Earnings Call Transcript - HUT Q2 2022

Operator, Operator

Welcome to Hut 8 Second Quarter Analyst and Investor Call. In addition to the press release issued earlier today, you can find Hut 8’s financial statements and MD&A on SEDAR and shortly on both EDGAR and hut8mining.com. Unless noted otherwise, all amounts referred to during this call are denominated in Canadian dollars. Any comments made during this call may include forward-looking statements within the meaning of applicable securities legislation regarding the future performance of Hut 8 Mining Corp and its subsidiaries. The statements made 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 three months ended June 30, 2022, as well as the company’s MD&A and annual information form for the year ended December 31, 2021. Any forward-looking statement speaks only as of the date on which it is made and the company disclaims any intent or obligation to update any forward-looking statement unless required by law. I would now like to turn the call over to Hut 8 CEO, Jaime Leverton.

Jaime Leverton, CEO

Thanks, Michelle. Good morning, everyone and thank you for joining us to discuss Hut 8’s financial results for the second quarter of the year. In our first full quarter generating fee-based monthly recurring revenue through our five data centers and an increased mining capacity that grew to 2.78 exahash by June 30, we generated strong quarterly revenue while also increasing our Bitcoin holdings. Notably, we continued to ramp up mining activities at our third mining site in North Bay, Ontario and installed nearly 7,200 new miners across all three of our mines. We increased our hash rate by more than 9% since the end of Q1 as our sites continue to generate strong revenue and support the continued vitality of the company. Looking forward, we anticipate organically growing our mining capacity to approximately 3.55 exahash by the end of 2022, while being ready as we always have been to be opportunistic about any inorganic opportunities that might arise. Hut 8 is one of the only digital asset miners that hasn’t sold down or encumbered our stack of Bitcoin, which speaks to our financial acumen and commitment to our balance sheet-first approach. Maximizing the value of the Bitcoin on our balance sheet is very much a priority for us and a key pillar of our business. We were very intentional in recalling the 2,000 Bitcoin that we had in our yield programs into our possession in mid-May before the contagion spread across the industry and plan to resume working our stack as soon as it’s prudent to do so. To that end, we continue to explore opportunities that will allow us to generate additional income in a responsible manner and anticipate that as markets stabilize, we will see compelling options materialize. We are one of the only digital asset miners that have diversified into the infrastructure space. And while we continue to be bullish on Bitcoin, we also believe strongly in the high-performance computing industry and the potential opportunities that lie ahead for HPC and the nascent blockchain and Web 3.0 industry. We spent much of the second quarter rationalizing our HPC business and eliminating products and services that weren’t delivering meaningful returns for us. We have completed the cleanup and are now ready to increase capacity and invest in building out the HPC infrastructure with the latest technology that will attract high-margin clients going forward. We have a long-term vision to execute a business strategy with three pillars: one, continuing to mine Bitcoin in our pool environment; two, maximizing the value of our Bitcoin reserves; and three, growing our HPC data center business. Our long-term vision is to generate enough revenue from our high-performance computing business and working the stack to fund our digital asset mining operations without being reliant on capital markets, which can be both expensive and at times unreliable. We have intentionally and successfully avoided selling Bitcoin to fund our mining operations business, unlike many of our peers. We believe current Bitcoin prices are repressed and we are taking a long view on our reserves. For us, it doesn’t make sense to sell Bitcoin at low prices only to fund additional Bitcoin mining and we are cognizant that the halving is not too far away. I have mentioned this before, but it bears repeating. We have been anticipating and preparing for possible market volatility for approximately a year. We were thoughtfully conservative in the back half of 2021 to operate prudently and avoid becoming swept up into the bull run we saw last fall and winter and I am confident that we have managed the downturn well to this point and we will continue to successfully navigate the market by maintaining a balance sheet-first approach going forward. 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 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.

Shane Downey, CFO

Thanks, Jaime, and good morning everyone. Given the challenging macro environment, we produced a solid result for Q2 2022. We achieved strong revenue of $43.8 million for the quarter, a 31% increase over the prior year quarter of $33.5 million. This performance was driven by strong digital asset mining activity with a solid contribution from the first full quarter of operations from the high-performance computing business, which we acquired earlier this year. We achieved revenue of $39.1 million from digital asset mining activities as we mined 946 new Bitcoin. This compares with $31.4 million of digital asset mining revenue in the same quarter in 2021 when we mined 553 Bitcoin. Operationally, this significant 71% increase in Bitcoin mined reflects the substantial increase in hash rate and efficiency as we have upgraded and expanded our entire fleet of ASICs, and came despite the increase in year-over-year Bitcoin network difficulty. Our newly acquired data center business contributed an additional $4.7 million of revenue, reflecting a full quarter’s worth of revenue since we acquired the business at the end of January 2022. Cost of revenue for the quarter was $47.7 million compared to $16.6 million in the prior year and consists of site operating costs and depreciation. Increased depreciation expense from $3 million in Q2 2021 to $20.9 million in Q2 2022 was driven by the addition of approximately $178 million of new mining equipment and infrastructure over the past 12 months as well as approximately $25 million of data center fixed assets through the previously mentioned acquisition. Site operating costs increased by $13.1 million to $26.8 million. Within the digital asset mining operation, site operating costs increased by $10.8 million driven by electricity costs, which stemmed from a combination of higher power prices and a modest increase in consumption. $2.3 million of operating costs related to the high-performance computing operation, all of which are incremental year-over-year. We have now substantially onboarded the team we need to drive profitable growth in our high-performance computing business. This includes sales, networking, cloud and data center operations personnel. In terms of margins, our digital asset mining operation generated mining margins of approximately 38% versus 62% in the prior year period, reflecting the combination of lower Bitcoin prices and the increased electricity costs. In light of these external factors, we were generally pleased with operating performance in the quarter. Margins in our high-performance computing business were strong and we continue to expect them to fall into the 35% to 40% range as previously communicated. As Jaime mentioned, in completing the integration of our HPC business, we identified certain low-margin products and services and have rationalized these offerings as a result. Following that exercise, we have withdrawn the revenue growth guidance provided as part of our Q1 2022 results, but want to emphasize that we believe these rationalizations were prudent and position us well to realize profitable revenue growth in 2023. General and administrative costs in Q2 were $12.3 million compared to $8.8 million in the prior year. The increase was primarily driven by sales tax expense, share-based compensation expense, higher insurance premiums and salaries and benefits costs related to ongoing build-out of our team. Insurance expense reflects increased premiums driven by tight global insurance markets, combined with an expansion of director and officer liability insurance and the incremental coverage related to our high-performance computing operations. Sales tax expense increased by $1 million primarily related to equipment purchases and imports during the quarter. SG&A expense related to the high-performance computing business were $1.9 million. We recorded a net loss of $88.1 million for the quarter compared to a net loss of $4 million in the prior year period. This net loss was substantially the result of non-cash revaluation losses during the quarter. Firstly, we recognized a $43.3 million gain on our warrants liability stemming from the revaluation under the Black-Scholes valuation model. That gain was more than offset by a revaluation loss on digital assets as a result of the decline in Bitcoin price during the quarter. The company incurred a total non-cash loss of $217.8 million on the revaluation of our Bitcoin holdings. $112.9 million of the loss was offset against accumulated gain recorded in other comprehensive income and the remaining $104.9 million non-cash loss was recorded as an expense in the statement of operations. Hut 8 achieved adjusted EBITDA of $6.8 million for Q2 2022, reflecting our ability to maintain profitability despite a challenging macro environment for digital asset mining. This compares with $14.4 million in the prior year period. To address our financial position, our balance sheet remains healthy with a cash balance of $60.1 million at the end of the quarter. As previously announced, we entered into a $65 million at-the-market offering program in February 2022. We raised approximately $61 million during the first six months of the year, which is approximately CAD77 million. Subsequent to quarter end, we completed the remainder of the program and raised an additional $4 million, or approximately CAD5 million. The proceeds from these issuances were and will continue to be invested in the growth of the company. 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 in place and that our substantial digital asset holdings remain fully unencumbered. Our Bitcoin holdings are marked at fair value and totaled $188.8 million as of June 30, 2022, based on 7,406 Bitcoin held in reserve. Our conservative approach to balance sheet management means we have been able to continue our long-term HODL strategy. We have not sold any Bitcoin since early 2021. With that, I will turn the call back to our operator, Michelle, for analyst Q&A.

Operator, Operator

Thank you. Your first question comes from Chris Brendler of D.A. Davidson. Please go ahead.

Chris Brendler, Analyst (D.A. Davidson)

Hi, thanks. Good morning and congrats on the results. I guess I will start with the cost per coin and the increase there. Can you talk about in general terms what your power cost did in the second quarter? And then perhaps most importantly, what it looks like going forward as North Bay ramps up? And then alongside that, just sort of give us some guideposts on how big as part of your operation North Bay will be at the end of this quarter?

Shane Downey, CFO

You want to start?

Jaime Leverton, CEO

Thanks, Chris. We expect North Bay to be at the full 35-megawatt capacity of Phase 1 by the end of this quarter. So I’ll take your questions in reverse order. From a power perspective, we actively manage power at our sites in Alberta on a 15-minute increment cycle. Meaning we’re always watching where power prices are, and when power prices get too high, we adjust operations accordingly. That’s a process that has always been in place and will continue to be in place as we pay close attention to the energy market. So I really can’t speculate on where energy prices are going, but that’s how we dynamically manage the sites that are grid connected in those 15-minute increments. And just as a reminder, our site in Drumheller is connected to the Alberta grid, whereas our site in Medicine Hat is connected directly to the Medicine Hat grid, which is separate from the broader Alberta grid, and we have different PPAs in place between those two sites. And then as you know, our site in North Bay is behind the meter; it’s not grid connected.

Chris Brendler, Analyst (D.A. Davidson)

Right. And I guess I wasn’t really looking for a forecast on where energy prices are going, but the idea we’ve talked about for months is that this third site will have a much better power cost. So your cost per coin should start to fall even regardless of what power costs do. I think power costs this quarter became problematic for many folks, given where energy prices were. We weren’t expecting the spike in natural gas prices. So not that surprised to see your site operating costs go up this quarter, but hoping that for the next couple of quarters we will see that start to stabilize as North Bay ramps up?

Jaime Leverton, CEO

Yes, exactly, assuming we don’t have more surprises on the grid side.

Chris Brendler, Analyst (D.A. Davidson)

Got it. Okay. And just from a growth perspective in the mining operations, it looks like you have some additional deposits. Can you talk about what new equipment—new mining rigs—you have coming and maybe what you paid for them relative to what you may have paid in the past, since prices have probably come down?

Jaime Leverton, CEO

We haven’t made any incremental orders from a mining equipment perspective. The remaining deliveries that we have are from a prior order that we made towards the end of last year and the beginning of this year with MicroBT, and they come in at about 1,000 units a month from that order through the balance of 2022, but we haven’t made an incremental order.

Chris Brendler, Analyst (D.A. Davidson)

Okay. Is that something you think will be part of the plans in the second half? How much capacity do you have to expand beyond where you are today?

Jaime Leverton, CEO

So as it stands today, we’ve placed the orders that we need to maximize the power that we have built out at the three sites.

Chris Brendler, Analyst (D.A. Davidson)

Okay. And how much of the operation will be North Bay when you get there, roughly percentage-wise?

Jaime Leverton, CEO

Phase 1 of North Bay maxes out at 35 megawatts. Drumheller is 42 megawatts and Medicine Hat is 67 megawatts.

Chris Brendler, Analyst (D.A. Davidson)

Is there a second phase for North Bay at some point?

Jaime Leverton, CEO

It is under contemplation.

Chris Brendler, Analyst (D.A. Davidson)

Okay, great. I will allow other folks to ask questions. I will get back in the queue, thanks, Jaime.

Operator, Operator

Thank you. The next question comes from Joseph Vafi from Canaccord. Please go ahead.

Jaime Leverton, CEO

Good morning, Joe.

Joseph Vafi, Analyst (Canaccord)

Hi, good morning, Jaime, how are you? Nice to see the emergence of this three-pillar strategy — a very differentiated approach relative to peers. To start, as the high-performance compute business begins to move into growth mode, how do you look at investment costs and returns in the mining business versus high-performance compute over the next year? Where do you want to invest or why would you deploy more investment capital into one side of the business versus the other? I’ll have a follow-up.

Jaime Leverton, CEO

Great question, Joe. As I think we’ve proven over the past 18 months, we like to be opportunistic when we look at growth opportunities. We run models based on projected returns, and I think this market environment is going to provide some unique opportunities for that opportunistic approach. It’s difficult to say what opportunities will present themselves in which pillar. We continue to look at growth in both and analyze the opportunities as they come forward.

Joseph Vafi, Analyst (Canaccord)

Fair enough. So it’s fair to say you evaluate opportunities in real time based on the dynamics and the economics on both the mining and HPC sides. Could you give a broader view of where you believe the demand environment is on the HPC side at this point? If you did start to ramp capacity there, how do you see that capacity being put to work and what kind of tempo or growth rate might you expect?

Jaime Leverton, CEO

We have five data centers, and each of them addresses different market segments and has different capacity available. We are looking at each of them and making determinations on where we want to invest and how we want to grow them based on the demand we’re seeing in each geographic market. At a high level, we’re very active and engaged in conversations in the Web 3 ecosystem. We see a lot of positive momentum coming in that segment with respect to our data centers and our offerings. It’s a unique position for us to have this full stack of infrastructure, from mining all the way up to Tier 3 traditional data center assets, which allows us to provide infrastructure for the Web 3 ecosystem in a way that is unique for a digital asset-native company. We see increasing momentum coming out of that ecosystem and continued strength in growth from the existing base of enterprise customers that we have today.

Joseph Vafi, Analyst (Canaccord)

Okay. That’s great. On the balance sheet cash, which is a nice amount in addition to your buffer, is some of that cash committed to the order flow on the MicroBT units or could part of it theoretically be deployed or used for other initiatives not yet begun?

Jaime Leverton, CEO

I’ll let Shane answer that with some specificity.

Shane Downey, CFO

We’re substantially paid up on that final MicroBT order. The $60 million cash balance at the end of the quarter gives us an appropriate level of flexibility as we think forward through the balance of the year and looking towards the start of 2023.

Joseph Vafi, Analyst (Canaccord)

Got it. Thanks, Shane. Thanks, everyone. Great job.

Jaime Leverton, CEO

Thanks, Joe.

Operator, Operator

Thank you. The next question comes from George Sutton of Craig-Hallum. Please go ahead.

Jaime Leverton, CEO

Good morning, George.

George Sutton, Analyst (Craig-Hallum)

Good morning and very nice to see the HODL strategy is starting to really pay off over the last handful of days. I was fortunate to listen to elevator music instead of your presentation for the first several minutes, so if you discussed this I apologize. But can you talk about the scope of the rationalization you mentioned relative to the HPC opportunity? And how quickly do you think you can refill the square footage that you’re talking about?

Jaime Leverton, CEO

The rationalization was more specific to lower-value product offerings that existed. We rationalized two of those product offerings that were not in our target margin window as opposed to specifically white space rationalization.

George Sutton, Analyst (Craig-Hallum)

I understand. That’s helpful. I know you’ve been slow playing machine purchases a bit given that prices have been coming down. Where do you think things sit from a broader perspective here with Bitcoin prices starting to strengthen?

Jaime Leverton, CEO

There is a lot of mining hardware available that is landed in North America. We haven’t seen the price move much over the last few weeks. But as I’ve said, we have the mining equipment that we need for the power that we have built out or are ramping for the balance of the year. So at this point, I’m not really looking at mining equipment for 2022.

George Sutton, Analyst (Craig-Hallum)

Understand. If we look out a year from now, are we more likely to hear you’ve expanded more aggressively into additional HPC areas or Bitcoin mining areas?

Jaime Leverton, CEO

It’s really difficult for me to predict where the right opportunities for growth are going to arise over the next 6 to 12 months. We’re in unique market conditions and we like to be incredibly opportunistic when we deploy capital as you saw from us last year. If the right opportunity doesn’t present itself in one pillar or the other, then we’re not going to move forward with it. So it’s impossible to say where the right opportunities will evolve over the next 6 to 12 months, but we are actively pursuing opportunities in both categories.

George Sutton, Analyst (Craig-Hallum)

Great. Thank you very much.

Operator, Operator

Thank you. The next question comes from Kevin Dede, HCW. Please go ahead.

Jaime Leverton, CEO

Good morning, Kevin.

Kevin Dede, Analyst (HCW)

Good morning, Jaime and Shane. Thanks for adding me. Jaime, did power prices ever go high enough in Alberta that you felt compelled to wind machines down at all? Or were you impacted by heat at all there in the quarter?

Jaime Leverton, CEO

We did have some peak power pricing during some of the hotter days. When we see peak power pricing, we do power down. We don’t mind powering down when prices are too high. In the case of our site in Drumheller, we participate in ancillary services, and that program remains active. So yes, Kevin, we monitor power pricing every 15 minutes and react accordingly.

Kevin Dede, Analyst (HCW)

Yes, right. I hadn’t realized that’s why I thought I’d ask. Is there any way to quantify that at all for us?

Jaime Leverton, CEO

I can have my team take that away for you, no problem.

Kevin Dede, Analyst (HCW)

Okay. In the meantime, could you give us a little insight on the investments you have to make on the five HPC centers that you have running? It’s unclear to me how fully utilized they are, how fully stacked they are with equipment. Given you sort of reset things, does that mean old equipment left and gives you an opportunity with new equipment in?

Jaime Leverton, CEO

The rationalization I referenced was specific to a couple of low-margin product lines, not equipment. We do have white space available at a few of the sites, and we are actively looking at how to best utilize that white space, whether to sell it or deploy it. Those activities are actively underway and are being led by our SVP of Operations, James Beer.

Kevin Dede, Analyst (HCW)

So, the $60 million in cash, how do you see spending going in building out the white space that you have available?

Jaime Leverton, CEO

We haven’t gotten into specifics on where growth is going to come, but we will let everyone know when those specifics are laid down.

Kevin Dede, Analyst (HCW)

Just another — could you help me understand the sales and marketing effort on the HPC side? How are you building that out and taking Hut 8 to market?

Jaime Leverton, CEO

We have an experienced sales leader responsible for go-to-market for HPC, Josh Rayner, who joined earlier this year. When we made the acquisition from TeraGo, it came with a full team that supported it, so we brought over some great sales resources and have added a number of sales team members aligned to driving into the Web 3 ecosystem. In total, we are up to about 10 people in the sales team. We also have Aaron Dermer who joined earlier this year to lead marketing and public affairs, and in that marketing team we now have three resources focused on overall go-to-market strategy, including messaging and lead generation for the HPC side of the business.

Kevin Dede, Analyst (HCW)

Could you talk a little about how you tie into other companies in the digital mining space? I understand Foundry is a partner, but how did that come to pass?

Jaime Leverton, CEO

We have had a long-standing strategic relationship with Foundry. They are our largest mining pool partner on the Bitcoin mining side. We have worked closely with them on purchase financing previously and with their related companies. When we purchased these data center assets, Foundry made a decision to put some of their core infrastructure into our data center facilities as well, so they are now a client of ours as we have historically been a client of theirs.

Kevin Dede, Analyst (HCW)

Was that new equipment, or are you spooling up servers you already had?

Jaime Leverton, CEO

It was existing infrastructure that they are moving into our data center.

Kevin Dede, Analyst (HCW)

Got it. Thank you very much, Jaime. Appreciate it.

Operator, Operator

Thank you. The next question comes from Bill Papanastasiou of Stifel. Please go ahead.

Jaime Leverton, CEO

No problem. Good morning, Bill.

Bill Papanastasiou, Analyst (Stifel)

Hi. Good morning. Thanks for taking my question. My first question is related to the HODL strategy that Hut 8 has. You’re one of the few public miners that have not sold in this bear market. Just wondering how you’re looking at potentially reentering a lending program later this year? I know you concluded that in May. Are you considering loaning out your Bitcoin again, or have market conditions not improved to the level you’d like?

Jaime Leverton, CEO

I addressed this a bit in my remarks, and Shane will add more color. We absolutely intend to revisit and evolve our 'work the stack' strategy. We’re not yet comfortable with where everything sits in the market from a counterparty perspective, but it’s something we expect to move into again. We are exploring a variety of opportunities for how we can best work the stack without taking undue risk on our Bitcoin reserves. Shane is leading that project on our side.

Shane Downey, CFO

Overall, Bill, Jaime said it well. We’ve been intentionally selective throughout 2021 with the counterparties we worked with, being Genesis and Galaxy previously, two well-capitalized firms we engaged with. In an abundance of caution, we made the determination in May to pause the yield program. Looking at how we reengage around working the stack could range from direct yield programs similar to what we’ve done in the past, to exploring algorithmic trading approaches against a small portion of our stack, and to employing derivative strategies where we can drive yield with acceptable counterparty risk. That’s where we are now and we will continue this work as we look toward relative stability in the broader digital asset space.

Bill Papanastasiou, Analyst (Stifel)

Great. Thank you for the color and apologies I wasn’t able to get on the call earlier. My next question is related to proof-of-stake. The company had about 11% of total mine Bitcoin equivalent coming from Ethereum operations. How are you looking at this potential upgrade to proof-of-stake and the strategy behind Hut 8?

Jaime Leverton, CEO

We are paying very close attention to the discussions around Ethereum moving to a proof-of-stake model. One thing we like about our GPU fleet is that it is housed in enterprise-grade chassis, which gives us flexibility. Today, Ethereum mining is performed at our Medicine Hat site, but over time we will look to move some or all of that compute into our data center environment. Having compute in the data center allows us to apply that resource to other types of workloads, and the team has been working on identifying other available workloads in addition to continuing to mine the next most profitable proof-of-work chain, whether that’s a hard fork of Ethereum Classic or other proof-of-work chains. So our strategy will be to parse that compute into a few different areas. We are happy with the mining economics today and will stick with our current strategy until we get more clarity on a post-merge world for proof-of-work chains.

Bill Papanastasiou, Analyst (Stifel)

Great. Thank you so much for the color. That’s helpful.

Jaime Leverton, CEO

Okay. Great. Thank you so much.

Operator, Operator

Thank you. Our last question comes from Gusto Gala of Truist Securities. Please go ahead.

Jaime Leverton, CEO

Good morning.

Julian, Analyst (Truist Securities)

Hey. Thanks for taking the question. Good morning. This is Julian on for Gusto. Most of my questions have been answered. Are there any total Bitcoin holdings that you are comfortable maintaining, or is it a moving target? I know you said you haven’t sold anything since early 2021, but how do you make decisions between holding and selling? Is there a target core holding that you’re particularly looking at?

Jaime Leverton, CEO

No, there is no target. Our commitment is to hold the Bitcoin on the balance sheet, particularly at these levels. We don’t think it makes sense to sell Bitcoin and then reinvest in equipment that’s going to have a payback period that extends past the halving. The math suggests selling Bitcoin now could cost you more to mine it later. That’s how we’re thinking today, and that thinking will be tested and evolve as market conditions and Bitcoin prices change.

Julian, Analyst (Truist Securities)

Got it. From Shane’s comments, I was going to ask about an asset management overlay strategy, but it seems you’re already thinking about that or have done it in the past, particularly around hedging or non-correlated exposure. It seems you’re exploring that now after the recent counterparty events and some of the other counterparties we have seen in the space. Is that fair to say you’re looking at that at the moment to step back into that, and when might you do so?

Jaime Leverton, CEO

Shane and his team are actively exploring potential strategies to work the stack going forward. We haven’t settled on timing or specifics yet; it’s an ongoing active investigation.

Julian, Analyst (Truist Securities)

Got it. All right. Thank you for taking the questions. Appreciate it.

Jaime Leverton, CEO

No problem. Michelle, are there any other questions?

Operator, Operator

There are no further questions at this time. Please continue with closing remarks.

Jaime Leverton, CEO

Okay. Well, thank you again everyone for joining the call and for your support. Have a wonderful day, and thanks Michelle for your help.

Operator, Operator

Thank you. Ladies and gentlemen, this does conclude our conference call for today. We thank you for your participation and ask that you please disconnect your lines.