Hut 8 Corp. Q3 FY2022 Earnings Call

Welcome to Hut 8’s Third Quarter Analysts and Investor Call. In addition to the press release issued earlier today, you can find Hut 8’s financial statements and MD&A on the Company’s website at www.hut8mining.com, under the Company’s SEDAR profile at www.sedar.com, and under the Company’s EDGAR profile at www.sec.gov. Unless noted otherwise, all amounts referred to during this call are denominated in Canadian dollars. Any comments during this call may include forward-looking statements within the meaning of the applicable securities legislation regarding the future performance of Hut 8 Mining Corp. and its subsidiaries. The statements reflect current expectations and as such are subject to a variety of risks and uncertainties that could cause actual results to differ materially from current expectations. These risks and uncertainties include, but are not limited to, the factors discussed in the quarterly MD&A for the quarter ended September 30, 2022, as well as the company's MD&A and annual information form for the year ended December 31, 2021. I would now like to turn the call over to Hut 8’s CEO, Jaime Leverton. Please go ahead.

Thanks so much, Karlen. Good morning everyone, and thank you for joining us to discuss Hut 8's financial results for the third quarter of the year. The industry continues to face challenging headwinds, fluctuating energy prices, and increasing global hash rate, the Ethereum merge and Bitcoin now in its fifth month of hovering around the US$20,000 range. With the benefit of hindsight, it's clear that we were prescient in taking a balance sheet-first approach, which has allowed us to continue operating thoughtfully and strategically. Throughout the quarter we remained focused on optimizing operations for both our mining and high performance computing businesses. We were successful in reducing our cost per coin by nearly 30% over the second quarter, and installed an aggregate of 2,205 new miners at our mining sites during Q3, bringing our operating capacity to 3.07 exahash, which is a 10% improvement over Q2. In our HPC business we completed renovations and upgrades to our flagship data center in Kelowna, British Columbia, and generated $4.4 million in revenue, comprised primarily of monthly recurring revenue from a number of client segments, including the blockchain and emerging technology industry. Ahead of the Ethereum merge we redeployed 180 GPU units to the Kelowna data center and are currently redeploying the balance of our fleet to our data centers to explore new opportunities to leverage the hardware, including in the zero-knowledge proof and Layer 2 space. Moving on to Bitcoin, with the largest self-mined, unencumbered reserves of any publicly listed company, we continue to be bullish on Bitcoin. In spite of the prolonged downward pressure on the digital asset over the last several months, holding continues to be the right approach for Hut 8 and our shareholders, particularly as we get closer to the next halving; we believe we'll see Bitcoin go up and to the right, which will further enhance our balance sheet. In the meantime, our stack sets us apart from our peers, given the inherent flexibility it affords us as we continue to prudently manage the business going forward. While we still intend to explore opportunities that will allow us to generate additional income from our stack, given the ongoing market instability and risk profile at the present time, we will remain conservative and maintain our stack in cold storage. We have a long-term vision to execute a business strategy with three pillars: continuing to mine Bitcoin in a pool environment, maximizing the value of our Bitcoin reserves and growing our HPC data center business. This strategy continues to be the right one for Hut 8; it is keeping us focused through this bear market, and we are in a strong position to continue to make the right decisions for our continued growth. Before I turn it over to our CFO, Shane Downey, who will review our key financial results, I would like to thank our Board for their ongoing support and guidance, our executive team for their leadership and our team for their execution across the business. To our investors, thank you. We know it has been a very dynamic time for the broader industry, and your support of Hut 8 is very much appreciated. Shane, over to you.

Great, thanks Jaime. And good morning everyone. Given the challenging macro environment, we produced solid results for Q3 2022. We achieved revenue of $31.7 million for the quarter, an $18.6 million decrease relative to the prior year third quarter of $50.3 million. This year-over-year decrease was driven by the price of Bitcoin, which more than offset the expansion of our Bitcoin mining fleet and incremental contributions from the high performance computing business we acquired in Q1 of this year. We achieved revenue of $27.3 million from digital asset mining activities as we mined 982 new Bitcoin. This compares with $47.9 million of digital asset mining revenue in the same quarter of 2021, when we mined 905 Bitcoin. We increased our mining capacity by a further 10% in the quarter, while our average cost of mining Bitcoin fell by 29% relative to the second quarter of 2022, reflecting favorable power rates combined with our progressively more efficient fleet. Our high performance computing business contributed an additional $4.4 million of revenue in the quarter, the majority of which is monthly recurring revenue. Cost of revenue for the quarter was $45.6 million compared to $21.2 million in the prior year, and consists of site operating costs and depreciation. The increased depreciation expense from $5.2 million in Q3 2021 to $25.3 million in Q3 2022 is primarily attributed to the increased number of miners deployed as well as mining infrastructure and data center assets acquired. Site operating costs increased by $4.3 million to $20.3 million from Q3 2021. Within the digital asset mining operation, site operating costs increased by $2 million consistent with expansion of our mining fleet. We incurred $2.3 million in operating costs related to the high performance computing operations, all of which are incremental year-over-year. Of note, with respect to our operations, late yesterday, we delivered a notice of events of default to Validus Power Corp., a third-party supplier of energy to our North Bay site, over failure of Validus to achieve key operational milestones within the dates contemplated under the power purchase agreement. Validus has also demanded that the company make payments for delivery of energy that are higher than those negotiated under the terms of the PPA. We intend to pursue all legal remedies available to us to enforce the terms of the PPA, and we'll share additional updates as appropriate. In terms of margins, our digital asset mining operation generated mining profit of $9.3 million versus $33.5 million in the prior year period, reflecting the combination of lower Bitcoin price and increased electricity costs. In light of these external factors, we are generally satisfied with the operating performance in the quarter. General and administrative costs in Q3 were $11.2 million compared to $10.8 million in the prior year. The increase was due to a combination of higher personnel costs, insurance premiums, and other costs, largely in support of the high performance computing line of business. This increase was partially offset by lower sales tax expense and share based compensation expense. Sales tax expense decreased by $2.5 million, primarily related to an overall decrease in the company's purchases and imports of mining equipment relative to the third quarter of 2021. SG&A expense related to the high performance computing business was $1.6 million for the quarter. We recorded a net loss of $23.8 million for the quarter compared to net income of $23.4 million in the prior year period. This net loss was primarily driven by lower revenue from digital asset mining operations and higher cost of revenue in the third quarter of 2022. Also impacting the net loss, we recorded a $7.3 million non-cash gain on revaluation of our digital assets, as a result of the increase in price of Bitcoin quarter-end-over-quarter-end, and we incurred a non-cash loss of $2.9 million on revaluation of warrants liability. Reflecting the operating results discussed previously, Hut 8 achieved adjusted EBITDA of $2.1 million for Q3 2022 compared with $30.7 million in the prior year period. Turning to the financial position, our balance sheet remains healthy with minimal debt and a cash balance of $33 million as of September 30, 2022. On August 17, 2022, we entered into an equity distribution agreement pursuant to which we established an out-the-market equity program with maximum proceeds of up to US$200 million or approximately C$270 million. To date, we've raised US$2 million or approximately C$2.6 million in net proceeds under this program. In light of the challenging capital markets environment generally, combined with ongoing volatility impacting the digital asset space, we remain committed to our conservative approach to balance sheet management. We are pleased with the modest level of non-recourse equipment financing we have in place, and that our substantial digital asset holdings remain fully unencumbered. Our Bitcoin holdings are marked at fair value and totaled $223.4 million as of September 30, 2022 based on 8,388 Bitcoin held in reserve. Our conservative approach to balance sheet management means we've been able to continue our long-term holding strategy. We have not sold any Bitcoins since early 2021. With that, I will turn the call back to Karlen for analyst Q&A.

Thank you. Ladies and gentlemen, we'll now conduct a question-and-answer session. Your first question comes from Joseph Vafi from Canaccord Genuity. Joseph, please go ahead.

Hi, good morning, everyone. Nice to see your conservative strategy shining right here today. Maybe we'll just start with looking as we are sitting here, getting ready to exit 2022 and we look to next year, there's a lot of uncertainty out there relative to Bitcoin, the macro, et cetera. And I know you're staying conservative. I was just wondering if you could provide some insight for us on what the plan may be for next year in terms of maybe increasing hash rate or power capacity or continuing to diversify the business over into the high compute side. And then I have a quick follow up.

I'll take that. Thanks so much, Joe. We've been transparent since really a year ago now with our strategy to be opportunistic for both organic and inorganic growth. Obviously, I can't give any guidance but that continues to be our plan.

Got it. That short answer goes a long way today. So maybe I'll just follow up on that, Jaime. When you look at the industry, there's clearly some distress out there today. How do you think this industry evolves in 2023? Given what's happening, do you expect to see merger activity accelerate industry-wide or perhaps other dynamics? And what do you think happens with the hash rate with Bitcoin down here—it's been a very resilient hash rate—so any comments you have on that would be great. Thanks a lot.

The hash rate has continued to surprise us all. It isn't behaving the way we would have thought it would, given the continued pressure on the price of Bitcoin and the increases we've seen in the energy markets. It's really difficult to predict whether it'll continue defying expectations and keep climbing or start to behave in a more expected manner. So we really can't guide, Joe. It's quite a dynamic situation, more so now than I think we've seen in cycles in the past. With respect to your first question, inevitably, we will see consolidation in this space. We've seen a number of announcements from various parties in this space that are struggling on the leverage side of their business. So I do think over the next six to 12 months, we will see consolidation.

Your next question comes from Gus Gala from Truist. Gus, please go ahead.

Hi, Jaime. I wanted to follow up on Validus. Does this maybe push you to consider getting further vertical, maybe look at power generation? And I just wanted to unpack the dynamics of what's going on with Validus exactly—essentially they offered a price they may not be able to attain in the power markets themselves. Is that the nature of what's going on and is there any chance you're able to retain the nice pricing they had previously offered?

It's difficult for us to comment given that it is an active and live negotiation. As we have updates on how the situation unfolds, of course, we'll share them.

Got you. But do you consider getting further vertical? Strategically you have a bit of cash there and things are distressed out there. It just plays into that type of question.

We are actively looking at a variety of different opportunities and it's really difficult to say at this point what's going to be the most strategic opportunistic path forward.

Got you. That's super helpful. As we look into next year, on balance, if you were going to invest in either the HPC business or self-mining right now, where do you think the best returns are?

That's an incredibly difficult question. It's opportunity specific. There's more distress in the mining space right now, but we'll continue to look at opportunities in both areas, again looking for the best strategic alternatives.

Your next question comes from Bill Papanastasiou from Stifel. Bill, please go ahead.

Hey, good morning. Thanks for taking my questions and nice print today. We've seen a lot of crazy events happen in the space this week, especially with the exchanges FTX and Binance. We also have a lot of miners in distress. Just wondering what you think the implications of what happened this week will be on the Bitcoin mining space, especially when it comes to distressed miners. We've heard news from Core Scientific and Argo, and probably we'll continue to hear more. What's your perspective? Thanks.

I think one of the struggles for the industry right now, particularly given what we're seeing with FTX and Alameda, is we really don't yet understand the full contagion. We don't know where all exposed counterparties are. For the industry, it's really going to depend where new holes show up. As I mentioned in my opening comments, we've made the determination to continue to keep our stack in cold storage until we have a good understanding of where potential contagion goes and where the counterparty risks are. Our view is we need to continue to be conservative and let it shake out.

Great. Thank you. And congrats on wrapping up the hashrate capacity to nearly 3.1 exahash. Given the news with North Bay and what's going on there, has guidance changed at all? Does it still remain at 3.6 exahash by the end of the year?

That becomes a bit fluid given the North Bay situation, so we’re going to have to wait and see how North Bay plays out.

Your next question comes from Chris Brendler from D.A. Davidson. Chris, please go ahead.

Hi. Thanks. I think I heard that the cost per coin went down 30% sequentially, and I wanted to know if you could give us a little more detail on what drove that. Obviously costs are a huge focus today. Was it moving to North Bay, which sounds like that may not be the case anymore? Or is it just lower seasonal costs for power? Help me think about the improvement in cost per coin.

I'll let Shane take that one.

Yes, good question, Chris. It's a combination of the above. Getting operations spun up at North Bay was a modest net contributor. The real point though is that in Q2 there was a spike in power costs driven by natural gas and the global macro situation, including the war in Ukraine. Seeing those costs normalize somewhat over the course of Q3 was a big sequential driver for the improvement, and that would be the biggest piece.

Does summer versus winter weather also have an impact? Should we expect costs to go back up in the fourth quarter or stay around here?

There is some seasonality to power markets in Alberta, but nothing particularly large or dramatic. It's difficult to handicap given the broader uncertainty in global markets today. As of now, we've been comforted in seeing things normalize relative to where they were in the middle part of this year.

One last one: the gross margin in the HPC business came down a little bit. Was that power related or something else?

On the HPC side, no, not power related. We continued the rationalizations we announced in Q2, and those took hold in Q3. Some product rationalizations occurred late in Q2, so think of it as a modest and anticipated impact on margins in Q3. This was an intentional move on our part and we believe it positions us well for growth as we head into 2023.

Yes. It's nice to have a little diversification these days. Thanks a lot, Shane. Appreciate it.

Your next question comes from Kevin Dede from HCW. Kevin, please go ahead.

Thanks. Hi, Shane. Can we drill in a little bit on North Bay? How much of the almost 3.1 exahash is there, and how much of that is at risk? What sort of timeline can you offer with regard to your negotiation with Validus? And if everything goes the ugly way, what of that 3.6 target is something we shouldn't consider hashing early next year, as much as you can quantify, please.

As we've previously disclosed, North Bay was running at approximately 25 megawatts compared to our Alberta sites, which are combined over 100 megawatts. So it's our smallest site. I can't give you a timeline. It's really difficult to handicap how long this will take to resolve with Validus.

Of that 25, is it all running now? How much of it ran through the third quarter?

It is running now and it ran consistently throughout the third quarter.

Have you filled all 25 megawatts? Is it at full capacity?

It is, yes.

With the M30 machines?

Yes.

On the Zenlayer side, can you give us some insight on how you're progressing there? Any insight on how they may be helping you fill out capacity utilization at the former TeraGo sites?

The Zenlayer partnership, which we announced a few weeks ago and we actually had a great meeting with the team in Toronto two weeks ago, is progressing. The hardware is still being delivered, so we expect those environments to be stood up toward the end of this year and available to start being sold into.

Is your team responsible for sales and marketing there or is that all Zenlayer?

It's combined. The teams work together.

Are those machines the ones that will be directed toward rendering zero-knowledge proofs and other HPC applications? And could you run through how that partnership looks financially for Hut 8?

The Zenlayer partnership is more bare metal; it's not the GPUs that we've repurposed into the data center. So those are two different environments. When we speak about repurposing GPUs for Layer 2 and zero-knowledge proof, that's separate from the relationship and partnership with Zenlayer.

Any insight on how things translate for you on both accounts? On the GPU side, do you have any expectation on what your computing power there could generate in revenue and on the Zenlayer side?

It's too soon to give guidance, Kevin. We're trialing a number of different workloads and applications with those GPUs, so I can't give guidance this morning.

Any other variance on the ETH mining side—have you considered other chains or approaches?

We've looked at other alternative chains. We haven't found anything where the economics are what we would want them to be, but we're looking at opportunities potentially for machine learning and AI workloads as well.

Can you speak at all to capacity utilization at the HPC sites; say the end of Q2 versus the end of Q3?

I don't have those metrics at my fingertips, Kevin, but we'll pull them and share them when we have them. That's a good question.

Remind me, what was North Bay slated to be all told? I recall there was an expansion option—was it to go to 100 megawatts?

Yes. The PPA was for up to 100 megawatts with the first phase being 35 megawatts.

Have you considered hedging your power costs in Alberta?

We have explored options, none that we've pursued at the present time.

Given you're comfortable in cold storage, when might you consider putting your Bitcoin to work again?

We were hopeful we'd be in a different position, but as a result of the incidents that kicked off over the weekend, we don't feel comfortable until we see how contagion runs through. We'll revisit toward the end of this year or the beginning of next year, but it very much depends on the state of the market and where we think the risks are, because protecting that stack is critically important.

Appreciate it Jaime. Thank you very much.

There are no further questions at this time. I'll turn it back to you for closing remarks.

Okay. Thank you so much, Karlen. Thank you again, everybody, for joining and for your continued support. We really, truly appreciate it. We'll talk to you soon.

Ladies and gentlemen this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.