Earnings Call Transcript - HUT Q4 2020

Operator, Operator

Welcome to the Year-end Financial Results Conference Call. My name is John. I'll be your operator for today's call. Operator instructions were provided. Please note the conference is being recorded. And I will now turn the call over to Jaime Leverton.

Jaime Leverton, CEO

Good morning, everyone. First and foremost, thank you for taking the time to join us today. This is my first earnings call since taking the helm here at Hut 8 on December 1, and I want to thank you all as investors and members of the bitcoin ecosystem for such a warm welcome into the role. I also want to thank the Board of Directors for putting their faith in me to lead Hut 8 through this next evolution of our innovation and growth journey. And most importantly, I want to thank the entire team here at Hut 8 for making me feel so at home since my arrival and for continually throwing themselves day and night into helping drive this company forward at a truly remarkable rate. Without further ado, I will now hand it over to Jimmy to walk us through our Q4 and 2020 audited year-end financials. Over to you, Jimmy.

Jimmy Vaiopoulos, CFO

Thank you, Jaime. Hi, everyone. This is Jimmy Vaiopoulos, CFO of Hut 8. Before continuing, I'd like to remind everyone that all amounts in the financial statements and discussed on this call are in Canadian dollars, unless stated otherwise. 2020 was a transformational year for both Hut 8 and the bitcoin industry. Hut 8 became the first company to successfully enter and exit the TSX Sandbox program and was actually the first cryptocurrency company to the TSX. We restructured the legacy Bitfury agreement to provide Hut 8 more autonomy and the ability to purchase bitcoin mining equipment from any manufacturer, and Hut 8 also transferred the site operations from being run externally by Bitfury to bring all operations and staff in-house to Hut 8. This reduced cost significantly for the company and increased the quality and control of our operation. Also, on June 25, 2020, we closed an oversubscribed prospectus offering for gross proceeds of $8.3 million. The net proceeds were used to purchase over 300 petahash per second of latest generation equipment from MicroBT, which was installed between September 2020 and January 2021 and is all running today. For bitcoin, we saw a price drop significantly mid-March to below USD 4,000 due to the aftermath of the COVID-19 shelter-in-place orders. It took almost until May 2020 for the bitcoin price to recover, at which point the bitcoin halving event took place where the block reward was cut in half. We saw a subsequent drop in the network difficulty rate by 15% but recovered quickly to pre-halving levels in June 2020. Although we currently have record level bitcoin prices creating incredible bitcoin economics, it is easy to forget that most of 2020 was a difficult year for many bitcoin miners, including Hut 8. Hut 8 revenue for the year ended December 31, 2020, was $40.7 million from mining 2,798 bitcoin, including hosting revenue of $1.7 million. This compares to the prior year of 8,618 bitcoin mined with revenue of $82 million, of which there was no hosting revenue. The reason for the decrease was due to difficult bitcoin economics, including the halving event, as mentioned. The site operating costs for the year were $39.7 million compared to the prior year of $45.4 million, a reduction of 13%. When comparing the operating cost against the number of bitcoin mined for the year, the average cost of mining each bitcoin in 2020 was $14,195 compared to $5,273 in 2019. We note that there are significant differences in how the industry calculates average cost of mining, and Hut 8 takes a conservative stance of using all operating costs, which is an audited figure. During the tight bitcoin economics of 2020, Hut 8 focused on maintaining the lean operation and reduced expenses by 45% on a corporate level from $6.1 million in 2019 to $3.4 million in 2020. The company was able to maintain a $2.9 million gain on the use of bitcoin throughout the year, despite the volatile bitcoin price by timing any sale of bitcoin to the best of their ability. This compared to the prior year gain on the use of bitcoin of $4.1 million. The unrealized gain on digital assets increased by 221% to $13.7 million in 2020 from $4.3 million in 2019 due to the increase in the bitcoin price, but did not include a $60.7 million unrealized gain on Hut 8's bitcoin holdings that wasn't recognized on the income statement, but instead was accounted for directly in the equity section of the company's balance sheet. The company reduced its net finance expense by 49% to $2.4 million in 2020, from $4.8 million in 2019 due to the reduction of the interest rate and finance expense related to Hut 8's bitcoin collateralized loan. This loan was fully repaid in February 2021, and all bitcoin collateral was returned. Hut 8 recognized a gain of $13.2 million related to the reversal of an impairment from the year ended December 31, 2018. This was primarily due to the positive change in the bitcoin economics through to the end of the year of 2020. Hut 8 recognized a negative $2 million in adjusted EBITDA for 2020 compared to a positive $33.5 million in the prior year. It is important to note that the adjusted EBITDA for Q4 2020, that quarter alone, was a positive $1.4 million, meaning that the negative adjusted EBITDA in 2020 resulted primarily from the first three quarters. Net income before tax increased by 87% to $4 million in 2020 from $2.1 million in 2019. This is the second year in a row that Hut 8 has been able to achieve positive bottom line profits. Hut 8 recognized a $15 million deferred income tax recovery, which had a net zero effect between the income statement and balance sheet as there was an offsetting amount recognized against the unrealized gain to bitcoin of $60.7 million through the equity section of Hut 8's balance sheet. This resulted in net income of $19 million. Working capital as at December 31, 2020, was $75.7 million, a 246% increase from the prior year working capital amount of $21.9 million. Looking forward into 2021, the company announced the March 24, 2021 bitcoin balance as 3,233 bitcoin, which had a price of USD 52,000. The bitcoin balance was approximately CAD 210 million. This bitcoin balance is a 17% increase from the December 31, 2020 balance, showing Hut 8's confidence in bitcoin and ability to grow its bitcoin holdings. This has put Hut 8 on great footing for 2021, as it has fully repaid its debt and has one of the strongest balance sheets and an established operation in the space. Back to you, Jaime.

Jaime Leverton, CEO

Thank you so much, Jimmy. Despite an incredibly difficult year for bitcoin mining economics, I couldn't be more pleased with how the team at Hut 8 performed, proving once again the prior experience navigating bitcoin market bull and bear cycles is paramount to success in this industry. The team demonstrated the criticality of timing and reduction of expenditures, thoughtful debt restructuring and seizing the opportunity to strengthen the balance sheet without sacrificing our core bitcoin assets. I'd also like to take this opportunity to highlight some of the key progress made so far in the early days of 2021. In January, we closed a private placement offering for gross proceeds of $77.5 million with institutional investors. As part of the proceeds from that financing, as Jimmy mentioned, we were able to fully repay the USD 20 million loan with Genesis Global Capital with all bitcoin collateral returned to Hut 8 at that time. In January, Hut 8 also confirmed an additional 5,400 M30S units to be shipped between January 2021 and July 2021 with an USD 11.8 million equipment financing loan with DCG Foundry. Four hundred units of which are already installed and hashing, bringing our total self-mining hash rate in production today to just under 1.1 exahash. We have also announced the creation of a yield account for 1,000 of our bitcoin holdings, which generate yield at a rate of 4% per annum with Genesis Global Capital, thus adding a third revenue line for Hut 8 and further building on our revenue diversification strategy. Since my arrival in December, we've expanded the depths of talent on our leadership team, including a new Head of Investor Relations, Sue Ennis; a new Head of Technology, Jason Zaluski; and a new General Counsel and Executive Vice President of Regulatory, Tanya Woods. In addition to a number of fabulous new team members in the field in Alberta as well as the welcoming of two incredible new board members in Sanjiv Samant and Chris Eldredge. Last month, we were honored to be recognized as 11th out of 10,000 in the 2021 OTCQX Best 50, which ranks the top-performing companies traded on the OTCQX Best Market last year. Year-to-date, we are thrilled to have increased our social media followers by 134% since the end of 2020 as we work to increase our focus on engaging more directly with our investors and with the marketplace. While it has been a busy start to the year already, rest assured, we are still just getting warmed up. I will now open up the call to Q&A.

Operator, Operator

Operator instructions were provided. And our first question is from Deepak Kaushal.

Deepak Kaushal, Analyst

I've got a handful of questions. I'll ask a few and then I'll jump back in queue. Maybe two follow-ups. Jaime, welcome to the conference call. Just curious, you mentioned that you have some capacity that's coming over the next several months. What do you guys expect in terms of your self-mining hash rate when that's all installed? And I assume that should be fully installed by the end of June, is that what you said?

Jaime Leverton, CEO

End of July is our expectation to have it fully installed. And the hash rate that we expect is 1.3 exahash, assuming that we replace some of our older equipment with the new equipment coming from MicroBT.

Deepak Kaushal, Analyst

Okay. And what would be the ratio? Or what would be the amount of exahash on top of that rate you're hosting?

Jaime Leverton, CEO

So our hosting business right now hosts just under 9 megawatts. We have not publicly said the exahash involved in the hosting business, but it's just under 9 megawatts of the 109 megawatts that we have in production today.

Deepak Kaushal, Analyst

Got it. Are you expecting, like, what kind of ratio are you targeting for long-term hosting versus self-mining?

Jaime Leverton, CEO

We have not released the ratio that we're targeting, Deepak.

Deepak Kaushal, Analyst

Okay. Got it. So I'm just curious, we're hearing about lead times well over 9 months for new equipment. I'm just curious as to what levers you see you have to be able to expand capacity in 2021. Or is this really a 2022 timing for a new expansion beyond the current planned rollout?

Jaime Leverton, CEO

We are exploring a number of options, Deepak. And when I have something that I can publicly share, I will absolutely do so.

Deepak Kaushal, Analyst

Okay. So can you comment just in general, what you're hearing in the industry in terms of lead times or prices of new equipment?

Jaime Leverton, CEO

In general, the lead times are definitely significant. We've seen orders with delivery dates well into 2022. But as you know, we were able to work with Foundry, our partner, to get equipment installed in the first half of 2021 with our January order. So we do expect to look for various areas of optionality, but certainly, general lead times are currently going into 2022.

Deepak Kaushal, Analyst

Okay. Got it. And I noticed that there was a good OpEx reduction for the full year versus the prior year. It looked like it creeped up again in Q4 and you've hired some new bodies. What should we expect for a quarterly run rate for OpEx, $1 million a quarter? $1.5 million a quarter? And how would that split between cash versus noncash OpEx?

Jaime Leverton, CEO

Yes. I think we can't give guidance on that right now, Deepak. As you know, we are in a phase of transformation and high growth. So I can't give you guidance on a steady state OpEx run rate.

Deepak Kaushal, Analyst

Okay. But since you are in a phase of transformation and high growth, that would suggest you're going to invest more, so that number should directionally be going up. Is that a fair assumption?

Jaime Leverton, CEO

I wouldn't make that assumption because we're looking at all parts of our business on both sides of the line.

Deepak Kaushal, Analyst

Okay. And then just a last question on expansion, and then maybe I'll jump back in the queue to give others a chance. After the equity raise and the debt repayment, is it just simple math here, you have about just over $50 million to spend on new capacity expansions. Is that how we should think about it?

Jaime Leverton, CEO

We haven't announced a use of proceeds, obviously, for the full $77.5 million. So I can't speak to it directly, but directionally.

Deepak Kaushal, Analyst

Okay. So can you comment on your current liquidity position today as of today? In terms of bitcoin line?

Jaime Leverton, CEO

I'll turn that over to Jimmy.

Jimmy Vaiopoulos, CFO

Yes. I could comment on the specific number, but you have a general idea by seeing how much cash we had on cash at year-end, how much cash we just raised, which was announced and our bitcoin that we just announced as well. So looking deep, I'm sure it can paint a pretty strong picture for you.

Deepak Kaushal, Analyst

Got it. And so just to reiterate, you have just over 3,000 bitcoin on the balance sheet. You put 1,000 with Genesis. Should we assume that the other 2,000 is something that you might liquidate to fund expansion? Or are you fully committed to holding that full balance on your balance sheet?

Jaime Leverton, CEO

At this time, we have no intention of liquidating that balance. We are committed to our HODL strategy.

Operator, Operator

Our next question is from Stuart Skyler.

Stuart Skyler, Analyst

Just a couple of quick things. First of all, the big elephant in the room, I think, everybody wants to know if there is anything that you can talk about as far as NASDAQ uplisting is concerned?

Jaime Leverton, CEO

Yes. Stuart, we are aware that others are not safe for making announcements regarding their moves toward NASDAQ. As you know, the road to NASDAQ is very uncertain and applications to list do not guarantee listing success. In short, the outcome of being listed is not guaranteed. We recognize that our shareholders are encouraging us to announce intentions and listing commitments. And we can assure you that we're exploring our options and we'll inform the market once we have more information to share.

Stuart Skyler, Analyst

Okay. Next, noticed in your statement today that basically, your cost of producing bitcoin seems awfully high compared to the competition. Is there a reason for that, obsolete machinery, potentially? What's going on?

Jimmy Vaiopoulos, CFO

I can touch on that, Jaime. So I touched on it at a high level in my discussion, but there's significant differences in what different issuers are including in their calculation for cost to mine bitcoin. So there's not a consistent way, especially, given this is a non-IFRS number. We've taken a conservative approach, which we see as a requirement under IFRS to use our audited number, that is the operating costs. So the full amount there. We've seen varying amounts of inclusion in the cost of mining. So although ours may look high, it's just inclusive of far more items — so it's not really apples-to-apples.

Stuart Skyler, Analyst

Are you including G&A — are you including your G&A expenses in that?

Jimmy Vaiopoulos, CFO

Everything on site. So all site expenses, electricity, everything that happens at the site level is included.

Stuart Skyler, Analyst

Okay. Okay. And the last question, basically, from what we are hearing from Jaime at this point is 1.3 exahash seems to be where you guys are going to be for the entire year. Am I wrong in assuming that? Or do you have other things that potentially could happen?

Jaime Leverton, CEO

That's the number that we expect to be at by the end of July, when the equipment that we have ordered to date comes online. That is not the number for the entire year, unless we don't make any incremental purchases in year. And at this time, I'm not at liberty to speak to that. But the 1.3 is based on what we have ordered to date, assuming that we replace existing hardware, and that would be as at the end of July.

Stuart Skyler, Analyst

Very good. And I wish this new management team success.

Jaime Leverton, CEO

Thank you, Stuart.

Operator, Operator

Our next question is from Kevin Dede.

Kevin Dede, Analyst

I was wondering, Jaime, if you could just sort of speak conceptually. I know you're exploring all options, and everybody sort of coming at you in different directions. But you've obviously structured this deal with Validus. And I was wondering if you could just sort of speak conceptually to the power options that that agreement might offer you? Or what other power options you might have in Alberta? Or what else might be on the table?

Jaime Leverton, CEO

You guys are relentless. You know that I will tell you what I can when it's available to be publicly released. What I can answer with respect to the MoU we signed with Validus is that we're absolutely exploring potential power options with Validus. Validus has a number of different options from a power perspective, primarily behind-the-fence generation. But at this point, it is still exploratory. And when there is something official to announce, I promise I will do so immediately.

Kevin Dede, Analyst

Okay. Fair enough. Appreciate the limitations you're forced to operate within. So Jimmy, could you add a little more color on that reversal of impairment, please? I just want to make sure I understand the accounting background there. It was a big number, like $13.2 million.

Jimmy Vaiopoulos, CFO

That's correct. Yes. So it's important to understand the historical context here. So at the end of 2018, it was very tough bitcoin economics during the heart of the crypto winter, bitcoin was, honestly, hovering in the mid-3,000s. And there was a large impairment that took place then. Some of that impairment was to the actual infrastructure of the sites that we have. Because bitcoin has recovered in the bitcoin economics, especially in the past few months have been so strong, we were able to recover some of the impairment that was allocated to the infrastructure on site. So it was a reversal of a prior impairment to $13.2 million.

Kevin Dede, Analyst

So was it booked in '18? Or was it booked in '20?

Jimmy Vaiopoulos, CFO

An impairment was booked in the year ended 2018. And a reversal of that impairment was booked in 2020. A portion of that impairment.

Kevin Dede, Analyst

Could either one of you sort of enlighten us on your plans for the equipment that's being phased out? I know maybe some of it is S9. So I'm just kind of wondering how you're handling it. Even in the current environment S9 can be run profitably. But given your power limitations, I'm just sort of wondering what sort of value you might be able to extract from things that are being replaced with the new MicroBT here?

Jaime Leverton, CEO

Great question. We're exploring our options there.

Kevin Dede, Analyst

Okay. That's how you walked in this morning, right? It didn't seem either; our legal counsel instructed us to say we're exploring our options.

Jaime Leverton, CEO

Yes. You got that right. We are staying very much on side here.

Operator, Operator

Our next question is from Greg Petrowski.

Greg Petrowski, Analyst

Kind of along the lines of the other questions. I'm trying to understand the nature of the business, and I'm trying to understand what is the actual physical run life of these miners? What is the depreciation life? And what is a CapEx per year requirement just to maintain existing mining capacity?

Jimmy Vaiopoulos, CFO

I can touch on that. We separate our equipment into two different columns in our notes: the chips (the units themselves) and the infrastructure. We have taken a conservative approach and have the useful life of the chips and the actual units themselves at two years, where the infrastructure is at four years. We have already seen equipment going past its useful life. In these economics, where we see strong bitcoin price runs yet constrained supply of new equipment, we've seen an elongated life on some of this older equipment. The infrastructure consists of various pieces like transformers, boxes, wires and everything that took to put the site together, and many of those items individually have a life of more than four years.

Jaime Leverton, CEO

Greg, it's a really difficult question to answer. We use an extremely conservative depreciation schedule, as Jimmy spoke to, being a two-year schedule for the mining hardware itself. Although the actual useful life of the hardware is certainly beyond that, and with the newest generation of equipment, we expect it to be significantly beyond that two-year window. It's really difficult to give you a CapEx projection based on where things are in the cycle, the very limited supply of the current generation of chips and the fact that bitcoin mining economics has extended the useful life. It's difficult to predict how long that useful life will be, given how difficult it is for the hash rate to come up with the supply constraints.

Greg Petrowski, Analyst

Okay. So maybe to ask the CapEx question in a different way, how much does it cost per year just to maintain existing production level? I mean that's a pretty basic maintenance CapEx number.

Jimmy Vaiopoulos, CFO

On an ongoing basis, it's difficult given the volatility of pricing for the current newest generation of mining hardware. The price point has gone up significantly in the last six months. Any annual CapEx guidance would be very heavily assumption based and it's difficult to give you a firm number based on the volatility of the pricing involved in the hardware itself.

Operator, Operator

And our next question is from Rama Aleway.

Rama Aleway, Analyst

Congratulations on the great numbers from last year, which was easy to forget. It was a difficult year. My question is going to be much broader than the previous ones. Bank of America had a low outcome of bitcoin's dirty little secrets. I just wondered if you could speak briefly to kind of what you see as the ESG challenges for mining going forward for the next year?

Jaime Leverton, CEO

It's a difficult question to answer. We are doing a lot of work on building out our ESG narrative in our ESG strategic plans. That is something that we're looking at quite aggressively as a new leadership team. The bitcoin mining industry in general, because it's so focused on the lowest possible cost of energy, tends to focus on energy that otherwise isn't being used, wasted energy, stranded energy. That's the lion's share of energy consumed by the bitcoin network. The other comment I will make is it's interesting how this narrative comes at the bitcoin industry so aggressively, but it doesn't come at the mainstream data center world, the cloud computing world, which are also heavy consumers of data and, therefore, power. This narrative seems quite targeted towards bitcoin itself. Again, because Bitcoin cares most about the lowest cost of energy, it's usually using energy that would otherwise be wasted. So certainly a narrative that we're working on. You're going to see more and more come from us in this space. Those are my thoughts at a very high level.

Rama Aleway, Analyst

I mean we hear a lot about the stranded power, but if you're running from the grid, then you are taking kind of available power or — a miner is. And there is a carbon dioxide toll for that for the mining community. Do you see any concerns about regulation? Do you see any concerns that beyond the price of power that the renewable powered miners are going to have some sort of edge on a go-forward basis?

Jaime Leverton, CEO

I think it's not something I can speak to directly at this time. But again, it's something we're spending a lot of time and energy focusing on, and we will be building out a strategy and sharing it over the next few months.

Operator, Operator

Our next question is from Matt Siminski.

Matt Siminski, Analyst

I noticed the majority of that revaluation gain is run through AOCI and not net income. Can you explain why?

Jimmy Vaiopoulos, CFO

Sure. There's guidance from the regulators on how to approach bitcoin and other cryptocurrencies under IFRS. The guidance is to classify bitcoin as an intangible asset. The way that it works is that if you have a loss on an intangible asset, then it goes through the income statement. If any of that loss is reversed, then it goes through the income statement as a gain, as we did for a portion of that gain. Anything above that goes straight to the equity section of the balance sheet. We're constrained by the requirements under IFRS and the guidance given by the regulators in Canada, which we have to follow.

Matt Siminski, Analyst

Okay. So is it safe to say for future revaluation in quarters ahead the appreciation in bitcoin will be run through AOCI going forward?

Jimmy Vaiopoulos, CFO

Yes. Unless there is a period where we mark our bitcoin down. We will be able to reverse that through the P&L. Anything more would, as you say, go through OCI.

Operator, Operator

And we have no further questions at this time.

Jaime Leverton, CEO

Okay. In that case, again, I want to thank everyone so much for joining and for your support. We look forward to speaking to you again in the not-too-distant future on our Q1 financials. Thanks so much. Have a great day, everybody.

Jimmy Vaiopoulos, CFO

Thanks, everyone.

Operator, Operator

Thank you, ladies and gentlemen. That concludes today's call. Thank you for participating. You may now disconnect.