F-1/A 1 d773846df1a.htm AMENDMENT NO. 4 TO FORM F-1 AMENDMENT NO. 4 TO FORM F-1
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As filed with the Securities and Exchange Commission on November 20, 2019

Registration No. 333-234356

 

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 4

to

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)

 

 

Cogency Global Inc.

10 E. 40th Street, 10th Floor

New York

NY 10016, USA

+1-800-221-0102

(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(4)

Ordinary Shares, par value US$0.00000005 per share

  US$126,500,000   US$16,420

 

 

(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 15 Class A 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.

(4)

Previously paid.

 

 

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 November 13, 2019.

10,000,000 American Depositary Shares

LOGO

Canaan Inc.

Representing 150,000,000 Class A Ordinary Shares

This is the initial public offering of American depositary shares, or ADSs, representing Class A ordinary shares of Canaan Inc., or Canaan.

We are offering 10,000,000 ADSs. Each ADS represents 15 Class A ordinary shares, par value US$0.00000005 per share.

Prior to this offering, there has been no public market for the ADSs or our shares. It is currently estimated that the initial public offering price per ADS will be between US$9.00 and US$11.00. We have applied for listing of the ADSs on the Nasdaq Global Market under the symbol “CAN.”

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

Investing in the ADSs involves risks. See “Risk Factors” beginning on page 16 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(i)

   US$                    US$                

Proceeds, before expenses, to us

   US$                    US$                

 

(i)

See “Underwriting” for additional disclosure regarding compensation payable by us to the underwriters.

The underwriters have a 30-day option to purchase up to an aggregate of 1,500,000 additional ADSs from us at the initial public offering price less the underwriting discounts and commissions.

Immediately prior to the completion of this offering, our outstanding share capital will be re-designated into Class A ordinary shares and Class B ordinary shares. Holders of Class A ordinary shares and Class B ordinary shares have the same rights except for voting and conversion rights. Each Class A ordinary share is entitled to one vote and each Class B ordinary share is entitled to 15 votes and is convertible into one Class A ordinary share at any time. Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances. Nangeng Zhang, our Chairman and Chief Executive Officer, will beneficially own 100% of our issued Class B ordinary shares. Upon the completion of this offering, we will be a “controlled company” as defined under the Nasdaq Stock Market Rules because Nangeng Zhang will hold 72.6% of the aggregate voting power of our total issued and outstanding share capital upon completion of this offering, assuming the underwriters do not exercise their over-allotment option.

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

 

Citigroup   China Renaissance   CMBI

 

Galaxy Digital     Huatai Securities   Tiger Brokers   Haitong International

Prospectus dated                , 2019.


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LOGO


Table of Contents

LOGO


Table of Contents

TABLE OF CONTENTS

 

Prospectus Summary

     1  

The Offering

     8  

Summary Consolidated Financial and Operating Data

     11  

Risk Factors

     16  

Special Note Regarding Forward-Looking Statements

     54  

Use of Proceeds

     55  

Dividend Policy

     56  

Capitalization

     57  

Dilution

     58  

Enforcement of Civil Liabilities

     60  

Our History and Corporate Structure

     62  

Selected Consolidated Financial and Operating Data

     64  

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

     69  

Industry Overview

     100  

Business

     111  

Regulation

     127  

Management

     137  

Principal Shareholders

     143  

Related Party Transactions

     146  

Description of Share Capital

     147  

Description of American Depositary Shares

     158  

Shares Eligible for Future Sale

     166  

Taxation

     168  

Underwriting

     174  

Expenses Related to this Offering

     185  

Legal Matters

     186  

Experts

     186  

Where You Can Find More Information

     187  

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 previous 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 the 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 cryptocurrency mining machines incorporating ASIC 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 provided us with a solid foundation in terms of both technology and capital resources, which better prepared 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 globally, according to Frost & Sullivan. In September 2018, we became the first in the industry to deliver commercial edge computing AI chips based on Risc-V architecture, which is a set of instructions that describes the way in which software talks to an underlying processor, and self-developed neural-network accelerator, which is a class of microprocessor designed as hardware acceleration for AI applications, with outstanding performance. As we are a fabless IC designer, the ICs that we design are manufactured, packaged and tested by industry-leading suppliers, including TSMC, Samsung, 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 in aggregate over 150 million ASICs in 2017, 2018 and the nine months ended September 30, 2019;

 

   

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.



 

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The price of Bitcoin experienced a significant drop in 2018 and remained relatively low through the end of the first quarter of 2019, while experiencing some recovery starting from the second quarter of 2019. The price of Bitcoin has a direct impact on the market demand for our Bitcoin mining machines, in terms of both the price and the quantity, and we expect this trend to continue. Furthermore, the significant drop in the Bitcoin price has had a negative effect on the value of our Bitcoin mining machine inventory. We expect our results of operations to improve along with the recovery of the Bitcoin price, but our results of operations generally lag behind the increase in the Bitcoin price. Furthermore, fluctuation in Bitcoin price can have direct impact on the trading price of the ADSs.

Our total revenues increased by 106.8% from RMB1,308.1 million in 2017 to RMB2,705.3 million (US$378.5 million) in 2018. During the same period, our net income decreased by 67.4% from RMB375.8 million to RMB122.4 million (US$17.1 million). Our total revenues decreased by 60.5% from RMB2,427.6 million in the nine months ended September 30, 2018 to RMB959.4 million (US$134.2 million) in the nine months ended September 30, 2019. Our net income was RMB149.9 million in the nine months ended September 30, 2018 and our net loss was RMB236.3 million (US$33.1 million) in the nine months ended September 30, 2019. Our adjusted net income (loss), a non-GAAP measure defined as net income (loss) excluding share-based compensation, was RMB471.3 million of adjusted net income in 2017 as compared to RMB141.0 million (US$19.7 million) of adjusted net income in 2018, and RMB164.1 million of adjusted net income in the nine months ended September 30, 2018 as compared to RMB13.8 million (US$1.9 million) of adjusted net loss in the nine months ended September 30, 2019. 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.



 

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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 classification of cryptocurrency mining as an eliminated industry by PRC government authority.

 

   

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 further developed, 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 March 2018, in order to mirror the shareholding structure of the then shareholders of Hangzhou Canaan, we issued and allotted our ordinary shares at par value to investment holding companies held by the then shareholders of Hangzhou Canaan. 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.



 

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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 Cogency Global Inc.

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



 

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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 the ADSs;

 

   

“ADSs” are to the American depositary shares, each of which represents 15 of our Class A 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, and immediately prior to and after the completion of this offering, are to our Class A and Class B 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, as the context requires.

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



 

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Renminbi into U.S. dollars were made at RMB7.1477 to US$1.00, the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on September 30, 2019. 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 November 15, 2019, the noon buying rate for Renminbi was RMB7.0075 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 1,500,000 ADSs representing 22,500,000 Class A 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;

 

   

“neural-network accelerator” are to a class of microprocessor designed as hardware acceleration for AI applications;

 

   

“nm” are to nanometer;

 

   

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

 

   

“POW” are to proof-of-work;

 

   

“Risc-V” are to an open source instruction set architecture, which is a set of instructions that describes the way in which software talks to an underlying processor, and Risc-V’s open source nature means that anyone can build a processor to support it without paying high royalty fees;



 

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“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;

 

   

“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;

 

   

“TOPS” are to tera-operations per second, which is a measurement of the computing performance of a chip; and

 

   

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



 

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THE OFFERING

 

ADSs Offered by Us

10,000,000 ADSs (or 11,500,000 ADSs if the underwriters exercise in full the option to purchase additional ADSs).

 

Public Offering Price

We estimate that the initial public offering price will be between US$9.00 and US$11.00 per ADS.

 

ADSs Outstanding Immediately After This Offering

10,000,000 ADSs (or 11,500,000 ADSs if the underwriters exercise in full the over-allotment option).

 

Ordinary Shares Outstanding Immediately After This Offering

2,015,597,778 Class A ordinary shares and 356,624,444 Class B ordinary shares (or 2,038,097,778 Class A ordinary shares and 356,624,444 Class B 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 1,500,000 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 15 Class A ordinary shares.

 

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

 

  You may surrender your ADSs for cancelation to the depositary to withdraw the Class A 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.


 

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Ordinary Shares

Our ordinary shares will be divided into Class A ordinary shares and Class B ordinary shares immediately prior to the completion of this offering. Holders of Class A ordinary shares and Class B ordinary shares will have the same rights except for voting and conversion rights. In respect of matters requiring a shareholder vote, each Class A ordinary share will be entitled to one vote, and each Class B ordinary share will be entitled to 15 votes. Each Class B ordinary share is convertible into one Class A ordinary share at any time by the holder thereof. Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances. Upon any sale or transfer of Class B ordinary shares by a holder thereof to any person or entity which is not an affiliate of such holder, or upon a change of beneficial ownership of Class B ordinary shares as a result of which any person who is not an affiliate of the registered shareholder becomes a beneficial owner of such shares, such Class B ordinary shares shall be automatically and immediately converted into the same number of Class A ordinary shares. For a description of Class A ordinary shares and Class B ordinary shares, see “Description of Share Capital.”

 

Use of Proceeds

We estimate that we will receive net proceeds of approximately US$87.7 million from this offering, or approximately US$101.7 million if the underwriters exercise their option to purchase additional ADSs from us in full, assuming an initial public offering price of US$10.00 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 for:

 

   

research and development for ASICs related to AI algorithms and applications;

 

   

research and development for ASICs related to blockchain algorithms and applications;

 

   

expansion of our AI and blockchain business globally by making strategic investments and establishing overseas offices;

 

   

supply chain optimization and repayment of debts incurred by us in connection with our reorganization; and

 

   

general corporate purpose.

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 the ADSs. You should carefully consider these risks before deciding to invest in the ADSs.

 

Listing

We have applied to list the ADSs on the Nasdaq Global Market.


 

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Proposed Trading Symbol

CAN.

 

Depositary

The Bank of New York Mellon.

 

Lock-up

We, our executive officers and directors and our existing shareholders have agreed with the underwriters not to sell, transfer or dispose of any ADSs, ordinary shares or similar securities for a period of 180 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 income and cash flows 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.

The following summary consolidated statements of income (loss) and cash flows data for the nine months ended September 30, 2018 and 2019 and the summary consolidated balance sheet data as of September 30, 2019 have been derived from our unaudited interim condensed consolidated financial statements included elsewhere in this prospectus.

Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements and include all normal recurring adjustments that we consider necessary for a fair statement of our financial position and operating results for the periods presented.

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.



 

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Summary Consolidated Statements of Comprehensive Income (Loss):

 

    Year ended December 31,     Nine months ended September 30,  
    2017     2018     2018     2019  
    RMB     RMB     US$         RMB             RMB             US$      
    (in millions)  

Net revenues:

           

Products revenue

    1,303.1       2,698.6       377.5       2,421.6       944.6       132.2  

Leases revenue

    —         —         —         —         13.3       1.9  

Service revenue

    4.7       6.0       0.8       5.8       0.8       0.1  

Other revenues

    0.3       0.7       0.1       0.2       0.7       0.1  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

    1,308.1       2,705.3       378.5       2,427.6       959.4       134.2  

Cost of revenues

    (703.7     (2,197.2     (307.4     (1,931.1     (802.0     (112.2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    604.4       508.1       71.1       496.5       157.4       22.0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

           

Research and development expenses(1)

    (99.8     (189.7     (26.5     (138.5     (105.4     (14.7

Sales and marketing expenses(1)

    (20.7     (38.7     (5.4     (34.3     (14.2     (2.0

General and administrative expenses(1)

    (125.3     (146.7     (20.5     (116.1     (291.2     (40.7
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    (245.8     (375.1     (52.5     (288.9     (410.8     (57.5
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations:

           

Interest income

    0.2       4.2       0.6       2.9       2.1       0.3  

Investment income

    5.6       3.2       0.4       2.3       2.9       0.4  

Interest expense and guarantee fee

    —         (53.1     (7.4     (34.2     (18.6     (2.6

Foreign exchange (loss) gain, net

    (1.2     (1.2     (0.2     (2.6     8.2       1.1  

Value added tax refunds

    38.8       110.2       15.4       103.1       0.3       0.0  

Other (loss) income, net

    (1.1     3.8       0.5       4.5       22.2       3.1  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income tax expenses

    401.0       200.2       28.0       283.4       (236.3     (33.1

Income tax expense

    (25.2     (77.8     (10.9     (133.5     —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

       375.8          122.4            17.1       149.9       (236.3     (33.1

Foreign currency translation adjustment, net of nil tax

    —         (65.2     (9.1     (67.5     13.0       1.8  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income (loss)

    375.8       57.2       8.0       82.4       (223.3     (31.2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Note:

(1)

Share-based compensation expenses were allocated to the following expense items:

 

     Year ended December 31,      Nine months ended September 30,  
     2017      2018      2018      2019  
     RMB      RMB      US$          RMB              RMB              US$      
     (in millions)  

Research and development expenses

     25.1        9.6        1.3        7.2        4.8        0.7  

Sales and marketing expenses

     0.1        1.1        0.2        0.9        0.3        0.0  

General and administrative expenses

     70.3        7.9        1.1        6.1        217.4        30.4  


 

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Summary Consolidated Statements of Financial Position:

 

     As of December 31,      As of September 30,  
     2017      2018      2019  
   RMB      RMB      US$          RMB              US$      
     (in millions)  

Cash and cash equivalents

     176.5        258.9        36.2        332.7        46.5  

Restricted cash

     —          286.3        40.1        —          —    

Accounts receivable

     1.3        23.7        3.3        4.4        0.6  

Inventories

     259.8        585.7        81.9        392.1        54.9  

Prepayments and other current assets

     636.4        186.7        26.1        610.2        85.4  

Income tax receivable

     —          27.1        3.8        25.1        3.5  

Property, equipment and software

     18.4        27.9        3.9        24.0        3.4  

Total assets

     1,203.2        1,402.7        196.2        1,596.1        223.3  

Short-term debts

     —          1,049.0        146.8        248.8        34.8  

Contract liabilities

     202.5        6.9        1.0        276.4        38.7  

Accrued liabilities and other current liabilities

     69.2        58.0        8.1        63.3        8.9  

Total liabilities

     346.0        1,161.7        162.5        686.3        96.0  

Total shareholders’ equity

     857.2        241.0        33.7        909.7        127.3  

Total liabilities and shareholders’ equity

     1,203.2        1,402.7        196.2        1,596.1        223.3  

Summary Consolidated Statements of Cash Flow:

 

     Year ended December 31,     Nine months ended September 30,  
         2017         2018         2018         2019  
     RMB     RMB     US$         RMB             RMB             US$      
     (in millions)  

Net cash provided by (used in) operating activities

     91.2       (12.7     (1.8     (163.1     (10.5     (1.5

Net cash provided by (used in) investing activities

     (86.8     84.0       11.8       91.2       (84.4     (11.8

Net cash provided by (used in) financing activities

     150.0       295.2       41.3       245.2       (119.5     (16.7

Net increase/(decrease) in cash and cash equivalents, restricted cash

     154.4       366.4       51.3       173.3       (214.4     (30.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

     (1.3     2.3       0.3       2.5       1.8       0.3  

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

     23.4       176.5       24.7       176.5       545.2       76.3  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

     176.5       545.2       76.3       352.3       332.7       46.5  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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



 

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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 (loss) for the years/period indicated:

 

             Year ended December 31,                      Nine months ended September 30,          
     2017      2018      2018      2019  
     RMB      RMB      US$      RMB      RMB     US$  
     (in millions)  

Net income (loss)

     375.8        122.4        17.1        149.9        (236.3     (33.1

Add:

                

Share-based compensation expenses

     95.5        18.6        2.6        14.2        222.5       31.1  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Adjusted net income (loss)

     471.3        141.0        19.7        164.1        (13.8     (1.9
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Summary Operating Data:

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

 

     Year ended December 31,      Nine months ended September 30,  
     2017      2018      2018      2019  
     Volume      ASP      Volume      ASP      Volume      ASP      Volume      ASP  
     set      RMB      set      RMB      set      RMB      set      RMB  

A7 series(1)

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

A8 series(2)

     —          —          503,237        4,842        432,739        5,272        265,756        1,206  

A9 series(3)

     —          —          35,324        3,665        2,529        4,578        88,034        2,071  

A10 series(4)

     —          —          —          —          —          —          56,556        7,556  
  

 

 

       

 

 

       

 

 

       

 

 

    

Total

     294,523        4,402        559,137        4,726        455,844        5,198        410,346        2,267  
  

 

 

       

 

 

       

 

 

       

 

 

    

 

Notes:

(1)

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

(2)

Mainly includes our A821, A841, A851 and A852 Bitcoin mining machines.

(3)

Mainly includes our A921 and A911 Bitcoin mining machines.

(4)

Mainly includes our A1047 Bitcoin mining machines.



 

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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 for the periods indicated:

 

     Year ended December 31,      Nine months ended September 30,  
     2017      2018      2018      2019  
     Total
Computing
Power Sold
     ASP per
Thash
     Total
Computing
Power Sold
     ASP per
Thash
     Total
Computing
Power Sold
     ASP per
Thash
     Total
Computing
Power Sold
     ASP per
Thash
 
     Thash/s      RMB      Thash/s      RMB      Thash/s      RMB      Thash/s      RMB  

A7 series(1)

     2,114,637        613        151,131        505        151,131        505        —          —    

A8 series(2)

     —          —          6,305,119        386        5,386,643        424        3,868,944        83  

A9 series(3)

     —          —          702,416        184        50,580        229        1,639,839        111  

A10 series(4)

     —          —          —          —          —          —          2,089,142        205  
  

 

 

       

 

 

       

 

 

       

 

 

    

Total

     2,114,637        613        7,158,666        369        5,588,354        424        7,597,925        122  
  

 

 

       

 

 

       

 

 

       

 

 

    

 

Notes:

(1)

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

(2)

Mainly includes our A821, A841, A851 and A852 Bitcoin mining machines.

(3)

Mainly includes our A921 and A911 Bitcoin mining machines.

(4)

Mainly includes our A1047 Bitcoin mining machines.

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 for the periods indicated:

 

    Year ended December 31,     Nine months ended September 30,  
    2017     2018     2018     2019  
    Cost(1)     Per unit
cost
    Cost per
Thash
    Cost(1)     Per unit
cost
    Cost per
Thash
    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     RMB in
millions
    RMB     RMB     RMB in
millions
    RMB     RMB  

A7 series(2)

    693.3       2,354       328       51.1       2,482       338       51.1       2,482       338       —         —         —    

A8 series(3)

    —         —         —         1,243.9       2,472       197       1,079.0       2,493       200       664.1       2,499       172  

A9 series(4)

    —         —         —         154.9       4,385       221       11.1       4,385       219       369.1       4,193       225  

A10 series(5)

    —         —         —         —         —         —         —         —         —         300.0       5,304       144  
 

 

 

       

 

 

       

 

 

       

 

 

     

Total

    693.3       2,354       328       1,449.9       2,593       203       1,141.1       2,503       204       1,333.2       3,249       175  
 

 

 

       

 

 

       

 

 

       

 

 

     

 

Notes:

(1)

Without taking into consideration the inventory and prepayment write down provision of nil, RMB786.0 million (US$110.0 million), RMB786.0 million and RMB0.8 million (US$0.1 million) in 2017, 2018 and the nine months ended September 30, 2018 and 2019, respectively, as well as a realized inventory and prepayment write down of nil, RMB71.1 million (US$9.9 million), RMB33.8 million and RMB569.0 million (US$79.6 million), respectively, for the same periods.

(2)

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

(3)

Mainly includes our A821, A841, A851 and A852 Bitcoin mining machines.

(4)

Mainly includes our A921 and A911 Bitcoin mining machines.

(5)

Mainly includes our A1047 Bitcoin mining machines.



 

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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 the 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 the 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 negatively impacted by sharp Bitcoin price decreases.

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, from January 1, 2019 to October 31, 2019, the highest Bitcoin price was US$12,686.39 and the lowest was US$3,225.30. The decrease in the Bitcoin price in 2018 resulted in a material decrease in our sales volume and in the average selling price of our Bitcoin mining machines. As the Bitcoin price only started to recover in the second quarter of 2019 and our operations generally lag behind the increase of Bitcoin price, our revenue for the nine months ended September 30, 2019 also decreased by 60.5% from the nine months ended September 30, 2018. We expect our results of operations to continue to be affected by the Bitcoin price, as 99.6%, 99.7% and 98.3% of our revenue were from sales of our Bitcoin mining machines and other Bitcoin mining machine parts and accessories in 2017, 2018 and the nine months ended September 30, 2019, 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. Furthermore, fluctuations in the Bitcoin price can have an immediate impact on the trading price of the ADSs even before our financial performance is affected, if at all.

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

 

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price, we recorded an inventories and prepayments write down of RMB786.0 million (US$110.0 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 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 and the nine months ended September 30, 2019, we recognized such price concessions of RMB152.8 million (US$21.4 million) and RMB11.1 million (US$1.6 million), respectively. We may continue to offer sales on credit to some of our customers, and if the Bitcoin price drops significantly in the future, we will need to recognize such as implicit price concession.

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, 2018 and the nine months ended September 30, 2019, sales of our Bitcoin mining machines and other Bitcoin mining machine parts and accessories accounted for 99.6%, 99.7% and 98.3% 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. Therefore, Bitcoin mining machines may become less productive as the available rewards for Bitcoin mining decrease.

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. As of September 30, 2019, we shipped more than 53,000 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.

 

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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 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.”

 

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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 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, 2018 and the nine months ended September 30, 2019, revenue from customers in the PRC accounted for 91.5%, 76.1% and 79.8%, 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. 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

 

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“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 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 June 2019, Bitcoin mining difficulty increased by approximately 25 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. In 2017, 2018 and the nine months ended September 30, 2019, we incurred research and development expense of RMB99.8 million, RMB189.7 million (US$26.5 million) and RMB105.4 million (US$14.7 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 mainly 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 major third-party foundry partner for our Bitcoin mining machine business. In 2017, 2018 and the nine months ended September 30, 2019, the value of the ICs we purchased from TSMC accounted for 63.5%, 63.1% and 57.8%, respectively, of our total procurement for the respective periods. It is important for us to have a reliable relationship with TSMC and other 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

 

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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.

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, RMB585.7 million (US$81.9 million) and RMB392.1 million (US$54.9 million) as of December 31, 2017, 2018 and September 30, 2019, 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 (US$52) in 2018 and further decreased to RMB122 (US$17) in the nine months ended September 30, 2019. 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

 

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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.

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$378.5 million) in 2018, but decreased from RMB2,427.6 million in the nine months ended September 30, 2018 to RMB959.4 million (US$134.2 million) in the nine months ended September 30, 2019. We may not be able to grow our revenue in the future 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.

 

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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;

 

   

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;

 

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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;

 

   

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.

We have incurred negative cash flows from operating activities and net losses in the past and can provide no assurance of our future operating results.

We have experienced negative cash flows from operating activities in the amount of RMB12.7 million (US$1.8 million) for the year ended December 31, 2018 and we incurred a net loss in the amount of RMB236.3 million (US$33.1 million) for the nine months ended September 30, 2019. We will need to generate and sustain increased revenue and net income levels in future periods in order to increase profitability, and, even if we do, we may not be able to maintain or increase our level of profitability over the long term. We cannot assure you that we will be able to generate positive cash flow from operating activities in the future or that we will be able to continue to obtain financing on acceptable terms or at all. Our ability to achieve profitability and positive cash flow from operating activities will depend on a mix of factors, some of which are beyond our control, including the price of Bitcoin, our ability to grow our AI business and manage our product mix and our ability to secure favorable commercial terms from suppliers.

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 printed circuit board, 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

 

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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.

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, 2018 and September 30, 2019, the outstanding balance of prepayments we made to our foundry service provider amounted to RMB606.0 million, RMB62.3 million (US$8.7 million) and RMB462.5 million (US$64.7 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, 2018 and September 30, 2019, our trade receivables amounted to RMB7.2 million, RMB27.5 million (US$3.8 million) and RMB4.4 million (US$0.6 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.

 

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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, 96% in 2018 and 96% in the nine months ended September 30, 2019, 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 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.”

 

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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 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

 

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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.

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 68 patents in the PRC,

 

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including six inventions, 49 utility model patents and 13 exterior design patent. As of the same date, we have registered 80 software copyrights and 30 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. 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, primarily software development tools, 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;

 

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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

 

   

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. Nangeng Zhang and Mr. Jiaxuan 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.

Our corporate actions are significantly influenced by our principal shareholders, including Nangeng Zhang, our Chairman and Chief Executive Officer, who have the ability to exert significant influence over important corporate matters that require approval of shareholders while their interests may differ from those of the other shareholders. This may deprive you of the opportunity to receive a premium for your ADSs and materially reduce the value of your investment.

Immediately prior to the completion of this offering, our outstanding share capital will be re-designated into Class A ordinary shares and Class B ordinary shares. Each Class A ordinary share is entitled to one vote and each Class B ordinary share is entitled to 15 votes at general meetings of our shareholders. Immediately after the completion of this offering, Nangeng Zhang, our Chairman and Chief Executive Officer, will beneficially own

 

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100% of our Class B ordinary shares, representing approximately 72.6% of the aggregate voting power of our issued and outstanding share capital assuming the underwriters do not exercise their option to purchase additional ADSs. However, the interests of our Chairman and Chief Executive Officer may differ from the interests of other shareholders. This concentration of ownership and the protective provisions in our amended and restated memorandum and articles of association, which will become effective upon the completion of this offering, may discourage, delay or prevent a change in control of our company, which could have the dual effect of depriving our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and reducing the price of the ADSs. We may not be able to enter into other transactions that could be beneficial to us without the consent of our Chairman and Chief Executive Officer. As a result of the foregoing, the value of your investment could be materially reduced.

We will be a “controlled company” under the Nasdaq Stock Market Rules and, as a result, will rely on exemptions from certain corporate governance requirements that provide protection to shareholders of other companies.

Upon the completion of this offering, we will be a “controlled company” as defined under the Nasdaq Stock Market Rules because Nangeng Zhang, our Chairman and Chief Executive Officer, will hold more than 50% of the aggregate voting power of our total issued and outstanding share capital. For so long as we remain a controlled company under that definition, we are permitted to elect to rely, and will rely, on certain exemptions from corporate governance rules, including an exemption from the rule that a majority of our board of directors must be independent directors. As a result, you will not have the same protection afforded to shareholders of companies that are subject to these corporate governance requirements.

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.

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% and 2.2% of our total sales in 2018 and the nine months ended September 30, 2019, respectively. 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.

 

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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 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,

 

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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, RMB110.2 million (US$15.4 million) and RMB0.3 million (US$48.7 thousand) in 2017, 2018 and the nine months ended September 30, 2019, 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 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 Commerce & Finance Law Offices, 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.

 

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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 Commerce & Finance Law Offices, our PRC legal adviser, 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.

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.

 

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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 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 had outstanding borrowings of RMB248.8 million (US$34.8 million) as of September 30, 2019, incurred primarily to support our operation. 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. 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

 

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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 mainly 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.

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.

 

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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 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

 

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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.

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

We were advised by Commerce & Finance Law Offices, our PRC legal adviser, 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

 

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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 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 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.

 

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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 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 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.

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.

 

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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, 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 the 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 the ADSs that they hold or on the gains on the sale of the ADSs by them, the value of our foreign corporate shareholders’ investments in the 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 the 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 the ADSs and this Offering

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

We have applied to list the ADSs on the 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 the 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 the ADSs may be materially and adversely affected.

The initial public offering price for the 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 the 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 the ADSs is likely to be volatile, which could result in substantial losses to investors.

The trading price of the 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 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 products 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 the ADSs, the market price for the ADSs and trading volume could decline.

The trading market for the 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 the ADSs, the market price for the 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 the ADSs to decline.

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

Sales of substantial amounts of the 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 the 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 10,000,000 ADSs (equivalent to 150,000,000 Class A ordinary shares) outstanding immediately after this offering, or 11,500,000 ADSs (equivalent to 172,500,000 Class A ordinary shares) if the underwriters exercise their option to purchase additional ADSs in full. In connection with this offering, we, our officers and directors have agreed not to sell any ordinary shares or ADSs for 180 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 the 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 the 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 the ADSs will likely depend entirely upon any future price appreciation of the ADSs. There is no guarantee that the 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 the ADSs, and you may even lose your entire investment in the 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 Class A ordinary shares. As a result, you will experience immediate and substantial dilution of approximately US$8.65 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$1.35 as of September 30, 2019, after giving effect to (i) the vesting of 16,000,000 restricted ordinary shares, (ii) the vesting of 11,897,436 restricted share units, and (iii) this offering and (2) the assumed initial public offering price of US$10.00 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 the 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.

The dual-class structure of our ordinary shares may adversely affect the trading market for our ADSs.

Certain shareholder advisory firms have announced changes to their eligibility criteria for inclusion of shares of public companies on certain indices, including the S&P 500, to exclude companies with multiple

 

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classes of shares and companies whose public shareholders hold no more than 5% of total voting power from being added to such indices. In addition, several shareholder advisory firms have announced their opposition to the use of multiple class structures. As a result, the dual-class structure of our ordinary shares may prevent the inclusion of our ADSs representing Class A ordinary shares in such indices and may cause some shareholder advisory firms to publish negative commentary about our corporate governance practices or otherwise seek to cause us to change our capital structure. Any such exclusion from indices could result in a less active trading market for our ADSs. Any negative actions or publications by shareholder advisory firms could also adversely affect the value of our ADSs.

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

We have adopted an amended and restated memorandum and articles of association that will become effective immediately prior to completion of this offering. Our new memorandum and articles of association contain provisions to 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 entitles each Class B ordinary share to 15 votes in respect of all matters subject to a shareholders’ vote. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties form seeking to obtain control of our company in a tender offer or similar transaction. Although we expect to issue all of our authorized Class B ordinary shares upon the completion of this offering, if any of such Class B ordinary shares are converted into Class A ordinary shares or canceled for any reasons, our board of directors will have the authority without further action by our shareholders to issue additional Class B ordinary shares, which will be dilutive to our Class A ordinary shareholders. In addition, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges, and relative participating, optional or special rights and the qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our Class A ordinary shares, in the form of ADS or otherwise. We could issue preferred shares quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ADSs may fall and the voting and other rights of the holders of our Class A ordinary shares and ADSs may be materially and adversely affected.

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 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

 

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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 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.”

Fluctuations in the exchange rate between the Renminbi and the U.S. dollar could result in foreign currency exchange losses and could materially reduce the value of your investment.

The value of the Renminbi against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions and the foreign exchange policy adopted by the PRC government. On July 21, 2005, the PRC government changed its policy of pegging the value of the Renminbi to the U.S. dollar. Following the removal of the U.S. dollar peg, the Renminbi appreciated more than 20% against the U.S. dollar over the following three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the Renminbi and the U.S. dollar remained 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 (IMF) completed the 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, the 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 had depreciated significantly in the backdrop of a surging U.S. dollar and persistent capital outflows of China. This depreciation halted in 2017, and the Renminbi appreciated approximately 7% against the U.S. dollar during this one-year period. Starting from the beginning of 2019, the Renminbi has depreciated significantly against the U.S. dollar again. In early August 2019, the PBOC set the Renminbi’s daily reference rate at RMB7.0039 to US$1.00, the first time that the exchange rate of the Renminbi to the U.S. dollar exceeded 7.0 since 2008. With the development of the foreign exchange market and progress towards interest rate liberalization and Renminbi internationalization, the PRC government may in the

 

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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.

Substantially all of our revenues and costs are denominated in Renminbi. We are a holding company and we rely on dividends paid by our operating subsidiaries in China for our cash needs. Any significant revaluation of the Renminbi may materially and adversely affect our results of operations and financial position reported in Renminbi when translated into U.S. dollars, and the value of, and any dividends payable on, the ADSs in U.S. dollars. To the extent that we need to convert U.S. dollars we receive from this offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we would receive. Conversely, if we decide to convert our 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. dollar amount.

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 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.

 

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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 the 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 cancel and withdraw such ordinary shares. Under our amended and 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 the 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 may give us a discretionary proxy to vote the ordinary shares underlying the ADSs at shareholders’ meetings if we have timely provided the depositary with notice of meeting and related voting materials and (i) we have instructed the depositary that we wish a discretionary proxy to be given, (ii) we have informed the depositary that there is no substantial opposition as to a matter to be voted on at the meeting, and (iii) a matter to be voted on at the meeting would not have a material adverse impact on shareholders.

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

ADS holders may not be entitled to a jury trial with respect to claims arising under the deposit agreement, which could result in less favorable outcomes to the plaintiff(s) in any such action.

The deposit agreement governing the ADSs representing our Class A ordinary shares provides that, to the fullest extent permitted by law, ADS holders waive the right to a jury trial of any claim they may have against us or the depositary arising out of or relating to our shares, the ADSs or the deposit agreement, including any claim under the U.S. federal securities laws. As the waiver relates to claims arising as a matter of contract in relation to the ADSs, we believe that, as a matter of construction of the clause, the waiver would likely to continue to apply to ADS holders who withdraw the Class A ordinary shares represented by the ADSs from the ADS facility with respect to claims arising before the withdrawal, and the waiver would most likely not apply to ADS holders who subsequently withdraw the Class A ordinary shares represented by ADSs from the ADS facility with respect to claims arising after the withdrawal. However, to our knowledge, there has been no case law on the applicability of the jury trial waiver to ADS holders who subsequently withdraw the Class A ordinary shares represented by the ADSs from the ADS facility.

If we or the depositary oppose a jury trial demand based on the waiver, the court would determine whether the waiver was enforceable based on the facts and circumstances of that case in accordance with the applicable

 

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state and federal law. To our knowledge, the enforceability of a contractual pre-dispute jury trial waiver in connection with claims arising under the federal securities laws has not been finally adjudicated by the United States Supreme Court. However, we believe that a contractual pre-dispute jury trial waiver provision is generally enforceable, including under the laws of the State of New York, which govern the deposit agreement, by a federal or state court in the City of New York, which has non-exclusive jurisdiction over matters arising under the deposit agreement. In determining whether to enforce a contractual pre-dispute jury trial waiver provision, courts will generally consider whether a party knowingly, intelligently and voluntarily has waived the right to a jury trial. We believe that this is the case with respect to the deposit agreement and the ADSs. It is advisable that you consult legal counsel regarding the jury waiver provision before investing in the ADSs.

If you or any other holders or beneficial owners of ADSs, including purchasers of ADSs in secondary market transactions, bring a claim against us or the depositary in connection with matters arising under the deposit agreement or the ADSs, including claims under federal securities laws, you or such other holder or beneficial owner may not be entitled to a jury trial with respect to such claims, which may have the effect of increasing the cost of bringing a claim and limiting and discouraging lawsuits against us and the depositary. If a lawsuit is brought against either or both of us and the depositary under the deposit agreement, it may be heard only by a judge or justice of the applicable trial court, which would be conducted according to different civil procedures and may result in different outcomes than a trial by jury would have, including results that could be less favorable to the plaintiff(s) in any such action.

Nevertheless, if this jury trial waiver provision is not permitted by applicable law, an action could proceed under the terms of the deposit agreement with a jury trial. No condition, stipulation or provision of the deposit agreement or ADSs serves as a waiver by any holder or beneficial owner of ADSs or by us or the depositary of compliance with U.S. federal securities laws and the rules and regulations promulgated thereunder.

You have the right to arbitration under the deposit agreement. However, it may not be most beneficial.

The deposit agreement provides that ADS holders and the depositary have the right to elect to have any claim they may have against us arising out of or relating to the Class A ordinary shares or ADSs or the deposit agreement settled by arbitration in New York, New York rather than in a court of law, and to have any judgment rendered by the arbitrators entered in any court having jurisdiction. An arbitral tribunal in any such arbitration would not have the authority to award any consequential, special, or punitive damages and its award would have to conform to the provisions of the deposit agreement. The deposit agreement does not give us the right to require that any claim, whether brought by us or against us, be arbitrated.

The deposit agreement may be amended or terminated without your consent.

We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs after an amendment to the deposit agreement, you agree to be bound by the deposit agreement as amended. However, amendment to certain rights that may increase costs or prejudice a substantial right of ADS holders will not take effect until 30 days after notice thereof in accordance with the deposit agreement. See “Description of American Depositary Shares” for more information.

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 the 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

 

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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.

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.

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 the 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

 

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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 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 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 Nasdaq Stock Market Rules; these practices may afford fewer protection to shareholders than they would enjoy if we complied fully with the Nasdaq Stock Market Rules.

As a Cayman Islands exempted company listed on the Nasdaq Global Market, we are subject to the Nasdaq Stock Market Rules. However, Nasdaq Stock 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 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 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 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 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 the ADSs in this offering), we do

 

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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 the ADSs, a decrease in the price of the ADSs may also result in our becoming a PFIC.

If we are a PFIC for any taxable year during which you hold the 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—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—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. Our U.S. counsel expresses no opinion with respect to our PFIC status.

 

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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 business 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 the 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$87.7 million, or approximately US$101.7 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$10.00 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$10.00 per ADS would increase (decrease) the net proceeds to us from this offering by US$9.3 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$8.8 million for research and development for ASICs related to AI algorithms and applications;

 

   

approximately US$8.8 million for research and development for ASICs related to blockchain algorithms and applications;

 

   

approximately US$8.8 million for expansion of our AI and blockchain business globally by making strategic investments and establishing overseas offices;

 

   

approximately US$61.3 million for supply chain optimization and repayment of debts incurred by us in connection with our reorganization; 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 September 30, 2019 presented on:

 

   

an actual basis; and

 

   

a pro forma basis to reflect (i) the re-designation of 2,222,222,222 ordinary shares (including 52,027,157 treasury stock) into 1,865,597,778 Class A ordinary shares and 356,624,444 Class B ordinary shares upon the completion of this offering, (ii) the vesting of 16,000,000 restricted ordinary shares upon the completion of this offering which would result in immediate recognition of previously unrecognized compensation expense that would be reflected as an increase in accumulated deficit and increase in additional paid-in capital of RMB41.0 million (US$5.7 million), (iii) the vesting of 11,897,436 restricted share units upon the completion of this offering which would result in immediate recognition of previously unrecognized compensation expense that would be reflected as an increase in accumulated deficit of RMB4.9 million (US$0.7 million) and increase in additional paid-in capital of RMB4.7 million (US$0.7 million), and (iv) the issuance and sale of the 150,000,000 Class A ordinary shares in the form of ADSs by us in this offering at an assumed initial public offering price of US$10.00 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 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 the 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 September 30, 2019  
     Actual     Pro Forma  
     RMB     US$     RMB     US$  
     (in thousands)  

Shareholders’ equity:

                                  

Ordinary shares (US$0.00000005 par value; 1,000,000,000,000 shares authorized, 2,222,222,222 shares issued, 2,170,195,065 shares outstanding as of September 30, 2019, 1,991,468,057 Class A and 356,624,444 Class B shares outstanding on a pro forma basis as of September 30, 2019)

     1       —         1       —    

Subscription receivable from shareholders

     (1     —         (1     —    

Treasury stocks (US$0.00000005 par value; 52,027,157 shares as of September 30, 2019, 24,129,721 shares on a pro forma basis as of September 30, 2019)

     —         —         —         —    

Additional paid-in capital

     1,047,076       146,492       1,724,706       241,295  

Statutory reserves

     97,307       13,614       97,307       13,614  

Accumulated other comprehensive loss

     (52,270     (7,313     (52,270     (7,313

Accumulated deficit

     (182,368     (25,514     (228,105     (31,913
  

 

 

   

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     909,745       127,279       1,541,638       215,683  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total capitalization

     909,745       127,279       .1,541,638       215,683  
  

 

 

   

 

 

   

 

 

   

 

 

 

A US$1.00 increase (decrease) in the assumed public offering price of US$10.00 per ADS (the mid-point of the estimated initial public offering price range shown on the front cover of this prospectus), would increase (decrease) each of additional paid-in capital, total shareholders’ equity and total capitalization by US$9.3 million.

 

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DILUTION

If you invest in the 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. Because our Class A ordinary shares and Class B ordinary shares will have the same dividend and other rights, except for conversion and voting rights, the following discussion is presented on the basis of all of our ordinary shares, including Class A ordinary shares and Class B ordinary shares.

Our net tangible book value as of September 30, 2019 was approximately RMB906.4 million (US$126.8 million), or RMB0.42 (US$0.06) per ordinary share as of that date, and US$0.90 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 (i) the re-designation of 2,222,222,222 ordinary shares (including 52,027,157 treasury stock) as 1,865,597,778 Class A ordinary shares and 356,624,444 Class B ordinary shares upon the completion of this offering; (ii) the vesting of 16,000,000 restricted ordinary shares upon the completion of this offering, (iii) the vesting of 11,897,436 restricted share units upon the completion of this offering, and (iv) the issuance and sale by us of 150,000,000 ordinary shares in the form of ADSs in this offering at an assumed initial public offering price of US$10.00 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 September 30, 2019, other than to give effect to (i) the re-designation of 2,222,222,222 ordinary shares (including 52,027,157 treasury stock) as 1,865,597,778 Class A ordinary shares and 356,624,444 Class B ordinary shares upon the completion of this offering; (ii) the vesting of 16,000,000 restricted ordinary shares upon the completion of this offering (iii) the vesting of 11,897,436 restricted share units upon the completion of this offering, and (iv) the issuance and sale by us of 150,000,000 ordinary shares in the form of ADSs in this offering at an assumed initial public offering price of US$10.00 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 net tangible book value as of September 30, 2019 would have been US$215.7 million, or US$0.09 per outstanding ordinary share and US$1.35 per ADS. This represents an immediate increase in net tangible book value of US$0.03 per ordinary share and US$0.45 per ADS to the existing shareholders and an immediate dilution in net tangible book value of US$0.58 per ordinary share and US$8.65 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 September 30, 2019

   US$ 0.06      US$ 0.90  

Pro forma net tangible book value per share after giving effect to (i) the vesting of 16,000,000 restricted ordinary shares, (ii) the vesting of 11,897,436 restricted share units, and (iii) this offering

   US$ 0.09      US$ 1.35  

Assumed initial public offering price

   US$ 0.67      US$ 10.00  

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

   US$ 0.58      US$ 8.65  

A US$1.00 increase (decrease) in the assumed public offering price of US$10.00 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$9.3 million, the pro forma net tangible book value per ordinary share and per ADS after giving effect to this offering by US$0.01 per ordinary share and US$0.15 per ADS and the dilution in pro forma net tangible book value per

 

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ordinary share and per ADS to new investors in this offering by US$0.06 per ordinary share and US$0.85 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 September 30, 2019, the differences between existing shareholders (including 16,000,000 restricted ordinary shares and 11,897,436 restricted share units) and new investors with respect to the number of ordinary shares (in the form of ADSs 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

     2,198,092,501        93.6   US$ 36.1        26.5   US$ 0.02      US$ 0.25  

New investors

     150,000,000        6.4   US$ 100.0        73.5   US$ 0.67      US$ 10.00  

Total

     2,348,092,501        100   US$ 136.1        100   US$ 0.06      US$ 0.87  

The above consideration for existing shareholders includes the amount of RMB178,462 (equivalent to approximately US$24,968) exercise price to be received in connection with the vesting of 11,897,436 restricted share units upon the completion of this offering.

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 the ADSs and other terms of this offering determined at pricing.

As of the date of this prospectus, there are also (i) unvested 17,764,103 restricted share units under our 2018 Share Award Scheme and (ii) 6,365,618 ordinary shares available for future issuance upon the exercise of future grants under our 2018 equity incentive plan. If any of these restricted share units are vested, there will be further dilution to new investors.

 

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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 Cogency Global Inc. 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.

Commerce & Finance Law Offices, our PRC legal adviser, 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. Commerce & Finance Law Offices 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

 

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predicated upon the liability provisions of the United States federal securities laws, 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 further developed, 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 March 2018, in order to mirror the shareholding structure of the then shareholders of Hangzhou Canaan, we issued and allotted our ordinary shares at par value to investment holding companies held by the then shareholders of Hangzhou Canaan. 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 income and cash flows data for the years ended December 31, 2017 and 2018 and the selected 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.

The following selected consolidated statements of income (loss) and cash flows data for the nine months ended September 30, 2018 and 2019 and the selected consolidated balance sheet data as of September 30, 2019 have been derived from our unaudited interim condensed consolidated financial statements included elsewhere in this prospectus.

Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements and include all normal recurring adjustments that we consider necessary for a fair statement of our financial position and operating results for the periods presented.

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.

 

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Consolidated Statements of Comprehensive Income (Loss):

 

     Year ended December 31,     Nine months ended September 30,  
     2017     2018     2018     2019  
     RMB     RMB     US$     RMB     RMB     US$  
     (in millions)  

Net revenues:

            

Products revenue

     1,303.1       2,698.6       377.5       2,421.6       944.6       132.2  

Leases revenue

     —         —         —         —         13.3       1.9  

Service revenue

     4.7       6.0       0.8       5.8       0.8       0.1  

Other revenues

     0.3       0.7       0.1       0.2       0.7       0.1  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

     1,308.1       2,705.3       378.5       2,427.6       959.4       134.2  

Cost of revenues

     (703.7     (2,197.2     (307.4     (1,931.1     (802.0     (112.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     604.4       508.1       71.1       496.5       157.4       22.0  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

            

Research and development expenses

     (99.8     (189.7     (26.5     (138.5     (105.4     (14.7

Sales and marketing expenses

     (20.7     (38.7     (5.4     (34.3     (14.2     (2.0

General and administrative expenses

     (125.3     (146.7     (20.5     (116.1     (291.2     (40.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     (245.8     (375.1     (52.5     (288.9     (410.8     (57.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations:

            

Interest income

     0.2       4.2       0.6       2.9       2.1       0.3  

Investment income

     5.6       3.2       0.4       2.3       2.9       0.4  

Interest expense and guarantee fee

     —         (53.1     (7.4     (34.2     (18.6     (2.6

Foreign exchange (loss) gain, net

     (1.2     (1.2     (0.2     (2.6     8.2       1.1  

Value added tax refunds

     38.8       110.2       15.4       103.1       0.3       0.0  

Other (loss) income, net

     (1.1     3.8       0.5       4.5       22.2       3.1  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income tax expenses

     401.0       200.2       28.0       283.4       (236.3     (33.1

Income tax expense

     (25.2     (77.8     (10.9     (133.5     —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     375.8       122.4       17.1       149.9       (236.3     (33.1

Foreign currency translation adjustment, net of nil tax

     —         (65.2     (9.1     (67.5     13.0       1.8  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income (loss)

     375.8       57.2       8.0       82.4       (223.3     (31.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Consolidated Statements of Financial Positions:

 

     As of December 31,      As of September 30,  
     2017      2018      2019  
   RMB      RMB      US$      RMB      US$  
     (in millions)  

Cash and cash equivalents

     176.5        258.9        36.2        332.7        46.5  

Restricted cash

     —          286.3        40.1        —          —    

Accounts receivable

     1.3        23.7        3.3        4.4        0.6  

Inventories

     259.8        585.7        81.9        392.1        54.9  

Prepayments and other current assets

     636.4        186.7        26.1        610.2        85.4  

Income tax receivable

     —          27.1        3.8        25.1        3.5  

Property, equipment and software

     18.4        27.9        3.9        24.0        3.4  

Total assets

     1,203.2        1,402.7        196.2        1,596.1        223.3  

Short-term debts

     —          1,049.0        146.8        248.8        34.8  

Contract liabilities

     202.5        6.9        1.0        276.4        38.7  

Accrued liabilities and other current liabilities

     69.2        58.0        8.1        63.3        8.9  

Total liabilities

     346.0        1,161.7        162.5        686.3        96.0  

Total shareholders’ equity

     857.2        241.0        33.7        909.7        127.3  

Total liabilities and shareholders’ equity

     1,203.2        1,402.7        196.2        1,596.1        223.3  

Consolidated Statements of Cash Flow:

 

    Year ended December 31,     Nine months ended September 30,  
    2017     2018     2018     2019  
    RMB     RMB     US$     RMB     RMB     US$  
    (in millions)  

Net cash provided by (used in) operating activities

    91.2       (12.7     (1.8     (163.1     (10.5     (1.5

Net cash provided by (used in) investing activities

    (86.8     84.0       11.8       91.2       (84.4     (11.8

Net cash provided by (used in) financing activities

    150.0       295.2       41.3       245.2       (119.5     (16.7

Net increase/(decrease) in cash and cash equivalents, restricted cash

    154.4       366.4       51.3       173.3       (214.4     (30.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

    (1.3     2.3       0.3       2.5       1.8       0.3  

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

    23.4       176.5       24.7       176.5       545.2       76.3  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

    176.5       545.2       76.3       352.3       332.7       46.5  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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 (loss) for the years/period indicated:

 

     Year ended December 31,      Nine months ended September 30,  
     2017      2018      2018      2019  
     RMB      RMB      US$      RMB      RMB      US$  
     (in millions)  

Net income (loss)

     375.8        122.4        17.1        149.9        (236.3      (33.1

Add:

                 

Share-based compensation expenses

     95.5        18.6        2.6        14.2        222.5        31.1  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted net income (loss)

     471.3        141.0        19.7        164.1        (13.8      (1.9
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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,      Nine months ended September 30,  
     2017      2018      2018      2019  
     Volume      ASP      Volume      ASP      Volume      ASP      Volume      ASP  
     set      RMB      set      RMB      set      RMB      set      RMB  

A7 series(1)

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

A8 series(2)

     —          —          503,237        4,842        432,739        5,272        265,756        1,206  

A9 series(3)

     —          —          35,324        3,665        2,529        4,578        88,034        2,071  

A10 series(4)

     —          —          —          —          —          —          56,556        7,556  
  

 

 

       

 

 

       

 

 

       

 

 

    

Total

     294,523        4,402        559,137        4,726        455,844        5,198        410,346        2,267  
  

 

 

       

 

 

       

 

 

       

 

 

    

 

Notes:

(1)

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

(2)

Mainly includes our A821, A841, A851 and A852 Bitcoin mining machines.

(3)

Mainly includes our A921 and A911 Bitcoin mining machines.

(4)

Mainly includes our A1047 Bitcoin mining machines.

 

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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,      Nine months ended September 30,  
     2017      2018      2018      2019  
     Total
Computing
Power Sold
     ASP per
Thash
     Total
Computing
Power Sold
     ASP per
Thash
     Total
Computing
Power Sold
     ASP per
Thash
     Total
Computing
Power Sold
     ASP per
Thash
 
     Thash/s      RMB      Thash/s      RMB      Thash/s      RMB      Thash/s      RMB  

A7 series(1)

     2,114,637        613        151,131        505        151,131        505        —          —    

A8 series(2)

     —          —          6,305,119        386        5,386,643        424        3,868,944        83  

A9 series(3)

     —          —          702,416        184        50,580        229        1,639,839        111  

A10 series(4)

     —          —          —          —          —          —          2,089,142        205  
  

 

 

       

 

 

       

 

 

       

 

 

    

Total

     2,114,637        613        7,158,666        369        5,588,354        424        7,597,925        122  
  

 

 

       

 

 

       

 

 

       

 

 

    

 

Notes:

(1)

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

(2)

Mainly includes our A821, A841, A851 and A852 Bitcoin mining machines.

(3)

Mainly includes our A921 and A911 Bitcoin mining machines.

(4)

Mainly includes our A1047 Bitcoin mining machines.

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,     Nine months ended September 30,  
    2017     2018     2018     2019  
    Cost(1)     Per unit
cost
    Cost per
Thash
    Cost(1)     Per unit
cost
    Cost per
Thash
    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     RMB in
millions
    RMB     RMB     RMB in
millions
    RMB     RMB  

A7 series(2)

    693.3       2,354       328       51.1       2,482       338       51.1       2,482       338       —         —         —    

A8 series(3)

    —         —         —         1,243.9       2,472       197       1,079.0       2,493       200       664.1       2,499       172  

A9 series(4)

    —         —         —         154.9       4,385       221       11.1       4,385       219       369.1       4,193       225  

A10 series(5)

    —         —         —         —         —         —         —         —         —         300.0       5,304       144  
 

 

 

       

 

 

       

 

 

       

 

 

     

Total

    693.3       2,354       328       1,449.9       2,593       203       1,141.1       2,503       204       1,333.2       3,249       175  
 

 

 

       

 

 

       

 

 

       

 

 

     

 

Notes:

(1)

Without taking into consideration the inventory and prepayment write down provision of nil, RMB786.0 million (US$110.0 million), RMB786.0 million and RMB0.8 million (US$0.1 million) in 2017, 2018 and the nine months ended September 30, 2018 and 2019, respectively, as well as a realized inventory and prepayment write down of nil, RMB71.1 million (US$9.9 million), RMB33.8 million and RMB569.0 million (US$79.6 million), respectively, for the same periods.

(2)

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

(3)

Mainly includes our A821, A841, A851 and A852 Bitcoin mining machines.

(4)

Mainly includes our A921 and A911 Bitcoin mining machines.

(5)

Mainly includes our A1047 Bitcoin mining machines.

 

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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 cryptocurrency mining machines incorporating ASIC 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 provided us with a solid foundation in terms of both technology and capital resources, which better prepared 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 globally, according to Frost & Sullivan. In September 2018, we became 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. As we are a fabless IC designer, the ICs that we design are manufactured, packaged and tested by industry-leading suppliers, including TSMC, Samsung, 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 in aggregate over 150 million ASICs in 2017, 2018 and the nine months ended September 30, 2019;

 

   

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.

 

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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;

 

   

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 the 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 machines in general, a sudden decrease of the Bitcoin price may lead to stagnant demand and decrease of selling price for our Bitcoin mining machines, which further lead to inventories and prepayments write-down that impact our gross margin.

Our results of operations generally lag behind the change of the Bitcoin price. 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. Such trend is expected to reverse as Bitcoin price started to recover in the second quarter of 2019. Furthermore, due to the decrease of the Bitcoin price in 2018, we made a total provision of RMB786.0 million (US$110.0 million) during the year and recorded a gross margin of 18.8%, compared with gross margin of 46.2% in 2017. As the Bitcoin price remained relatively low throughout the first quarter of 2019 and only started to recover in the second quarter of 2019, we continued to experience low demand of our Bitcoin mining machines despite a low selling price in the first half of 2019, and as a result our revenue for the nine months ended September 30, 2019 decreased by 60.5% from the nine months ended September 30, 2018. The Bitcoin price drop in 2018 also led to our offering of credit sales, and such Bitcoin price trend also caused our customers who purchased our Bitcoin mining products on credit to be less willing to

 

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make payment. We consider the portion of the contract price on credit and not yet collected as implicit price concession and we recognize revenue based on subsequent information regarding our collection of such portion of the contract price. We only recognize the portion of contract price we received up to the issuance date of our financial statements to be our revenue for the period covered by such financial statements. Payment received subsequent to the issuance of our financial statements will be recognized as revenue in a subsequent period. For 2018 and the nine months ended September 30, 2019, we recognized the uncollected portion of the contract price of RMB152.8 million (US$21.4 million) and RMB11.1 million (US$1.6 million), respectively, as price concession. To the extent we collect any of these outstanding uncollected portion of the contract price, we will recognize as revenue such collected amount in subsequent period(s).

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.”

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, RMB2,698.3 million (US$377.5 million) in 2018 and RMB943.2 million (US$132.0 million) in the nine months ended September 30, 2019. 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 (US$38.5 thousand) in 2018 and RMB1.4 million (US$0.2 million) for the nine months ended September 30, 2019. 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.

 

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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 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 work closely with a limited number of such production partners. For example, we currently mainly rely on one third-party foundry for our Bitcoin mining machine business, 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 mainly 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.

 

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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 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. As the Bitcoin price fluctuates, we may adjust selling price of Bitcoin mining machines on a weekly basis, as customers are only willing to pay for machines based on their ability to recover their investment through mining Bitcoins over a relatively short period of time. Our sales arrangements usually require a full prepayment before the delivery of products. However, as the Bitcoin price experienced a significant downtrend during 2018, we started to offer credit sales to certain significant, long-standing customers in China. The payment terms under credit sales generally consist of 50% down payment and 50% subsequent payments over a period of 90 to 180 days. With the adoption of a more dynamic pricing strategy, 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 if the Bitcoin prices continue to decrease in the post-sale period; hence providing implicit price concessions to these customers and the ultimate amount of price concessions to be provided to these credit sales customers is highly dependent on the changes of Bitcoin prices.

 

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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. 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 historically have not been able to overcome the constraint on variable consideration at the time of product sale or at subsequent period-end dates until we have knowledge about the resolution of the uncertainty through payment by the customer. We use all the subsequent information through the date of issuance of our financial statements to adjust the estimated variable consideration for the period, representing updated information on the best estimate of the amount of transaction price that is probable of being received and therefore not constrained as of period-end. We will continue to monitor and evaluate historical data and other factors in determining the total transaction price (including implicit price concessions) that can be recognized for product sales on credit. In 2017, 2018 and the nine months ended September 30, 2019, the contract amounts that were not included in the transaction prices due to the aforementioned variable consideration constraint were nil, RMB152.8 million (US$21.4 million) and RMB11.1 million (US$1.6 million), respectively. In 2017, 2018 and the nine months ended September 30, 2018 and 2019, the adjustment to the previously estimated variable consideration amounted to nil, nil, nil and RMB22.2 million (US$3.1 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 2017, 2018 and the nine months ended September 30, 2019, respectively.

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.

Leases revenue

From July 2019, we started to generate revenue from the leases of Bitcoin mining machines with rental periods of six months. The leases cannot generally be extended or terminated at the customer’s discretion. Rental charges are computed based on the type of Bitcoin mining machine and the rental period. The leases of Bitcoin mining machines meet the classification of operating leases, and revenues from operating leases are recognized on a straight-line basis over the contract terms.

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

 

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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.

Operating lease assets

Operating lease assets consist of lease contracts for Bitcoin mining machines with customers, which are reclassified from inventories at the beginning of lease period. Operating lease assets are recorded at cost less accumulated depreciation and impairment losses. Depreciation is provided using a straight-line method over the estimated economic lives which is generally 18 months. Depreciation expenses are included in costs of revenues. We monitor accounting estimates relating to the depreciation period. Changes made to estimates are reflected in depreciation expense on a prospective basis.

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. The fair value of our ordinary shares was determined with assistance from an independent valuation firm.

 

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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 with the following assumptions:

 

     Share options
granted as of
October 8,
2016
 

Risk-free interest rate

     2.29%  

Estimated volatility rate

     36.53%  

Dividend yield

     0.0%  

Exercise multiple

     2.8x  

Expected term (in years)

     0.83  

Exercise price (RMB)

     0.023  

Fair value of share options (RMB)

     1.30  

The risk-free rate of interest is based on the yield curve of China Government Bond as of valuation date. Volatility is estimated based on annualized standard deviation of daily stock price return of comparable companies for the period before valuation date and with similar span as the expected expiration term.

Determining the fair value of the share options required us to make complex and subjective judgments, assumptions and estimates, which involved inherent uncertainty. Had we used different assumptions and estimates, the resulting fair value of the share options and the resulting share-based compensation expenses could have been different.

The following table sets forth the fair value of ordinary shares and share-based awards estimated at the valuation dates indicated below with the assistance from an independent valuation firm:

 

Date

 

Type

  Share-
based
awards
granted
    Exercise
price
    Intrinsic
Value
    Weighted
average
fair value
of share-
based
awards
    Fair
value of
ordinary
shares
    Discount for
lack of
marketability
    Discount
rate
   

Type of valuations

Oct 8, 2016

  Share option     39,600,000       0.023       1.30       1.30       1.32       26.     28.0   Retrospective

Nov 22, 2017

  Restricted share unit     71,200,000       0.015       N/A       1.56       1.58       19.0     16.5   Retrospective

Apr 24, 2018

  Restricted ordinary share     19,594,000       —         N/A       2.56       2.56       16.0     16.0   Retrospective

Apr 30, 2019

  Share transfer     N/A       N/A       N/A       N/A       2.25       16.0     16.0   Contemporaneous

The major assumptions used in calculating the fair value of ordinary shares include:

 

   

Weighted average cost of capital, or WACC: The discount rates we listed in the table above were based on the WACC determined based on a consideration of the factors, including risk-free rate, comparative industry risk, equity risk premium, company size and non-systematic risk factors.

 

   

Comparable companies: In deriving the WACCs, which are used as the discount rates under the income approach, eight publicly traded companies were selected for reference as our guideline companies. The guideline companies were selected based on the following criteria: (i) companies with business model of fabless IC design and (ii) companies that are publicly listed in the United States or publicly listed in China.

 

   

Discount for lack of marketability, or DLOM: DLOM was quantified by the Black-Scholes put options model. Under this option-pricing model, which assumed that the put option is struck at the spot price of the stock before the privately held shares can be sold, the cost of the put option was considered as a basis to determine the DLOM. This option pricing model is one of the methods commonly used in

 

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estimating DLOM as it can take into consideration factors like timing of a liquidity event, such as an initial public offering, and estimated volatility of our shares. The farther the valuation date is from an expected liquidity event, the higher the put option value and thus the higher the implied DLOM. The lower DLOM is used for the valuation, the higher is the determined fair value of the ordinary shares.

The income approach involves applying appropriate discount rates to estimated cash flows that are based on earnings forecasts. The growth rates of our total revenues, as well as major milestones that we have achieved, contributed to the fair value of our ordinary shares to be RMB1.32 per share as of October 8, 2016, to be RMB1.58 per share as of November 22, 2017, to be RMB2.56 per share as of April 24, 2018 and to be RMB2.25 per share as of April 30, 2019. However, these fair values are inherently uncertain and highly subjective. The assumptions used in deriving the fair values are consistent with our business plan. These assumptions include: no material changes in the existing political, legal and economic conditions in China; our ability to retain competent management, key personnel and staff to support our ongoing operations; and no material deviation in market conditions from economic forecasts. These assumptions are inherently uncertain. The risks associated with achieving our forecasts were assessed in selecting the appropriate discount rates.

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,      Nine months ended September 30,  
    2017     2018      2018     2019  
    RMB     %     RMB     US$     %      RMB     %     RMB     US$     %  
    (in millions, except for percentages)  

Products revenue

    1,303.1       99.6       2,698.6       377.5       99.8        2,421.6       99.8       944.6       132.2       98.5  

Blockchain products(1)

    1,303.1       99.6       2,698.3       377.5       99.7        2,421.6       99.8       943.2       132.0       98.3  

AI products

    —         —         0.3       0.0       0.0        —         0.0       1.4       0.2       0.1  

Leases revenue(2)

    —         —         —         —         —          —         —         13.3       1.9       1.4  

Service revenue

    4.7       0.4       6.0       0.8       0.2        5.8       0.2       0.8       0.1       0.1  

Other revenues

    0.3       0.0       0.7       0.1       0.0        0.2       0.0       0.7       0.1       0.1  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    1,308.1       100.0       2,705.3       378.5       100.0        2,427.6       100.0       959.4       134.2       100.0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Notes:

(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.

(2)

We started to lease our Bitcoin mining machine in July 2019 to achieve better liquidity management when the Bitcoin price is low. We typically lease our Bitcoin mining machines for a period of six months, but with the option, at the mutual agreement of the parties, of ending the lease in three months. Our customer is responsible for the maintenance of the Bitcoin mining machines during the lease period. Going forward, we may continue to employ this model when the Bitcoin price is low.

 

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

 

    Year ended December 31,     Nine months ended September 30,  
    2017     2018     2018     2019  
    Revenue     Volume     ASP     Revenue     Volume     ASP     Revenue     Volume     ASP     Revenue     Volume     ASP  
    RMB in
millions
    set     RMB     RMB in
millions
    set     RMB     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       76.3       20,576       3,710       —         —         —    

A8 series(2)

    —         —         —         2,436.8       503,237       4,842       2,281.6       432,739       5,272       320.5       265,756       1,206  

A9 series(3)

    —         —         —         129.5       35,324       3,665       11.6       2,529       4,578       182.3       88,034       2,071  

A10 series(4)

    —         —         —         —         —         —         —         —         —         427.3       56,556       7,556  
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    1,296.5       294,523       4,402       2,642.7       559,137       4,726       2,369.5       455,844       5,198       930.1       410,346       2,267  
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

 

Notes:

(1)

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

(2)

Mainly includes our A821, A841, A851 and A852 Bitcoin mining machines.

(3)

Mainly includes our A921 and A911 Bitcoin mining machines.

(4)

Mainly includes our A1047 Bitcoin mining machines.

The Bitcoin price hike in late 2017 resulted in strong demand and higher average selling prices for our A7 and A8 series products. In 2018, a significant 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, despite having much stronger computing power, had a lower average selling price as compared with our A7 and A8 series products. As the Bitcoin price slump continued in 2019 and only started to recover in the second quarter of 2019, the average selling price of our A8 and A9 series products further decreased in the nine months ended September 30, 2019. Due to the general recovery of the Bitcoin price in the second quarter of 2019 as well as a higher computing power per machine, we were able to sell our A10 series products that we rolled out in April 2019 at a higher average selling price. 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 power-efficiency.

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,     Nine months ended September 30,  
    2017     2018     2018     2019  
    Revenue     Total
Computing
Power
Sold
    ASP per
Thash
    Revenue     Total
Computing
Power Sold
    ASP per
Thash
    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     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       76.3       151,131       505       —         —         —    

A8 series(2)

    —         —         —         2,436.8       6,305,119       386       2,281.6       5,386,643       424       320.5       3,868,944       83  

A9 series(3)

    —         —         —         129.5       702,416       184       11.6       50,580       229       182.3       1,639,839       111  

A10 series(4)

    —         —         —         —         —         —         —         —         —         427.3       2,089,142       205  
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    1,296.5       2,114,637       613       2,642.7       7,158,666       369       2,369.5       5,588,354       424       930.1       7,597,925       122  
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

 

 

Notes:

(1)

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

(2)

Mainly includes our A821, A841, A851 and A852 Bitcoin mining machines.

 

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(3)

Mainly includes our A921 and A911 Bitcoin mining machines.

(4)

Mainly includes our A1047 Bitcoin mining machines.

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.

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.

 

     Year ended December 31,     Nine months ended September 30,  
     2017      2018     2018     2019  
     RMB      %      RMB     US$     %     RMB     %     RMB     US$     %  
     (in millions, except for percentages)  

Cost of revenue excluding the impact of write-downs

     703.7        100.0        1,482.3       207.4       67.5       1,178.9       61.0       1,370.2       191.7       170.9  

Inventory and prepayment write-down

     —          —          786.0       110.0       35.8       786.0       40.7       0.8       0.1       0.1  

Realized inventory and prepayment write-down

     —          —          (71.1     (9.9     (3.2     (33.8     (1.7     (569.0     (79.6     (71.0
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

     703.7        100.0        2,197.2       307.4       100.0       1,931.1       100.0       802.0       112.2       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 inventory and the estimated realizable value of our inventory, which is significantly affected by the Bitcoin price. In 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$110.0 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. The price of Bitcoin has experienced recovery starting in the second quarter of 2019. We expect our results of operations, including the quantity of Bitcoin mining machines sold and their average selling price, to increase with the recovery of the Bitcoin price in 2019. However, our results of operations generally lag behind the increase in the Bitcoin price.

 

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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:

 

    Year ended December 31,     Nine months ended September 30,  
    2017     2018     2018     2019  
    Cost(1)     Volume     Per unit cost     Cost(1)     Volume     Per unit cost     Cost(1)     Volume     Per unit cost     Cost(1)     Volume     Per unit cost  
    RMB in
millions
    set     RMB     RMB in
millions
    set     RMB     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       51.1       20,576       2,482       —         —         —    

A8 series(3)

    —         —         —         1,243.9       503,237       2,472       1,079.0       432,739       2,493       664.1       265,756       2,499  

A9 series(4)

    —         —         —         154.9       35,324       4,385       11.1       2,529       4,385       369.1       88,034       4,193  

A10 series(5)

    —         —         —         —         —         —         —         —         —         300.0       56,556       5,304  
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    693.3       294,523       2,354       1,449.9       559,137       2,593       1,141.1       455,844       2,503       1,333.2       410,346       3,249  
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

 

 

Notes:

(1)

Without taking into consideration the inventory and prepayment write down provision of nil, RMB786.0 million (US$110.0 million), RMB786.0 million and RMB0.8 million (US$0.1 million) in 2017, 2018 and the nine months ended September 30, 2018 and 2019, respectively, as well as a realized inventory and prepayment write down of nil, RMB71.1 million (US$9.9 million), RMB33.8 million and RMB569.0 million (US$79.6 million), respectively, for the same periods.

(2)

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

(3)

Mainly includes our A821, A841, A851 and A852 Bitcoin mining machines.

(4)

Mainly includes our A921 and A911 Bitcoin mining machines.

(5)

Mainly includes our A1047 Bitcoin mining machines.

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,     Nine months ended September 30,  
    2017     2018     2018     2019  
    Cost(1)     Total
Computing
Power Sold
    Cost per
Thash
    Cost(1)     Total
Computing
Power Sold
    Cost per
Thash
    Cost(1)     Total
Computing
Power Sold
    Cost per
Thash
    Cost(1)     Total
Computing
Power Sold
    Cost per
Thash
 
    RMB in
millions
    Thash/s     RMB     RMB in
millions
    Thash/s     RMB     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       51.1       151,131       338       —         —         —    

A8 series(3)

    —         —         —         1,243.9       6,305,119       197       1,079.0       5,386,643       200       664.1       3,868,944       172  

A9 series(4)

    —         —         —         154.9       702,416       221       11.1       50,580       219       369.1       1,639,839       225  

A10 series(5)

    —         —         —         —         —         —         —         —         —         300.0       2,089,142       144  
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total

    693.3       2,114,637       328       1,449.9       7,158,666       203       1,141.1       5,588,354       204       1,333.2       7,597,925       175  
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

 

 

Notes:

(1)

Without taking into consideration the inventory and prepayment write down provision of nil, RMB786.0 million (US$110.0 million), RMB786.0 million and RMB0.8 million (US$0.1 million) in 2017, 2018 and the nine months ended September 30, 2018 and 2019, respectively, as well as a realized inventory and prepayment write down of nil, RMB71.1 million (US$9.9 million), RMB33.8 million and RMB569.0 million (US$79.6 million), respectively, for the same periods.

(2)

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

(3)

Mainly includes our A821, A841, A851 and A852 Bitcoin mining machines.

(4)

Mainly includes our A921 and A911 Bitcoin mining machines.

(5)

Mainly includes our A1047 Bitcoin mining machines.

In general, we tend to incur higher production costs per Thash 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

 

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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, (iii) our A921 Bitcoin mining machine that employs 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, and (iv) our A10 series products that employ improved design for 16nm processing technology and a larger number of ASICs have higher per unit production costs due to the larger number of ASICs, and lower per Thash production costs due to the advancement of production technology, as compared with our A9 series products.

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, 2018 and the nine months ended September 30, 2019, our gross profit was RMB604.4 million, RMB508.1 million (US$71.1 million) and RMB157.4 million (US$22.0 million), respectively. Our overall gross profit margin was 46.2%, 18.8% and 16.4%, respectively, in the same periods. 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$110.0 million) in 2018 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 in 2018. As our results of operations generally lag behind the change of the Bitcoin price, the decrease of the Bitcoin price in the second half of 2018 continued to impact our operation during the nine months ended September 30, 2019, and resulted in a low gross margin.

 

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Operating expenses

Our operating expenses include research and development expenses, sales 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,     Nine months ended September 30,  
    2017     2018     2018     2019  
    RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  
    (in millions, except for percentages)  

Research and development expenses

    99.8       7.6       189.7       26.5       7.0       138.5       5.7       105.4       14.7       11.0  

Share-based compensation expense included in research and development expenses

    25.1       1.9       9.6       1.3       0.4       7.2       0.3       4.8       0.7       0.5  

Sales and marketing expenses

    20.7       1.6       38.7       5.4       1.4       34.3       1.4       14.2       2.0       1.5  

Share-based compensation expense included in sales and marketing expenses

    0.1       0.0       1.1       0.2       0.0       0.9       0.0       0.3       0.0       0.0  

General and administrative expenses

    125.3       9.6       146.7       20.5       5.4       116.1       4.8       291.2       40.7       30.4  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Share-based compensation expense included in general and administrative expenses

    70.3       5.4       7.9       1.1       0.3       6.1       0.3       217.4       30.4       22.7  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    245.8       18.8       375.1       52.5       13.9       288.9       11.9       410.8       57.5       42.8  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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.

Sales 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.

 

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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.

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 the 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%.

 

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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 w