annum for the year ended December 31, 2018.

We believe that our existing cash and cash equivalents and anticipated cash flows from operating activities will be sufficient to meet our anticipated working capital requirements and capital expenditures in the ordinary course of business for the next 12 months. We may, however, need additional cash resources in the future if we experience changes in business conditions or other developments, or if we find and wish to pursue opportunities for investments, acquisitions, capital expenditures or similar actions. If we determine that our cash requirements exceed the amount of cash and cash equivalents we have on hand at the time, we may seek to issue equity or debt securities or obtain credit facilities. The issuance and sale of additional equity would result in further dilution to our shareholders. The incurrence of indebtedness would result in increased fixed obligations and could result in operating covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.

 

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Our ability to manage our working capital, including receivables and other assets and liabilities and accrued liabilities, may materially affect our financial condition and results of operations.

The following table sets forth a summary of our cash flows for the periods indicated:

 

     Year ended December 31,  
     2017     2018  
     RMB     RMB     US$  
     (in millions)  

Net cash provided by (used in) operating activities

     91.2       (12.7     (1.9

Net cash (used in) provided by investing activities

     (86.8     84.0       12.2  

Net cash provided by financing activities

     150.0       295.2       42.9  

Net increase in cash and cash equivalents, restricted cash

     154.4       366.4       53.3  
  

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents, restricted cash

     (1.3     2.3       0.3  

Cash and cash equivalents, restricted cash at the beginning of year

     23.4       176.5       25.7  
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, restricted cash at the end of year

     176.5       545.2       79.3  
  

 

 

   

 

 

   

 

 

 

Operating Activities

Net cash used in operating activities in 2018 was RMB12.7 million (US$1.9 million). The principal items accounting for the difference between our net cash used in operating activities and our net income of RMB122.4 million (US$17.8 million) were a RMB325.8 million (US$47.4 million) increase in inventories and a RMB449.7 million (US$65.4 million) decrease in prepayments and other current assets.

Net cash provided by operating activities in 2017 was RMB91.2 million. The principal items accounting for the difference between our net cash provided by operating activities and our net income of RMB375.8 million were a RMB201.0 million increase in contract liabilities, offset by a RMB587.1 million increase in prepayments and other current assets.

Investing Activities

Net cash provided by investing activities was RMB84.0 million (US$12.2 million) in 2018, which was primarily attributable to proceeds from the disposal of short-term investments of RMB1,498.7 million (US$218.0 million), which was partially offset by purchase of short-term investments of RMB1,405.5 million (US$204.4 million).

Net cash used in investing activities was RMB86.8 million in 2017, which was primarily attributable to payment for short-term investments of RMB941.4 million, which was partially offset by proceeds from the disposal of short-term investments of RMB859.8 million.

Financing Activities

Net cash provided by financing activities was RMB295.2 million (US$42.9 million) in 2018, which was attributable to proceeds from borrowings of RMB1,952.2 million (US$283.9 million), which was partially offset by the repayment of borrowings of RMB964.9 million and payment for a deemed distribution of RMB692.1 million as part of our corporate reorganization.

Net cash provided by financing activities was RMB150.0 million in 2017, which consisted of proceeds from capital contributions of shareholders of RMB150.0 million.

 

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Capital Expenditures

We made capital expenditures of RMB12.7 million and RMB24.9 million (US$3.6 million) in 2018 and 2017, respectively. Our capital expenditures primarily comprise expenditures for the purchase of equipment and software, intangible assets and other long-term assets. We will continue to make capital expenditures to meet the expected growth of our business.

Commitments

The following table sets forth our contractual obligations as of December 31, 2018:

 

     Total      Less than
1 Year
     1 – 2 Years      More than
2 Years
 
     RMB      US$      RMB  
     (in thousands)  

Lease commitment

     55,560.4        8,080.9        16,861.6        17,208.3        21,490.5  

Off-Balance Sheet Arrangements

We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity, or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

Holding Company Structure

Canaan Inc. is a holding company with no material operations of its own. We conduct our operations through our subsidiaries in Hong Kong and China. Canaan Inc.’s ability to pay dividends depends upon its receipt of dividends from our PRC subsidiaries. If our existing PRC subsidiaries or any newly formed subsidiaries incur debt in the future, the instruments governing their debt may restrict their ability to pay dividends to us. In addition, our subsidiaries in China are permitted to pay dividends to us only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Under PRC law, each of our subsidiaries in China is required to set aside at least 10% of its after-tax profits each year, if any, to fund certain statutory reserve funds until such reserve funds reach 50% of its registered capital. In addition, our subsidiaries in China may allocate a portion of their after-tax profits based on PRC accounting standards to enterprise expansion funds and staff bonus and welfare funds at their discretion. The statutory reserve funds and the discretionary funds are not distributable as cash dividends. Remittance of dividends by a subsidiary out of China is subject to examination by the banks designated by SAFE. Our PRC subsidiaries have not paid dividends and will not be able to pay dividends until they generate accumulated profits and meet the requirements for statutory reserve funds.

Inflation

Since inception, inflation in China has not materially affected our results of operations. According to the National Bureau of Statistics of China, the year-over-year percentage changes in the consumer price index for December 2017 and 2018 were increases of 1.8% and 1.9%, respectively. Although we have not been materially affected by inflation in the past, we may be affected if China experiences higher rates of inflation in the future.

 

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Quantitative and Qualitative Disclosures about Market Risk

Foreign Exchange Risk

Substantially all of our revenues and substantially all of our expenses are denominated in Renminbi. The functional currency of our company and our Hong Kong subsidiary is the U.S. dollar. The functional currency of our subsidiaries in the PRC is the Renminbi. We use Renminbi as our reporting currency. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at the applicable rates of exchange at the balance sheet date. Transactions in currencies other than the functional currency during the year are converted into functional currency at the applicable rates of exchange prevailing when the transactions occurred. Transaction gains and losses are recognized in the statements of operations.

We do not believe that we currently have any significant direct foreign exchange risk and have not used any derivative financial instruments to hedge exposure to such risk. Although in general our exposure to foreign exchange risks should be limited, the value of your investment in our ADSs will be affected by the exchange rate between the U.S. dollars and the Renminbi because the value of our business is effectively denominated in Renminbi, while our ADSs will be traded in U.S. dollars.

The conversion of Renminbi into foreign currencies, including U.S. dollars, is based on rates set by the PBOC. The PRC government allowed the Renminbi to appreciate by more than 20% against the U.S. dollar between July 2005 and July 2008. Between July 2008 and June 2010, the exchange rate between the Renminbi and the U.S. dollar was stable and traded within a narrow band. Since June 2010, the Renminbi has fluctuated against the U.S. dollar, at times significantly and unpredictably. On November 30, 2015, the Executive Board of the International Monetary Fund completed its regular five-year review of the basket of currencies that make up the Special Drawing Right, or the SDR, and decided that with effect from October 1, 2016, Renminbi is determined to be a freely usable currency and will be included in the SDR basket as a fifth currency, along with the U.S. dollar, the Euro, the Japanese yen and the British pound. In the fourth quarter of 2016, the Renminbi depreciated significantly in the backdrop of a surging U.S. dollar and persistent capital outflows from China. With the development of a foreign exchange market and progress towards interest rate liberalization and Renminbi internationalization, the PRC government may in the future announce further changes to the exchange rate system, and we cannot assure you that the Renminbi will not appreciate or depreciate significantly in value against the U.S. dollar in the future. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the Renminbi and the U.S. dollar in the future.

To the extent that we need to convert U.S. dollars into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we receive from the conversion. Conversely, if we decide to convert Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollars amounts available to us.

We estimate that we will receive net proceeds of approximately US$             million from this offering if the underwriters do not exercise their option to purchase additional ADSs, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us. Assuming that we convert the full amount of the net proceeds from this offering into Renminbi, a 10% appreciation of the U.S. dollar against the Renminbi, from the exchange rate of RMB6.8755 for US$1.00 as of December 31, 2018 to a rate of RMB7.5631 to US$1.00, will result in an increase of RMB             million in our net proceeds from this offering. Conversely, a 10% depreciation of the U.S. dollar against the Renminbi, from the exchange rate of RMB6.8755 for US$1.00 as of December 31, 2018 to a rate of RMB6.1880 to US$1.00, will result in a decrease of RMB             million in our net proceeds from this offering.

 

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Interest Rate Risk

We have not been exposed to material risks due to changes in market interest rates, and we have not used any derivative financial instruments to manage our interest risk exposure. However, we cannot provide assurance that we will not be exposed to material risks due to changes in market interest rates in the future.

After the completion of this offering, we may invest the net proceeds we receive from the offering in interest-earning instruments. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. The fair market value of fixed rate securities may be adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall.

Credit Risk

Financial instruments that potentially expose us to concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments and accounts receivable. We place our cash and cash equivalents with financial institutions with high credit ratings and quality.

We conduct credit evaluations of customers, and generally do not require collateral or other security from our customers. We establish an allowance for doubtful accounts primarily based upon the age of the receivables and factors surrounding the credit risk of specific customers.

Recent Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board, or FASB, issued ASU 2016-02, Leases (Topic 842), or ASU 2016-02. Under this guidance, an entity is required to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. This guidance offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election, by class of underlying asset, not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expenses for such lease generally on a straight-line basis over the lease term. We decided to make this election. The new leases standard also provides lessees with a practical expedient, by class of underlying asset, to not separate non-lease components from the associated lease component. If a lessee makes that accounting policy election, it is required to account for the non-lease components together with the associated lease component as a single lease component and to provide certain disclosures. We elect not to adopt this practical expedient. The ASU initially required a modified retrospective transition approach for existing leases, whereby the new lease standard will be applied to the earliest year presented. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements, or ASU 2018-11, which provides entities the option to initially apply ASU 2016-02 at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. ASU 2016-02 and ASU 2018-11 are effective for the annual reporting period beginning after December 15, 2018, including interim periods within that reporting period. We will adopt this guidance as of January 1, 2019 and utilize the alternative transition method through a cumulative-effect adjustment at the beginning of the first quarter of 2019. We estimate that approximately RMB48.9 million would be recognized as total right-of-use assets and total lease liabilities on the consolidated balance sheet as of January 1, 2019. Other than as disclosed above, our management does not expect the new standard to have a material impact on our consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, or ASU 2016-13. This guidance requires that financial assets measured at amortized cost be presented at the net amount expected to be collected. The measurement of expected credit losses is based on historical experience, current conditions, and reasonable and supportable

 

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forecasts that affect the collectability. In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, or ASU 2018-19, which clarifies certain topics included within ASU 2016-13. ASU 2016-13 and ASU 2018-19 are effective for the annual reporting period beginning after December 15, 2019, including interim periods within that reporting period. We are currently evaluating the impact on our consolidated financial statements of the adoption of this guidance.

In October 2018, the FASB issued ASU 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities, which amends the guidance for determining whether a decision-making fee is a variable interest and requires organizations to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety. The standard is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. We are currently evaluating the impact of this accounting standard update on our consolidated financial statements.

In May 2017, the FASB issued ASU No. 2017-09 Compensation — Stock Compensation (Topic 718). The FASB issued this update to provide clarity and reduce both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation — Stock Compensation, to a change to the terms or conditions of a share-based payment award. The amendments in this update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The amendments in this update are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for (1) public business entities for reporting periods for which financial statements have not yet been issued and (2) all other entities for reporting periods for which financial statements have not yet been made available for issuance. We elected to early adopt this ASU for all the periods presented. The impact of this ASU to the consolidated financial statements is immaterial.

 

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INDUSTRY OVERVIEW

Overview of the IC Industry

ICs are the foundation of the technology sector and are found in virtually every electronic hardware and computing device. According to Frost & Sullivan, the total size of the global IC market was US$401.6 billion in 2018, and the overall IC industry sales revenue in China increased at a CAGR of 21.3% from US$45.6 billion in 2014 to US$98.7 billion in 2018, with forecasted sales reaching US$193.8 billion by 2023 at a CAGR of 14.4%.

In the IC industry, fabless IC design is a mature business model widely adopted globally. Companies with strong design capabilities adopt the fabless model to focus exclusively on IC design and are able to avoid huge capital expenditures by taking advantage of the access to capacity provided by the foundry industry. The fabless IC design industry in China, in terms of sales revenue, has also grown significantly at a CAGR of 25.5% from US$15.5 billion in 2014 to US$38.5 billion in 2018, accounting for 35.2% of the global fabless IC design industry in 2018. Driven by the advancement of process technology and continual support from the government, the fabless IC design industry in China is forecasted to further grow at a CAGR of 15.6% to reach US$79.4 billion in 2023, according to Frost & Sullivan. Other characteristics of the IC industry include: (1) a mismatch between supply and demand which might lead to inventory overstock or understock; and (2) the requirement of continuous research and development investment to sustain competitiveness.

As new technologies such as big data, AI, blockchain and IoT emerge and generate immense demand for processing and computing ICs, ASIC, FPGA, CPU and GPU chips experienced growth from 2014 to 2018. The growth of the market for ASIC chips, which are customized for a particular use and offer strong computing power and superior power-efficiency, is expected to surpass those of other types of ICs and to grow at a 5-year CAGR of 15.8% from 2018 to 2023. In comparison, the processing chip industry is expected to grow at a CAGR of 8.0% in terms of sales revenue from 2018 to 2023.

Market Size Breakdown of Global Processing IC Chip Industry by Sales Revenue (in US$ Billion)

 

LOGO

Note: The IC market is formed by processing segments including CPU, GPU, FPGA, ASIC and others. Non-processing chips, including memory, baseband chips, radio frequency chips and others, are not included in the above chart.

Source: Frost & Sullivan

Overview of Blockchain Applications with ASIC

Overview of Blockchain Industry

Blockchain is an open-source peer-to-peer decentralized digital ledger comprising a series of data blocks that are linked and secured using cryptography. Transactions are validated by nodes who agree to a protocol that determines the true state of the ledger. The digital ledger is continuously growing as new blocks are added to it to record the most recent transactions in a linear, chronological order. The information is stored across a network of a large number of computers all over the world with no central intermediary involved.

 

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Blockchain technology holds significant potential to dramatically disrupt a broad spectrum of industries beyond the storage and transfer of value. Blockchain technology also has the potential to turbocharge the effectiveness and profitability of most businesses, or even to revolutionize the world economy. Cryptocurrencies may be the most obvious application of the blockchain, but the transparent and immutable nature of the distributed ledger technology presents a multitude of practical use cases. For example, the blockchain-based application in financial services has the potential to revolutionize international payments, making them faster, cheaper, and more secure with lower counterparty risk, which would ultimately make our society more productive. Further, the trade finance blockchain platform can improve and accelerate the financing of international trade. Similarly, in the public sector, blockchain-based applications can allow for better traceability and proof of transaction and can manage the digital identity of people and ownership and transaction information on different assets such as real property and vehicles in order to increase efficiency and reduce fraud.

Overview of Bitcoin and Blockchain Mining Economics

Bitcoin, introduced to the world in December 2008, is the first cryptocurrency and has become the most important cryptocurrency in terms of public recognition and transaction volume. As the largest and most secure public blockchain network, Bitcoin has proven the efficacy of blockchain technology. Further development of Bitcoin will help to expand the blockchain industry and ecosystem. The massive amount of computing power required to operate the Bitcoin network will continue to drive the development and innovation of IC solutions for complex computational problems. Bitcoin is designed with a finite supply of 21 million. The number of Bitcoin reward per new block is designed to halve approximately every four years, and Bitcoins will be fully mined out by the year 2140. As of June 30, 2019, 17.8 million Bitcoins have already been mined.

“Mining” is the process of adding transaction records to Bitcoin’s blockchain, which serves to confirm transactions to the rest of the network. Mining is intentionally designed to be resource-intensive and difficult so that the number of blocks found each day by miners remains steady. Individual blocks must contain a proof of work to be considered valid.

Bitcoin mining serves to both add transactions to the blockchain and to release new Bitcoin. The mining process involves compiling recent transactions into blocks and trying to solve a computationally difficult puzzle. The first participant who solves the puzzle gets to place the next block on the blockchain and claim the rewards. The rewards incentivize mining and include both the transaction fees (paid to the miner in the form of Bitcoin) as well as the newly released Bitcoin.

The chart below illustrates the Bitcoin industry value chain and key players, according to Frost & Sullivan. The Bitcoin industry consists of five major elements, namely hardware supply, operation of mining farm and mining pool, trading and payment. Hardware suppliers, such as Canaan, mainly focus on mining IC design and mining machine manufacture as well as sales of mining machines. Mining farms usually refer to physical mining sites where operators offer customers custodian services for their mining hardware. Operation of mining pools refers to services that enable miners to contribute their computing power and split mining rewards. Trading refers to services provided by cryptocurrency exchanges for consumers to buy and sell cryptocurrency. Payment refers to services provided by Bitcoin payment processors, which enables merchants and businesses to receive payments in Bitcoins from individuals for goods sold and services rendered.

 

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Value Chain of the Bitcoin Industry

 

 

LOGO

Source: Frost & Sullivan

The demand and price of Bitcoin mining machines are primarily determined by the expected economic return of Bitcoin mining activities, which is significantly affected by the Bitcoin price, as well as other factors such as the electricity price, the hash rate of mining equipment, the total network hash rate and the difficulty of mining.

The total network hash rate and the mining difficulty, which is the complexity of the task that miners need to solve to create the block, are positively correlated in the sense that the more difficult mining on the network becomes, the more hash rate is needed, leading to additional demands for mining hardware within the network. According to Frost & Sullivan, from 2014 to 2018, the hash rate of the Bitcoin network experienced an upward trend, despite some fluctuations. As of the end of June 2019, the hash rate of the Bitcoin network reached approximately 56 Ehash/s.

The Bitcoin price rose stratospherically by 1,289.0% in 2017. As the value of Bitcoin became more extensively recognized, more investments rushed into the market, which led to the sharp increase of the Bitcoin price during the year. As a result, an increasing number of miners have been seeking more high-performance cryptocurrency mining hardware to offset the fast-growing mining difficulties.

 

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Bitcoin Hash Rate and Price

 

 

LOGO

Source: Frost & Sullivan

From 2009 to June 2019, the total mining revenue, including mining rewards and transaction fees, experienced fluctuations and increased from approximately US$8.6 thousand in July 2010 to approximately US$559.7 million in June 2019. There were two halving events, or times when the amount of Bitcoins awarded for solving a block is halved, which occurred in November 2012 and July 2016. After the first halving event in November 2012, mining revenue increased nearly ten times from US$2.5 million in November 2012 to US$23.9 million in October 2013. After the second halving event in July 2016, mining revenue increased from US$49.2 million in July 2016 to US$179.8 million in June 2017. As suggested by the historical data, the halving event would generally stimulate the Bitcoin price and further increase the total mining revenue in the long run.

Based on the value chain analysis, the Bitcoin mining revenue can be viewed as being shared among various parties:

 

   

Upstream suppliers for Bitcoin mining machine manufacturers

 

   

Bitcoin mining machine manufacturers

 

   

Bitcoin miners

 

   

Bitcoin holders

Bitcoin mining machine manufacturers typically price their product based on 150 to 300 days of payback period of Bitcoin mining, which is defined as the period of time for a miner to recover the costs of Bitcoin mining based on the market prevailing Bitcoin price. It is estimated that the proportion of the total Bitcoin mining revenue they captured in 2017 and 2018 were 22.9% and 23.4%, respectively. While Bitcoin miners currently rely on mining rewards, which are the newly released Bitcoins, for the majority of their revenue, the reduction in Bitcoin supply will cause most of the revenue to be generated from Bitcoin transaction fees in the long run.

 

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Bitcoin Mining Revenues and Transaction Fee Percentage (in US$ Million)

 

 

LOGO

Source: Frost & Sullivan

According to Bitcoin.com, the range of Bitcoin daily closing price during the last 12 months as of July 21, 2019 was between US$3,202 to US$12,806. The range of total computing power of Bitcoin network during the last 12 months as of July 21, 2019 was between 34.8 EH/s to 68.3 EH/s. According to Frost & Sullivan, the payback cycle analysis discussed below utilizes the specifications of Canaan’s A921 Bitcoin mining machine assuming Bitcoin miner purchase this machine at its production costs of approximately RMB220 per Thash/s, based on different utility cost assumption (Case 1: Based on utility price at RMB0.2 per kWh; Case 2: Based on utility price at RMB0.4 per kWh).

Illustrative Sensitivity Analysis of Payback Period (Number of Days)

 

LOGO

 

Notes:

(1)

Above indicative analysis is based on various assumptions which may not reflect the actual payback cycle.

(2)

Canaan’s A921 system product has a computing power of 20 Thash/s and power consumption of 1,800 Watt.

 

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(3)

The symbol “ * ” denotes scenarios where the value of Bitcoin rewarded is not able to cover the cost of the Bitcoin mining machine.

(4)

Other key assumptions for the above payback cycle analysis includes (i) daily fixed rewards of 1,800 (current theoretical reward level) Bitcoins available across the entire Bitcoin network, which are distributed uniformly across miners by the computing power to which the miners contribute; (ii) the Bitcoin mining machine operates 24 hours per day.

(5)

For simplicity purposes, the payback cycle analysis also applies certain assumptions, which in reality would vary across miners and evolve over time. These assumptions include (i) Bitcoin prices staying at a constant level during the payback period and mining revenues being measured with given bitcoin spot rate; (ii) the network computing power staying at a constant level throughout the payback period; (iii) miners incurring constant electricity costs; (iv) Miners not receiving any transaction fees; (v) miners not incurring operational costs other than initial purchase cost of the Bitcoin mining machine and utility costs; and (vi) no halving event of Bitcoin occurs during the payback period.

As shown in the table above, given a constant utility cost at RMB0.4 per kWh, assuming Bitcoin price of US$7,000 and network computing power of 50 EH/s as well as holding all other above assumptions constant, the actual payback cycle at that particular moment would be 259 days, which is in line with Bitcoin miner’s expectation, making the sale of Bitcoin mining machines above the cost of RMB220 per Thash viable. However, a potential buyer of Bitcoin mining machine may take into consideration of increase in network computing power to 70 EH/s in view of launch of new generation of Bitcoin mining machines by major market players, therefore making the expected payback cycle to be 611 days and difficult to justify a price tag of RMB220 per Thash. In contrast, another potential buyer of Bitcoin mining machine may consider his or her personal bullish view of future Bitcoin price and expect a future Bitcoin price of US$9,000, thereby expecting the payback cycle to be 164 days. Manufacturers of Bitcoin mining machine typically make judgment on prevailing Bitcoin miner sentiment and price their products accordingly.

Cryptocurrency mining machines comprise the overwhelming majority of blockchain hardware. The global Bitcoin mining hardware industry is predominately comprised of ASIC-based Bitcoin mining hardware. According to Frost & Sullivan, the market size of the global Bitcoin mining machine industry in terms of revenue increased from RMB1.1 billion in 2014 to RMB21.4 billion in 2018, representing a CAGR of 110.0%. In the next five years, the market size of the global Bitcoin mining machine market in terms of revenue is expected to increase to RMB31.7 billion in 2023, representing a CAGR of 8.2%. It is likely that the price of Bitcoin in late 2019 would continue to fluctuate in the mid-to-high price range. As compared with the beginning of 2019, the market size of the ASIC-based mining machine in the second half year of 2019 is estimated to recover but the total revenue in 2019 would still decrease by approximately 23.4% from 2018, which is mainly influenced by the decrease of the Bitcoin price at the beginning of 2019. The next halving event is designed to occur in 2020. Generally, the halving event would cause a positive influence on the Bitcoin mining market by driving the Bitcoin price up. Therefore, the market for ASIC-based Bitcoin mining machines is anticipated to increase faster than it has in 2019 and eventually reach approximately RMB31.7 billion by 2023.

Market Size of ASIC-based Bitcoin Mining Hardware Industry, by Revenue (in RMB Billion)

 

 

LOGO

 

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Note: the market size refers to the sales revenue of ASIC-based mining machines and accessories made by professional manufacturers. The chart uses the exchange rate of US$1 to RMB6.616.

Source: Frost & Sullivan

Competitive Landscape of the ASIC-based Bitcoin Mining Machine Industry

The global ASIC-based Bitcoin mining machine market is relatively concentrated with a few large competitors. Most of the leading players are based in the PRC. We are ranked second globally and in the PRC among fabless designers of ASIC-based Bitcoin mining machines in terms of shipment of Bitcoin mining machines and total share of computing power for the six months ended June 30, 2019, according to Frost & Sullivan. For the six months ended June 30, 2019, our market share in terms of computing power sold amounted to 21.9% and our market share in terms of shipment of Bitcoin mining machines amounted to 23.3%, according to Frost & Sullivan.

 

Ranking

  

Company Name

   Estimated Sales
Volume
(Thousand Sets)
     Market Share
(Sales Volume)

(%)
     Estimated
Computing
Power Sold
(Million TH/S)
     Market Share
(Computing
power) (%)
 

1

   Company A      700.2        64.5        11.6        65.2  

2

   Canaan      253.3        23.3        3.9        21.9  

3

   Company C      93.0        8.6        1.4        7.9  
     

 

 

    

 

 

    

 

 

    

 

 

 
   Top three total      1,046.5        96.4        16.9        95.0  
     

 

 

    

 

 

    

 

 

    

 

 

 
   Total      1,085.4        100        17.8        100  
     

 

 

    

 

 

    

 

 

    

 

 

 

Note: the above ranking only considers the producers of end products, which do not include GPU card producers.

According to Frost & Sullivan, our range of Bitcoin mining machines offer strong computing power, low energy consumption, high reliability and high performance-to-price ratio compared to those of its peers.

Overview of AI Application with ASIC

AI is a branch of computer science that makes it possible for machines to learn from structured data sets, adjust to new inputs and perform human-like tasks. AI processes include training (the acquisition of information and rules for using the information), inference (using rules to reach approximate or definite conclusions) and self-correction. Some of AI’s functions include voice recognition, object detection, predictive analysis and machine vision.

Driven by the growing volume of big data, the increasing adoption of AI-related applications and services, and the increasing demand for intelligent virtual assistants, the global AI industry has experienced strong growth in recent years. According to Frost & Sullivan, the global AI industry is expected to continue its upward trend with a CAGR of 33.2% from RMB396.3 billion in 2018 to RMB1,660.6 billion in 2023, with China outperforming the global average at an estimated CAGR of 51.0% during the same period, reaching RMB285.8 billion at the end of 2023.

Key Trends of AI Chips Market

AI chips can be broadly categorized into two categories: cloud AI chips targeting cloud training and inference and edge AI chips used on a specific smart device mainly for inference purposes. AI chips targeting cloud training and inference are generally used for processing big data on the cloud server, in the process of which an AI model is trained to analyze the data, learn from the data and obtain the intelligence to perform analysis and conduct inference. On the other hand, edge AI chips would be used mainly for inference at the edge with machine learning models that have been trained on the cloud, which effectively addresses the issues faced

 

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by cloud AI chips such as latency, bandwidth, and privacy concerns. Underpinned by the rapid development of IoT and 5G technology, it is expected that the global edge AI chip segment will register a higher CAGR of approximately 62.1% from 2018 to 2023 than that of cloud chips during the same period.

In China, network operators such as China Telecom and China Unicom are moving toward 5G to deliver differentiated services for enterprise and vertical markets. As the fundamental component, edge chips can play an important role to facilitate the offering of AI services for companies and consumers. While edge AI computing power is expected to have strong demand in the future, power consumption and costs are two of the key constraints of wide adoption of edge AI technology. Benefiting from the lower cost, higher power efficiency and various downstream IoT applications, ASIC edge AI chips are anticipated to grow at a faster CAGR and gain a larger market share from 21.3% in 2018 to approximately 40.9% in 2023, according to Frost & Sullivan.

Market Size of China Edge AI Chip Industry, by Revenue (in RMB Billion)

 

 

LOGO

Note: The market size includes revenue generated by foreign players in China.

Source: Frost & Sullivan

Key AI Application Scenarios

The rapid development of IoT technology creates substantial demand for artificial intelligence chips. In recent years, IoT technologies have moved from to-business end and to-government end toward to-customer end. The application of IoT appliances and devices of to-customer end has been increasing due to the growing focus on smart retail and the rising implementation of automation in homes in recent years.

Edge devices cover various IoT application scenarios. In the future, many edge devices in AI application scenarios will mainly perform inference computing, which requires the edge devices to have sufficient inference computing ability. As compared with cloud computing, edge computing transfers intelligent computing to edge devices, and the computing process is performed on distributed device nodes of smart devices (such as mobile phones), rather than in centralized cloud environments. Edge computing is carried out in local network, which greatly reduces the processing time and bandwidth cost of network transmission. It can also save more energy for edge devices with limited power and prolong the service life of devices.

Emerging advancements in hardware and modules drive the development of AI and AI driven IoT devices at the edge are booming in China. As IoT devices become more common and incorporate more processing power, a vast amount of data is being generated on the outer “edge” of computing networks. Traditionally, the data produced by IoT devices is relayed back to a central network server. Once that data is processed, further instructions are sent back to the devices out on the edge of the network, which may cause latency, bandwidth,

 

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and privacy concerns. Edge computing offers a solution to these problems by relocating crucial data processing to the edge of the network.

The future of network infrastructure is unlikely to be found solely on the edge or in the cloud, but rather somewhere in between the two. By combining the data-gathering potential of edge computing with the storage capacity and processing power of the cloud, companies can keep their IoT devices running fast and efficiently without sacrificing valuable analytical data that could help them improve services and drive innovation.

Business intelligence and life intelligence are two key verticals of IoT application and are expected to be the driving force in the AI field. The market shares of the business intelligence and life intelligence segments accounted for 8.3% and 19.9% of the AI-empowered vertical industries in 2018, respectively, and are expected to increase to 15.9% and 26.1% in 2023, respectively.

 

   

Business Intelligence. Business intelligence encompasses, among others, smart building, smart retail and smart industrial applications. With regard to smart building, AI technology is used in conjunction with information technology to optimize overall building performance, and is also applied to access control systems, smart locks and smart meters. With regard to smart retail, AI technology can be applied by businesses for analytical purposes to empower sales growth, create business opportunities and enhance operational efficiency. AI technology also enables merchants to provide personalized experiences for customers, such as deploying smart sensors throughout their stores to provide customers with relevant and targeted purchasing information. In addition, AI technology can help merchants to identify and track each individual item for better inventory management. With regard to smart industrial applications, AI technology can be applied in logistic solutions, including intelligent sorting and transportation in complex warehousing environments. According to Frost & Sullivan, the market size of business intelligence in China amounted to RMB970.6 million in 2018, and is expected to increase to RMB29.6 billion in 2023 at a CAGR of 98.1%.

 

   

Life Intelligence. Life intelligence mainly refers to the application in smart homes, which enables users to control various smart devices such as air conditioners and kitchen appliances, remotely and locally. Life intelligence also includes other IoT applications such as smart toys. According to Frost & Sullivan, the market size of life intelligence in China amounted to RMB2.3 billion in 2018, and is expected to grow at a CAGR of 84.1% to RMB48.7 billion in 2023.

Market Size of AI-Empowered Vertical Industries in China (in RMB Million)

 

LOGO

Note: The above chart includes software and services, which cover SaaS and Platform as a Service, AI software development kit, as well as hardwares such as AI embedded smart IoT devices.

 

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Competitive Landscape of Global and China AI Chips

Due to advances in both AI technology and ICs, both the global and Chinese AI chip markets have started to flourish over the past few years, with leading IC designers and high-tech companies, such as Intel, Nvidia, Google and Amazon, as well as new players rushing into the market. Despite the competition, the AI chip industry is still in its early stages with limited commercially available applications. As the AI chip industry develops, the market is expected to expand, taking into account the potential rise in supply and unpredictable demand. However, new market entrants may lack manufacturing experience and may need time to build up their competitiveness. Only a few players have developed commercialized products.

Among a wide range of applications in edge AI chips, Apple and Qualcomm have been leading global players in AI-powered smartphone chips, while Huawei and Cambricon have successfully integrated AI processing units onto their smartphone processor Kirin. Most domestic players in China are focusing on consumer IoT scenarios such as smart home, smart building and smart retail markets by taking advantage of consumption upgrades and the deployment of the 5G network. These companies include, among others, Canaan, Hisilicon and Rockship. As the IoT industry continues to grow rapidly, more diversified needs and application scenarios will emerge. Driven by user needs, innovation in AI chip technologies will facilitate a more closely connected research and development process and commercializing process and will eventually form an open, mutually beneficial industry ecosystem.

Market Drivers of AI Chips in China

China’s AI Chips market is expected to continue growing over the next few years. We believe the main drivers are:

 

   

Increasing capital investment. Artificial intelligence chips are enjoying increasing capital support as more investors are becoming interested in the industry. Capital from technology companies and investors are flowing into this industry, which will further improve innovations of AI chips and provide huge market potential in different market sectors.

 

   

Development of 5G technology. The development of 5G technology is an accelerator of many aspects of the technology sector, including the development of the AI chips market. 5G will increase the speed and efficiency of data transmission from edge to cloud for processing. 5G technology has officially entered the stage of infrastructure layout, and commercial use is planned to begin in 2020.

 

   

More application scenarios. Chinese AI chips, which previously were mostly applied to security-related functions, are being applied to smart IoT devices such as smart speakers, smart TV, smart wearables and smartphones in recent years.

 

   

Favorable government policies. In July 2017, the State Council of China released the “New Generation Artificial Intelligence Development Plan” ( LOGO ). This policy outlines China’s strategy to build a domestic AI industry worth nearly US$150 billion in the next few years and to become the leading AI power by 2030.

 

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BUSINESS

Mission

Our mission is to make supercomputing available for everyone and to enable the wide adoption of blockchain and AI technologies for better living.

Overview

We provide supercomputing solutions through our proprietary high performance computing ASICs. Our visionary management team has a clear strategy to commercialize supercomputing technology. In January 2013, Mr. Nangeng Zhang, our chairman and chief executive officer, and his team, invented and delivered one of the first Bitcoin mining machines incorporating ASIC technology. Our founders and management team have a clear strategy to commercialize supercomputing technology. We initially dedicated our research and development efforts to ASIC applications for Bitcoin mining, which rapidly built up our know-how of ASIC design. Such experience provides us with a solid foundation in terms of both technology and capital resources, which better prepares us for further research and development involving AI chips. We were the second largest designer and manufacturer of Bitcoin mining machines globally in terms of computing power sold in the six months ended June 30, 2019, according to Frost & Sullivan. During the same period, our Bitcoin mining machines sold accounted for 21.9% of the combined computing power of all the Bitcoin mining machines sold in the global market, according to Frost & Sullivan. We were the first in the industry to deliver commercial edge computing AI chips based on Risc-V architecture and self-developed neural-network accelerator with outstanding performance in September 2018. As we are a fabless IC designer, the ICs that we design are manufactured, packaged and tested by industry-leading suppliers, including TSMC, STATS ChipPac, ASE and SPIL.

We have developed significant advantages in our business and technological capabilities, including the following:

 

   

Our mastery of the whole IC design process;

 

   

Our years of accumulated engineering experience in applying theoretical research to the mass production of new products, producing over 100 million chips in 2017 and 2018;

 

   

Our ability to achieve a fast time-to-market with our products and our successful early monetization of the ASIC design in blockchain applications have provided us with an early advantage with respect to both technology and capital reserve to pursue our strategic initiatives;

 

   

Our breakthroughs in various technological fields to improve ASIC performance, such as low voltage and high power efficiency operations and high computing density, all of which are crucial features for ASICs for blockchain and AI solutions;

 

   

Our ownership of most of the intellectual property we employ, and our accumulation of valuable know-how and multiple generations of proprietary silicon data through our years of ASIC design experience;

 

   

Our ability to provide a holistic AI solution to our customers, including AI chips, algorithm development and optimization, hardware module, end-product and software services; and

 

   

Our close and trusted partnerships with leading global suppliers, which have enabled us to achieve high-quality, high yield rate and stable production, with a 100% success rate for all of our seven tape-outs.

Our total revenues increased from RMB1,308.1 million in 2017 to RMB2,705.3 million (US$393.5 million) in 2018, representing a year-on-year growth of 106.8%. During the same period, our net income decreased from RMB375.8 million to RMB122.4 million (US$17.8 million), representing a year-on-year decrease of 67.4%. Our adjusted net income, a non-GAAP measure defined as net income excluding share-based compensation, was RMB141.0 million (US$20.5 million) in 2018 as compared to RMB471.3 million in 2017. See “Summary Consolidated Financial and Operating Data—Non-GAAP Financial Measures.”

 

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Our Competitive Strengths

We believe that the following strengths contribute to our success and differentiate us from our competitors:

We are a leading provider of supercomputing solutions.

According to Frost & Sullivan, blockchain and AI have the potential to disrupt every industry in the economy, and we believe computing power is the key bottleneck for blockchain and AI performance. In order to facilitate more integration of blockchain and AI technologies into people’s work and daily lives, we believe it is necessary that the computing power for these technologies become energy efficient, affordable and reliable so that the applications can be supported. In view of this, we expect ASICs to play a crucial role in supporting the development and accessibility of blockchain and AI technologies as ASICs can provide equivalent computing power with remarkably high power efficiency and low cost, as compared with other types of chips.

We believe that we are one of the few companies in the world to possess advanced technological know-how throughout the ASIC design process, including algorithm development and optimization, standard cell design and optimization, low voltage and high power efficiency operations, design of high performance system and heat dissipation technology. We believe that our deep know-how in designing and the mass production of high power efficiency ASICs in Bitcoin mining machines enables us to capture and sustain a leadership position in both the blockchain and AI fields. Further, our years of experience and deep know-how enable us to achieve high computing power with reduced size and increased power efficiency of ASICs, which is fundamental to designing commercially successful ASICs for AI applications.

We secure our competitiveness in blockchain applications with superior tapeout success and proprietary silicon data. We were the second largest designer and manufacturer of Bitcoin mining machines globally in terms of computing power sold in the six months ended June 30, 2019, accounting for 21.9% of the combined computing power of all the Bitcoin mining machines sold in the global market, according to Frost & Sullivan. Since June 2015, we have completed a total of seven tape-outs for 28nm, 16nm and 7nm ASICs at a 100% success rate. The high tape-out frequency and success rate as well as superior final test yield demonstrates our strong design capabilities and sophisticated operations. We own most of the intellectual property we employ, and we have accumulated valuable know-how and multiple generations of proprietary silicon data through our years of ASIC design experience.

On the other hand, we were the first in the industry to deliver commercial edge computing AI chips based on Risc-V architecture and self-developed neural-network accelerator with outstanding performance in September 2018, which is widely recognized as a milestone for hardware advancement in the AI edge computing field, according to Frost & Sullivan. Our AI chip is a one stop integrated solution under SoC architecture with voice and image recognition capabilities that can seamlessly integrate different algorithms to handle a wide range of application scenarios, including smart homes, smart retail and intelligent driving. Tirelessly honing our IC design capability and product strength and following our long-term research and development roadmap, we have been continuously advancing the technology and performance of our products, and we are in a position to innovate with our partners to launch AI-facing best practices, empowering end customers with high-performance, all-scenario industry AI solutions.

We are able to achieve a fast time-to-market.

Mr. Nangeng Zhang, our chairman and chief executive officer, and his team, invented and delivered one of the first cryptocurrency mining machines to incorporate ASIC technology. We were also among the first to recognize the advantage of ASICs for AI application and initiated research and development in the field beginning in 2016, enjoying first-mover advantage in the development of ASICs for AI application.

Since 2017, we have released four generations of Bitcoin mining products. We believe our ability to deliver new products with high performance more quickly provides us with a strategic advantage given that the

 

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performance requirements in Bitcoin mining continue to rapidly evolve. For our AI chips, we collaborate closely with our customers and technology partners to understand and help them identify their needs to commercialize our innovations into our products, such as scenario-based algorithm development and optimization, and continue to optimize our products based on immediate feedback from our customers. We design our ASICs in-house, enabling us to leverage proprietary silicon data for next generation products. Furthermore, from our past 100% successful tape-outs, we own the most critical silicon data that gives us advantages to deliver the most advanced product ahead of our competitors.

Our design capability and fast time-to-market are evidenced by the fact that we were the first to deliver 7nm ASICs, the most advanced process technology in the world.

We were the first in the industry to deliver commercial edge computing AI chips on Risc-V architecture and self-developed neural-network accelerator with outstanding performance.

Besides high computing power and high energy efficiency, edge-based AI processing involves low latency and offers better protection for confidentiality of the proprietary data, making ASICs the most promising candidate to perform edge-based AI tasks, according to Frost & Sullivan. After we initiated the research and development process for the application of ASICs for AI solutions in 2016, we released the first generation of our AI chip, K210, in September 2018, which is embedded with our self-developed neural-network accelerator that enables leading voice and image recognition functionalities which can be widely applied in smart homes, smart buildings and other IoT applications.

We were the first in the industry to deliver commercial edge computing AI chips based on Risc-V architecture and self-developed neural network accelerator with outstanding performance, which is widely deemed to be a milestone for hardware advancement in the AI edge-computing field, according to Frost & Sullivan. Compared with other IC architecture, Risc-V is suitable for IoT hardware adoption due to its flexibility and open-source characteristics. Further, the code of Risc-V is simple, elegant and very well suited for edge computing, according to Frost & Sullivan, and our self-developed neural-network accelerator enables hardware acceleration to increase power efficiency and enhance performance.

Our K210 chip offers a one stop integrated solution under SoC architecture that enables multiple functions of AI, including machine vision and machine hearing functions, and is able to achieve increased power efficiency compared to other systems with the same computing power. In addition, our edge computing AI chips protect and enhance the confidentiality of proprietary data. Compared with the AI chips offered by competitors, our single AI chip can handle a wider range of AI application scenarios.

Our K210 chip is widely accepted and recognized for its cutting-edge technology and commercialization potential. As of June 30, 2019, we have shipped over 20,000 K210 chips and development kits to AI product developers, the majority of which are from overseas, and we have initiated cooperation with over 20 AI algorithm companies to co-develop holistic AI solutions for end consumers. Most edge devices have no learning capability now and everything is run on rule-based systems. Our AI products and services upgrade the infrastructure so that all the edge devices are intelligent, which will enhance the robustness of our AI development ecosystem and ultimately provide a better experience for end consumers. We have also actively explored collaboration with business partners and integrated our AI chips in different IoT vertical markets, such as smart home, smart building and smart retail.

We jointly developed and launched, with the AI platform of a leading Chinese technology company, a core processing module for AI operations, which is characterized by its compactness, excellent performance, ease of development and verification by developers, and suitability to be used as a development platform or to be applied directly in products. Our cooperation with this company demonstrates our unique value as an edge computing hardware provider in its AI ecosystem. We also have a mutually beneficial strategic cooperation with iSoftStone, in which we provide iSoftStone with support for AI chip hardware and relevant algorithm optimization and have access to iSoftStone’s vast customer network.

 

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Our outstanding production track record and strong supply chain management ensure our product quality and production capability.

We have an outstanding mass production track record and have established strong supply chain management through partnerships with leading global production partners throughout our IC production processes, which ensure our product quality and production stability as well as accumulating feedback from actual production which we use to continuously improve our test yield. Since June 2015, we have completed a total of seven tape-outs for 28nm, 16nm and 7nm ASICs with a 100% success rate. The high tape-out frequency and success rate demonstrates our strong design capacities, sophisticated operations and strong supply chain management capability.

We have access to the 7nm process, currently the most advanced production process according to Frost & Sullivan, with our partnership with TSMC, the leading IC foundry globally, with whom we have developed an established, trusted, stable and mutually beneficial relationship since early 2015. We were selected by TSMC as one of the first few partners for the tape-out of 7nm ASICs, the most advanced IC process technology in the world, demonstrating our position as a top tier IC designer globally. We also work extensively with ASE, STATS ChipPac and SPIL, which are among the largest IC packaging and testing services providers in the world, for IC packaging and testing services. Currently, as we have achieved sufficient production volume and our product range has widened, we are in a position to work with different foundries and IC packaging and testing services providers for different products and are still able to secure a favorable price and production capacity allocation. By diversifying our suppliers, we will be able to mitigate supply chain risks and better meet fluctuating demand.

We believe we are one of the few companies that is able to develop such strong relationships with these leading production partners due to our advanced research and development capabilities, rich product engineering experiences, robust capital position and the business opportunities our products present to these leading production partners.

Our ability to make sustainable investments in AI technology.

With solid proprietary technology as a result of our research and development investments and fast time-to-market of our products, we have achieved early commercialization and monetization for the ASIC design in blockchain applications. As a result, we have managed to be financially resilient and mostly self-sufficient. In 2017 and 2018, we sold a total of 294,523 units and 559,137 units of Bitcoin mining machines, respectively, representing a total computing power sold of 2,114,637 Th/s and 7,158,666 Th/s and generating RMB1,296.5 million and RMB2,642.7 million (US$384.4 million) of revenue, respectively.

Up to December 31, 2018, we have only raised in total RMB307.5 million of funding in our two series of equity financing. Since we released our A6 series of Bitcoin mining machine in 2015, we have been profitable. We believe the successful commercialization of our ASIC products in blockchain application has provided us with an early advantage with respect to both technology and capital reserve for long-term development.

We have a visionary management team, as well as a talented research and development team.

Our management team is focused on the development trends of leading technologies. They have a clear strategy to commercialize supercomputing technology. We initially dedicated our research and development efforts to ASIC applications for Bitcoin mining, which rapidly built up our know-how of ASIC design. Such experience provides us with a solid foundation in terms of both technology and capital resources, which better prepares us for further research and development involving AI chips.

Our co-founders possess complementary expertise in IC design and manufacturing and software development. Building on these skills, our co-founders have been able to effectively identify and monetize business opportunities in blockchain technology. Mr. Nangeng Zhang and his team are credited with inventing one of the first Bitcoin mining machines to incorporate ASIC technology.

 

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We are dedicated to the technological development of ASIC applications in blockchain and AI. Unlike many of our industry peers, we have never been involved in cryptocurrency speculation or any cryptocurrency mining activities. We are persistently focused on technological development, design and research, and are deeply committed to the long-term development of the blockchain and AI industries. We are passionate about leveraging our current position in the blockchain and AI industries to support and elevate those industries.

Our core research and development team has remained stable, working together with the co-founders for over four years. We had a research and development team of 148 members as of December 31, 2018, with an average of more than seven years of industry experience.

Our Growth Strategies

We intend to grow our business using the following key strategies:

Strengthen our leadership position in supercomputing solutions.

We believe in the long-term growth potential of blockchain and edge computing applications in AI. As a result, we will continue to introduce IC solutions offering higher performance for blockchain and AI applications with customized software development and services. We will also continue to upgrade our Bitcoin mining machines with enhanced performance and competitiveness by incorporating the most advanced technologies. In addition, for our AI products, we will continue to enhance the performance and functionalities of our AI chips and provide a holistic AI solution to end customers. We strive to offer the most user-friendly, cost effective AI solution for our customers.

Continue to invest in high power efficiency IC design.

We aspire to develop advanced IC designs for supercomputing hardware and innovative applications. We will follow a market-oriented research and development approach to ASIC production process and physical design, and we will focus on projects that have a relatively clear path toward market acceptance and commercialization opportunities.

We have consolidated the research and development of back-end and physical design for both our blockchain and AI products into our high power efficiency design group, in order to consolidate internal technology and provide comprehensive support to both business lines. We will continue to invest in research and development and attract talent to strengthen our technology development capabilities for our high-power efficiency design group. We will also continue to provide internal training and development to our current employees.

Continue to introduce new AI products.

We will continue to design and launch AI chips and other ASICs for AI applications, as well as educate and explore the market for software and application/end-use partners for our AI ASICs. We will initially focus on edge computing and continue to explore applications in the fields of smart retail and intelligent driving. We are currently developing the second generation of our AI chips and will continue to release new generations of our AI chip.

Enhance our AI platform business model to build on our AI products.

Leveraging our AI chip as the core hardware, we plan to create an AI SaaS platform to enable holistic AI service incorporating hardware, algorithm and software for end customers to create a complete and open ecosystem. Tailoring the needs of different IoT scenarios, our AI SaaS platform will enable us and our business partners to offer an optimized combination of AI chip model, algorithms and customized software and user interface for AI end customers. For example, in order to facilitate the application of smart lock, our low cost,

 

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high performance AI SoC is combined with different algorithms and provides conditional access as a service. The customers do not have to be bothered with underlying infrastructure and we charge the customers by number of entrances per month rather than by one time hardware purchase. The implementation of this strategy will simplify the development process of AI solutions, ensure a better experience for end customers, and also create a constant revenue stream generated from the SaaS service we provide in the future.

Continue to enhance our supply chain management.

We plan to strengthen our supply chain management capability by improving internal coordination among procurement, manufacturing and quality control, as well as upgrading our management software. In addition, we intend to deploy an enhanced inventory management system based on dynamic sales projections and to adopt a more prudent policy for prepayment to suppliers. We will also enhance our supply chain capability, including production management, design quality, working capital efficiency and final test yields.

We are devoted to upgrading our relationships with production partners, such as establishing direct communication with teams in charge of production decision-making at our suppliers and enhancing our bargaining power. We will selectively explore collaboration opportunities with new partners who have leading technologies and sufficient capacities to enhance our production flexibility and operating efficiency. For example, with a view to diversifying our IC packaging and testing suppliers, we commenced our cooperation with SPIL in 2017. We will also explore collaboration with new foundries in order to diversify our supply chain.

Continue to expand our overseas operations.

We plan to further diversify our business geographically as well as explore new markets globally. To achieve this, we plan to establish overseas offices in Singapore, Japan, the United States and Israel to facilitate local marketing campaigns so as to enhance our overseas exposure and expand our overseas customer base. We also plan to recruit talent for research and development, investment, and sales for our overseas offices. We intend to increase our international sales team to meet the increased demand from overseas markets. We also intend to pursue strategic overseas investment opportunities, such as identifying and acquiring suitable companies that would help us reach our expansion goals.

 

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Our Business Model

We are a fabless IC designer that provides advanced semiconductor solutions for supercomputing hardware. We are engaged in the front-end and back-end of IC design, which are the major components of the IC product development chain. We currently sell Bitcoin mining machines under our AvalonMiner brand that feature our proprietary ASICs which we design in-house, as well as ASICs designed for AI applications. We also sell Bitcoin mining machine parts and offer after-sales technical services for our products.

See forth below is a diagram illustrating the production process of our IC products:

 

LOGO

We closely partner with industry-leading third-party suppliers to fabricate, test and package the IC products we design. For our Bitcoin mining machine, we assemble the final Bitcoin mining machines by integrating the ICs produced by us and related components we procure. Our strong design capability has ensured that we have achieved a 100% tape-out success rate to date. Our front-end design capability ensures the robustness of our ICs, which can recover from any logic fault. Further, we carry out a complete verification process notwithstanding the significant time pressure to roll out new designs. We use FPGA based prototyping and simulation to ensure that the functionality and performance of our products are consistent with their design intent. Moreover, our rich experiences from previous tape-outs provide us with a vast amount of data that enable us to more accurately estimate the product’s power efficiency, performance and yield rate at the back-end design stage.

We have endeavored to leverage the trend of early and large-scale adoption of advanced process technologies to build a world-class semiconductor company. We aim to continuously introduce ICs of higher performance and power efficiency for application in both the blockchain and AI fields.

Our Products

Bitcoin Mining Solutions

In 2009, CPUs were the initial Bitcoin mining solution. As the requirements for computing power grew, Bitcoin miners gradually migrated to chips with stronger computing power, including GPU and FGPA. In 2013,

 

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Mr. Nangeng Zhang, our chairman and chief executive officer, began to offer ASIC-based hardware as a more effective Bitcoin mining solution.

Set forth below is a summary of the milestones and status of the development of our ASICs developed for Bitcoin mining solutions.

 

ASICS

  

Status and expected timeline*

28nm

  

•  Production end of life

16nm, First Generation

  

•  Production end of life

16nm, Second Generation

  

•  Mass production of final products in 4th quarter 2017

16nm, Third Generation

  

•  Mass production of final products in 2nd quarter 2018

7nm, First Generation

  

•  Mass production of final products in 3rd quarter 2018

16nm, Fourth Generation

  

•  Mass production of final products in July 2019

8nm, First Generation

  

•  Mass production in September 2019 (expected)

 

*

The expected timeline of the mass production of 8nm ASICs is based on our best estimates, which can be affected by factors beyond our control, including but not limited to, delays cause by our suppliers.

Since our incorporation in 2013, we have offered a single line of Bitcoin mining machines, under the AvalonMiner brand. The AvalonMiner Bitcoin mining machines feature our proprietary ASICs, and the ASICs are integrated with components procured by us including a circuit board, PMU boards, a cooling fan, heat sensors, and enclosed with an aluminum casing. We typically introduce new series of Bitcoin mining machines every year incorporating the latest technological development in terms of ASIC design and process technology. We also sell Bitcoin mining machine parts, mainly battery packs, that our customers, especially our overseas customers, purchase along with Bitcoin mining machines.

Set forth below are certain specifications of our selected AvalonMiner products.

 

Bitcoin Mining Machine

  

Release Date

  

ASICs

   Number of
ASICs in Each
Product
     Computing
Power
(GH/s)
     Power
Consumption
(W/GHs)
 

A6

   November 2015    28nm      80        3,500        0.30  

A721

   November 2016    16nm, First Generation      72        6,000        0.15  

A741

   January 2017    16nm, First Generation      88        7,300        0.16  

A761

   December 2017    16nm, First Generation      104        8,800        0.15  

A821

   January 2018    16nm, Second Generation      104        11,000        0.11  

A841

   March 2018    16nm, Second Generation      104        13,000        0.10  

A851

   July 2018    16nm, Third Generation      104        14,500        0.10  

A921

   August 2018    7nm, First Generation      104        20,000        0.09  

A911

   January 2019    16nm, Third Generation      204        19,500        0.09  

A10

   April 2019    16nm, Fourth Generation      240        31,000        0.06  

ASICs for AI Applications

We began to develop ASICs for AI applications in 2016 and completed the tape-out of our AI chips in June 2018. Our AI chips are miniaturized chips characterized by high-performance and low energy consumption. Each

 

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AI chip is designed with an artificial neural-network and high-performance processors, which mainly provides heterogeneous, real-time and off-line AI applications. In September 2018, we released the first generation of our AI chip, Kendryte K210, and we began mass production in the fourth quarter of 2018. K210 is a SoC that integrates machine vision and machine hearing functions. We were the first in the industry to deliver commercial edge computing AI chips based on Risc-V architecture and self-developed neural-network accelerator with outstanding performance.

Through the development of various generations of ASICs for Bitcoin mining, we have accumulated rich experience in reducing the size and increasing the power efficiency of the ASICs while achieving high computing power, which is fundamental to designing commercially successful ASICs for AI applications. Specifically, using TSMC’s ultra-low-power 28nm advanced process with dual-core 64-bit processors for better power efficiency, stability and reliability, K210 is able to achieve low voltage and high power efficiency compared to other systems with the same processing power. K210’s computing power is 0.3T, and its power consumption is 300mW, achieving superior power-efficiency compared with what our competitors offer, according to Frost & Sullivan. Further, K210 is a SoC and provides a “single” chip solution, as compared with competing products that require separate chips to perform. As such, our AI chips will involve less set up costs for our customers and are able to avoid potential function loss when any of the chips malfunctions.

Set forth below is a summary of the milestones and status of the development of our AI products.

 

Product

  

Status

Kendryte K210—28nm

  

•  Released in September 2018

  

•  Mass production and shipment of final products in 4th quarter 2018

K210 empowers our clients to provide AI solutions in the field of IoT through its machine vision and machine hearing capabilities. Details of these capabilities are set out below:

 

   

Machine Vision. K210 is a highly adaptive embedded machine vision solution. It can perform convolutional neural-network calculations with high power efficiency. It is capable of object detection, image classification, face detection and recognition, obtaining size and coordinates of targets in real time and analyzing the type of detected targets in real time.

 

   

Machine Hearing. K210 comes with a high-performance microphone array audio processor capable of real-time source orientation detection, sound field imaging, beamforming, voice wake-up and speech recognition.

Our AI chips’ capabilities have the potential to be applied in a number of AI solutions in the field of IoT that involve automation, image and voice recognition, motion control and authentication. We currently focus on the following applications:

 

   

Smart Homes. K210 can be applied in smart home appliances and security systems, including air conditioners, microwave ovens, gas meters, speakers, electronic door locks featuring facial recognition functions, and household monitoring systems.

 

   

Agriculture. K210 can increase crop yields when used for AI-powered agricultural monitoring, pest and disease monitoring and automated control.

 

   

Smart Retail. K210 can power AIoT devices in smart retail to elevate customer experience, including supporting facial recognition for payment, automatically classifying items in vending machines, and tracking and analyzing customer flows.

 

   

Surveillance and Security. AI applications in image and voice recognition can be used by companies, schools or hotels for security purposes.

 

   

Advanced driver-assistance systems. K210 can empower image or video capturing devices installed in cars to detect human movements and facial expression for driver fatigue warning.

 

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Our AI chips can also be used for the following applications:

 

   

Smart Industrial Applications. K210 can be applied in logistics solutions, including intelligent sorting and transportation in complex warehousing environments, smart industrial machinery and robots, monitoring of electrical equipment, equipment fault detection and analysis of industrial equipment data. End users of such applications will mainly be logistics companies and manufacturers who wish to become more cost-efficient.

 

   

Medical Industry. K210 can be utilized in medical solutions, including intelligent auxiliary diagnosis and treatment, medical image recognition, medicine identification search, medicine excavation, health management and medical care.

 

   

Education. K210 can enhance the process of providing education to students and help teachers improve their teaching methods by allowing for the use of educational robots, virtual tutors, self-adaptive/personalized teaching, intelligent interactive platforms, educational efficiency inspection, teaching interaction and educational review. In addition, our AI chips can be utilized in body gesture detection or emotion detection technologies to identify child abuse, bullying or school violence incidents.

 

   

Authentication. Image and voice recognition can also be used as an authentication method for devices, such as AI-powered face unlock for smartphones, and commercial transactions, such as ATM and bank transactions.

To enhance the robustness of our AI development ecosystem and ultimately to provide better user experiences, we offer comprehensive developer support to facilitate the development of AI applications. In particular, we provide schematic diagrams, reference printed circuit board and comprehensive design guidelines for hardware engineers, and we provide software development kits, debugging tools, an integrated development environment and their source codes for software engineers. We have also actively explored collaboration with business partners, including iSoftStone, and have integrated our AI chips in different IoT vertical markets, such as smart lock, smart toy and smart meter.

Sales and Marketing

We have assembled a dedicated team of marketing personnel and software engineers to focus on the development and marketing of our AI products. Our AI marketing team is organized around application scenarios, with dedicated team members. To generate interest from our customers, we also actively promote our latest research and development achievements and display our sample products. In particular, we started to market our AI chips in the first half of 2018. We are also in the process of working with a number of industry participants in the industries of smart city management systems, smart home devices, lighting solutions, smart apparel, telecommunications, intelligent entertainment devices and intelligent security devices, to further explore their interest in our AI products. In addition, we participate in industry associations, including the Zhejiang Software Industry Association, the Zhejiang Blockchain Technology Application Association, the Chinese Private Technology Entrepreneur Association, the Hangzhou Association of Enterprises with Foreign Investment and the China Communications Industry Association (IoT Application Branch), which help us acquire customers and discover potential partners.

Our Customer Base

Bitcoin Mining Machines

We generally provide our Bitcoin mining products to individual or corporate customers on a first-pay-first-serve basis, while we prioritize potential customers whom we believe have stronger potential for a longer-term relationship. However, we do not restrict or control the end-use of our Bitcoin mining products.

Except for situations where our Bitcoin mining products have major defects upon delivery, our customers cannot return or exchange their purchases for upgrades, despite the possibility that their old Bitcoin mining products may no longer be economical for Bitcoin mining for them.

 

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In 2017 and 2018, we sold RMB1,303.1 million and RMB2,698.3 million (US$392.5 million) of Bitcoin mining products, respectively, out of which RMB110.7 million and RMB647.7 million (US$94.2 million), respectively, were sold to our overseas customers in over 55 countries, representing 8.5% and 23.9%, respectively, of our total revenue for Bitcoin mining products.

AI Applications

Our target customers are companies that are in the IoT industry, including, among others, those engaged in intelligent security solutions, smart appliances and instruments, intelligent medical solutions, logistic solutions, AI-powered educational solutions, robotics and authentication. We plan to increase our sales and marketing efforts to cover major customer groups in the IoT field. We currently focus on customers operating in large to mid-sized cities. While our current distribution method is to sell our AI ASICs directly to AI product developers, we plan to also sell our products through distributors in the future. We are already in talks with a number of local and overseas distributors.

K210 has received strong interest from the Risc-V developer community. Up to June 30, 2019, we have shipped over 20,000 AI chips and development kits to AI product developers, the majority of which are from overseas, and we have initiated cooperation with more than 20 AI algorithm companies to develop holistic AI solutions for end consumers.

Research and Development

We became a global pioneer in offering ASIC solutions for blockchain computation purposes as a result of the work done by our research and development team led by our chairman and chief executive officer, Mr. Zhang. Mr. Zhang and his team are credited with inventing one of the first cryptocurrency mining machines incorporating ASIC technology. Further, leveraging our knowledge and experience in ASIC technology, we began developing ASICs for AI application in 2016 and became the first in the industry to deliver commercial edge computing AI chips on Risc-V architecture and self-developed neural-network accelerator with outstanding performance, which is widely recognized as a milestone for hardware advancement in the AI edge computing field, according to Frost & Sullivan.

To implement our research and development roadmap and our plan to diversify our product offering, members of our research and development team are primarily organized under two focus groups, including (i) a high power-efficiency computing group consisting of 80 team members, which is responsible for chip design and optimization and (ii) an AI products group consisting of 52 team members, which are responsible for the design of our Kendryte series including algorithm optimization and end application.

As of December 31, 2018, our research and development team is comprised of 148 members, representing approximately 46.1% of our total employees, with an average of seven years of industry experience. Our research and development team includes 76 members with a master’s degree or above. In addition to Mr. Zhang, Mr. Wu heads our research and development efforts and has extensive experience in the industry. Mr. Wu holds a bachelor degree in computer science and technology from Beijing University of Posts and Telecommunications and a master’s degree in software engineering from Beihang University. The members of our research and development team have relevant educational backgrounds, including undergraduate and advanced degrees in computational science and design and other relevant fields, and many are fluent in multiple coding languages. Many of our research and development personnel have gained relevant design and engineering experiences at other leading IC design houses.

We believe we are one of the few companies in the world to possess advanced technological know-how for ASIC design, including algorithm development and optimization, standard cell design and optimization, low voltage and high power efficiency operations, design of high performance system and heat dissipation technology. We were also the first in the industry to deliver commercial edge computing AI chips based on

 

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Risc-V architecture and self-developed neural-network accelerator with outstanding performance for commercial adoption. We are devoted to in-house research and development of core advanced technologies, such as energy-efficient computing. As it requires a substantial amount of time and production engineering experience to integrate the results of research and development and master the core technologies in the ASICs field, we have created high barriers to entry against our competitors.

We were recognized by the Ministry of Science and Technology, the Ministry of Finance and the State Administration of Taxation of the PRC as a High-tech Enterprise in 2016 and maintained that designation in 2017 and 2018.

Research and Development Achievements

Our research and development efforts have yielded significant results which enable us to establish our brand recognition and our competitive position. Some of our research and development results are protected by copyrights and patents while the rest are part of our proprietary trade secrets. As of December 31, 2018, we have registered a total of 49 patents in the PRC, including two inventions, 40 utility model patents and seven exterior design patents. As of the same date, we have registered 69 software copyrights and 23 IC layout-design rights in the PRC. In particular, we have been focusing on designing ASICs utilizing the most advanced process technologies available and achieved the following technological breakthroughs:

 

   

mass production of 28 nm ASICs in 2015, which positioned us among the leading global players using the then most advanced process technology in the world;

 

   

mass production of the first generation of 16nm ASICs in 2016, which made us among the first-movers in the world to use this advanced process technology on blockchain-related ASICs;

 

   

mass production of the second generation of 16nm ASICs in 2017;

 

   

mass production of the third generation of 16nm ASICs in 2018;

 

   

mass production of the fourth generation of 16nm ASICs in 2019;

 

   

release and mass production of the first generation of ASICS for AI application in 2018;

 

   

7nm ASICs design tape-out in April 2018 and mass production by TSMC began in August 2018; and

 

   

8nm ASIC design tape-out in June 2019 and the anticipated mass production of 8mm ASIC design in September 2019.

Research and Development Roadmap

The core strength of our capabilities consists of designing products with high computing power and high energy efficiency. We aspire to develop advanced IC designs for supercomputing hardware and innovative applications, including blockchain and AI. We follow a market-oriented research and development approach, and we focus on research and development projects that have a relatively clear path toward market acceptance and commercialization opportunities. We are also able to diversify the application of our technology from pure blockchain application to the AI field, and we plan to increase our investment in the development of our AI chips and the establishment of an AI development ecosystem by providing AI chips with better performance and fostering an interactive developer community using our products.

Production

Our Fabless Model

We do not directly manufacture ICs used for our products. Instead, we utilize what is known as a fabless model, whereby we cooperate with world-class production partners for all phases of the manufacturing process of

 

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our ICs, including wafer fabrication and packaging and testing. Under the fabless model, we are able to leverage the expertise of industry leaders that are certified by the ISO in such areas as fabrication, assembly, quality control and assurance, reliability and testing. In addition, the fabless model allows us to avoid many of the significant costs and risks associated with owning and operating various fabrication and packaging and testing facilities. Our fabrication partner is responsible for procurement of the majority of the raw materials used in the production of our ICs. As a result, we can focus our resources on research and development, product design and additional quality assurances.

We closely work with leading global production partners, including TSMC for IC fabrication, and SPIL (which was acquired by ASE in April 2018), ASE and STATS ChipPac for IC packaging and testing. TSMC is the world’s largest dedicated foundry for semiconductor. ASE and JCET, the ultimate parent company of STATS ChipPac, are among the largest IC packaging and testing service providers in the world.

IC Fabrication

We work with TSMC, currently our only IC fabrication partner, to formulate semi-annual purchase plans in order for them to allocate their production resource, and we place actual orders according to our business needs. After we place our orders, and once TSMC accepts our orders, we are required to prepay in full in order to secure production capacity from TSMC. It takes an average of approximately three months from the time when we place our order to the delivery of wafers. We started our cooperation with TSMC in 2015, and we do not maintain any long-term contract or framework agreement.

Packaging and Testing

We started our cooperation with ASE in 2015, STATS ChipPac in 2016 and SPIL in 2017. According to our agreements, we provide rolling forecasts and firm orders for our packaging and testing partners to purchase necessary materials. We typically settle with our packaging and testing partners on a monthly basis and we are required to pay them within 30 days upon receipt of invoices. In addition, if our firm orders are lower than forecasted which leads to packaging and testing partners’ overstock of materials, we are obliged to reimburse them.

Assembly Plant

We currently operate an assembly plant located in Hebei Province that has a gross floor area of 7,538.5 square meters. Subject to the amount of ICs we can obtain from our production partners, we have the flexibility to adjust the production capacity of our Bitcoin mining machines. For example, we can adjust the assembly worker’s shifts in response to the purchase orders we receive.

Quality Control

We emphasize quality control in all aspects of our operations. From product development, component sourcing to product assembly and delivery, we strictly control the quality of our products and components, to ensure our Bitcoin mining machines meet our stringent internal standards as well as international and industry standards. We also require our fabrication, packaging and testing service providers to apply their stringent quality control standards. In particular, we have attained the CE certification and U.S. Federal Communication Commission certification for some of our AvalonMiner products.

We have implemented various quality-control checks into our production process and the IC fabrication process by our production partners. In addition, we provide timely and effective after-sales services and support to our users.

We devote significant resources to quality control of our products with a dedicated team.

 

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Warranty and After Sales Services

We provide warranties of not longer than six months, which we believe is in line with prevailing industry practice. Our warranties cover regular maintenance services and parts and labor for repairs. The components used in our products are typically covered by warranties provided by the respective suppliers.

We have devised a standard operating procedure for customer service. We collect and record customer feedback and complaints from different channels and make timely responses in order to achieve customer satisfaction.

We accept exchanges of our Bitcoin mining machines only for major defects. We believe our exchange policy is consistent with relevant PRC laws and regulations governing product quality and consumer rights and interests. We have not received any requests for exchange which individually or in aggregate has had a material adverse effect on our business and financial condition. In addition, up to December 31, 2018, we have not experienced any product recall that adversely impacted our reputation, business operations or financial condition.

Competition

Cryptocurrency mining machines comprise the overwhelming majority of blockchain hardware. The global Bitcoin mining machine market is relatively concentrated with a few large players. Most of the leading players are based in the PRC. We are the second largest Bitcoin mining machine designer and manufacturer globally in terms of market share of computing power sold in the six months ended June 30, 2019, according to Frost & Sullivan. In the six months ended June 30, 2019, the total computing power of all the Bitcoin mining machines sold by us accounted for approximately 21.9% of the combined computing power of all the Bitcoin mining products sold in the global market, according to Frost & Sullivan.

Our competitors include many well-known domestic and international players. We expect that competition in the Bitcoin mining industry will continue to be intense as we compete not only with existing players that have been focused on Bitcoin mining, but also new entrants that include well-established players in the semiconductor industry, and players who were not predisposed to this industry in the past. In the IC industry for AI products, we expect to face competition from existing and new players that are more established than us. Some of these competitors may also have stronger brand names, greater access to capital, longer histories, longer relationships with their suppliers or customers and more resources than we do.

Intellectual Property

We regard our patents, IC layout design rights, copyrights, trademarks, domain names, know-how, proprietary technologies and similar intellectual property as critical to our success, and we rely on a combination of protections provided by patents, IC layout design rights, copyrights, trademark and trade secret law and confidentiality agreements, non-compete agreements and nondisclosure agreement with our employees and others to protect our proprietary rights. As of the date of this prospectus, we had registered 53 trademarks in the PRC and one trademark in the United States.

As of the date of this prospectus, we have registered a total of 49 patents in the PRC, including two inventions, 40 utility model patents and seven exterior design patents. As of the same date, we have registered 69 software copyrights and 23 IC layout-design rights in the PRC. Proprietary know-how that is not patentable and proprietary technologies and processes for which patents, IC layout design rights and copyrights are difficult to enforce are also of significant importance to our operations. We rely on trade secret protection and confidentiality agreements to safeguard our interests in this respect. Certain elements in our operations are not covered by patents, IC layout design rights or copyrights. We have taken security measures to protect these elements.

Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our technology. Monitoring unauthorized use of our technology is difficult and costly, and we

 

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cannot be certain that the steps we have taken will prevent misappropriation of our technology. From time to time, we may have to resort to litigation to enforce our intellectual property rights, which could result in substantial costs and diversion of our resources.

We have in the past entered and may continue in the future to enter into IP licensing agreements with third parties for the use of their proprietary technologies in the development of our products. Third parties may initiate litigation against us alleging infringement of their proprietary rights or breach of a licensing agreement or declaring their non-infringement of our intellectual property rights. In the event of a successful claim of infringement or breach of a licensing agreement and our failure or inability to develop non-infringing technology or license the infringed or similar technology or cure the breach on a timely basis, our business could be harmed. Moreover, even if we are able to license the infringed or similar technology, license fees could be substantial and may adversely affect our results of operations.

See “Risk Factors—Risks Relating to Our Business and Industry—If we fail to adequately protect our IP rights, our ability to compete effectively or to defend ourselves from litigation could be impaired, which could reduce our total revenue and increase our costs” and “Risk Factors—Risks Relating to Our Business and Industry—We may face IP infringement claims or other related disputes, which could be time-consuming, costly to defend or settle and result in the loss of significant rights and lower sales.”

Insurance

We do not maintain business liability or interruption insurance, which, based on publicly available information available to us relating to IC design companies based in the PRC, is in line with customary industry practice in the PRC. Any uninsured occurrence of business disruption, litigation or natural disaster, or significant damages to our uninsured equipment or facilities could have a material adverse effect on our results of operations. See “Risk Factors—Risks Relating to Our Business and Industry—Our insurance coverage is limited and may not be adequate to cover potential losses and liabilities. A significant uninsured loss or a loss in excess of our insurance coverage could have a material adverse effect on our results of operations and financial condition.”

Employees

As of December 31, 2018, we employed a total of 321 employees that are classified as follows:

 

Function

   Number of
Employees
     Percentage of
Total Number of
Employees
 

Management

     44