Hut 8 Mining Corp

TSX:HUT

Earnings Call Transcript 2019-Q1

[Operator]

Welcome to the Hut 8 Mining First Quarter [ Filing ] Conference Call. My name is Sylvia, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Andrew Kiguel, CEO. Mr. Kiguel, you may begin.

[Andrew Kiguel, President, CEO & Director]

Thank you very much. Welcome, everybody. Good morning to the Hut 8 Mining Q1 Call. I'll maybe just start off with the sort of an overview here, and then I'll turn it over to Jimmy to walk you through the financials and then we'll take questions. So we had revenue of $12.1 million for Q1, and we mined 2,405 bitcoin. While mining economics improved in April, started -- basically, the uptick started April 1, the first quarter was still tough. And some of that was primarily for most of Q1, price of bitcoin was trading below $4,000, network difficulty increased by 14%, and then we had the polar vortex and other cold weather in Alberta, which resulted in somewhat higher electricity pricing. So although we had initiated a whole bunch of cost reductions that were successful, they were somewhat offset by some higher power prices. And these were record temperatures. There are some more details on that in our MD&A. Despite that, with the higher cost, we still managed to decrease our price per bitcoin to $3,950 in Q1. And so we see that the benefits of our cost reductions and our electricity optimizations have been successful. In addition, we also reduced our overhead by a couple of hundred thousand dollars in Q1 to $747,000 for the quarter, which is -- we continue to drive to keep the company lean and bring that down. Just to put things in some perspective, we think that our electricity optimization in Q1 ended up saving, as we estimate, about $5 million. So while we maybe lost a little bit of revenue, there were some coin we, I think, were pretty effective there in keeping cost fairly low by not mining at periods of time when the energy price was peaking when we had this very weird cold weather that flowed through the western part of Canada. As part of the other thing, we -- again, we remain committed to solely mining bitcoin. It's a question we get as often as possible and retaining as much as we can. Despite what were harsh conditions, at the end of March 31, we had 2,615 bitcoin, and our operations -- as I see in the press release, our operations today are stronger than ever, and we feel very confident and we're poised for strong financial improvement. Just to put it in perspective, I think for -- in terms of the industry, Q1 seems to have marked the bottom of the bitcoin cycle. It was really right at the end of the quarter when we started seeing the uptick in the bitcoin price that we've been seeing today. To put things in further perspective, we mined 2,405 bitcoin at the end of the quarter -- or sorry, for Q1 quarter. That resulted in $12.1 million in revenue. At today's bitcoin price, that will be close to $30 million in revenues. Since our cost per bitcoin decreased from Q1, I mean people can do the math, but I think what you can see there, even if we used our cost price at $3,950 per coin on $30 million of revenue, you can see that it would have significant impact on our margins based on what's happening today. And again these are the -- for the reasons that we're sort of saying that the company is stronger than ever, and I can tell you since then electricity prices have really stabilized and we've actually seen our cost come down a lot more than that. Q1, we also mined more bitcoin than ever before. That's because we had all of our operations up and going. That was an integration of the 12 new BlockBoxes that we bought at the end of Q4 last year. And so we feel very confident. There is a lot of positive things happening in the bitcoin ecosystem. And so we're excited for what's happening here right now. So with that, I would like to say Q1 was a tough quarter, but it certainly doesn't feel reflective of where the company is today. I'll turn it over to Jimmy to talk about Q1.

[Demetrios Vaiopoulos, CFO & Corporate Secretary]

Thank you, Andrew. This is Jimmy Vaiopoulos speaking, CFO, 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. For the first quarter of 2019, the company mined 2,405 bitcoin, resulting in revenue of $12.1 million compared to the same period of the prior year of 817 bitcoin mined with revenue of $11 million. Revenue between the 2 periods increased by 10%, while the amount of bitcoin mined increased by 194%. The reason for this difference in bitcoin mined to revenue was primarily due to the decrease in average bitcoin price in Q1 2019 of USD 3,800 from the same period of the prior year of USD 10,600 while average difficulty rates increased by over 120% between Q1 2019 and the same period of the prior year. The site operating cost for the year were $12.6 million, and the cost to mine each bitcoin was USD 3,950. This quarter was an anomaly as Alberta had extreme weather conditions, including a polar vortex and record cold temperatures, which negatively affected our operations. This caused higher-than-normal natural gas prices in all North America and resulted in increased electricity costs at our Drumheller site and a smaller portion of our Medicine Hat site, which is exposed to market natural gas prices. We've seen the natural gas market returning to normal in March 2019. The Hut 8 team has worked hard to keep a lean cost structure, which is shown as the expenses for the first quarter of 2019, excluding noncash share-based compensation, were $774,000 (sic) [ $747,000 ] compared with Q4 2018 of $994,000. This has helped minimize losses at the worst of the crypto winter, but will also provide a good basis to become more profitable in the next bitcoin pricing cycle, which we believe we're seeing the beginning of in Q2 2019. Hut 8 recognized negative $1.3 million in adjusted EBITDA, the first quarter of negative operations, and a net loss of $6.1 million. Both losses were largely as a result of bitcoin prices remaining at around 52-week lows during Q1 2019, hash rates increasing and a volatile natural gas market, which all negatively impacted operations for the first quarter of 2019. For Q1 2019, fair value on remeasurement of digital assets was $790,000, which represents a gain on adjusting the value of digital assets held to the market value on the reporting date. This is the first gain on remeasurement of digital assets for Hut 8 and marks the potential bottoming of the bitcoin price. Subsequent to March 31, 2019, to today's date, we have seen crypto winter turn closer to a crypto spring as the bitcoin price has increased by 112%, while difficulty rates have only increased by 5%. This has increased -- this has improved bitcoin mining economics thus far in Q2 2019, and our team is optimistic about the future of bitcoin. I'll now pass the call back over to Andrew.

[Andrew Kiguel, President, CEO & Director]

Yes. I think we'll -- operator, we can turn it over for questions.

[Operator]

[Operator Instructions] And the first question comes from Deepak from GMP Securities.

[Deepak Kaushal, Director and Technology & Communications Analyst]

I know we just spoke a couple of weeks ago when you did Q4, but I do have some questions. There's been a lot of developments since then. Andrew, first on the cost synergy. You said $5 million. I think that was $5 million in the quarter, right, not annualized?

[Andrew Kiguel, President, CEO & Director]

Correct. So it -- that's not a savings number. What that number is, it's electricity optimization. So as I said before, the price of electricity is way more volatile than the price of bitcoin, believe it or not. And so it will go from $0.02 a kilowatt-hour to $2 a kilowatt-hour in a span of an hour. And so rather than us looking to mine 100% of the time, what we do is we sort of see these spikes and we curtail our mining. And so by curtailing our mining during sort of peak periods, which generally happen in the morning when people are getting up and ready for that, and then in the evenings when they come home, we might curtail our production for 1.5 hours a day. And it's that savings of not mining for 1.5 hours a day that ended up saving us incremental potential cost of about $5 million.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. So could you say what your percentage uptime was during the quarter in terms of mining? Are we thinking like you are up 98% of the time still? Or does that optimization bring you down to the 80s?

[Andrew Kiguel, President, CEO & Director]

No, it's still very high. Like on -- even on super cold days, like we're still going to be up 90% of the time, right? I mean it's -- we are talking about 1.5 hours a day during extreme periods of time when the price might spike up to $3 or $4 a kilowatt hour. So it's minimal downtime, and I think you can see that in terms of the number of bitcoin that we mined is more than we had ever mined before.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. And it's fairly predictable. So if you wanted to schedule any downtime maintenance, you could do it in the same periods, too, right?

[Andrew Kiguel, President, CEO & Director]

Well, no. The weather is not predictable, but we do try -- and like I said, it's short periods of time, maybe like 45 minutes in the morning and 45 minutes in the evening. So we do try and do some maintenance and things we need to do at that time, although if the weather is minus 40 degrees outside, sometimes it's hard to do that also.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Got it. Okay. Just another question. When we think about capacity expansion, before I get to the capital, from a technology perspective, are you guys tied to only using Bitfury BlockBox? I know that's been your preference. That's what you've been using for now. Are you able in your agreement to go elsewhere if you need to? And is there anything else on the market that is kind of appealing versus what you're seeing from Bitfury these days?

[Andrew Kiguel, President, CEO & Director]

So we do have an exclusivity that goes both ways. There are ways around it. But frankly, we've been very satisfied with the Bitfury equipment that we are seeing. Even with the older equipment that we had been depreciating at 2 years, like -- we did the math, we do the math every week, but those boxes are still hugely profitable. And even though they are coming up on 2 years, we see no reason to even need to update them now even though we have that option. So it's tricky. And keep in mind, Bitfury owns a good chunk of the company and they have been excellent partners to us, so I don't know that necessarily that we would want to go outside that. We have looked at a bunch of stuff. There is a new Bitmain machine. I think it's called the S18, which is supposed to be quite powerful. The issue with that is that it's pretty hard to get your hands on them. Again, this is somewhat hearsay, but my understanding is that Bitmain was unable to secure production at Taiwan Semiconductor. And so that the actual amount at those new machines that are available is pretty low. I think that the other things that come with that as well as is that one of the benefits of using the BlockBox is that we can locate them in pretty remote areas. Like some of the reasons in some of the new sites and things that we are looking at, it's somewhat stranded energy at remote places. If you're using other equipment, generally speaking, you've got to build up an entire facility. You got to build the site or retrofit a site. And that's time-consuming, it's expensive, and it can take 12 months. And frankly, you don't know what the market is going to be in 12 months. Like the cheapest bitcoin you're going to mine is the bitcoin you mine today. And so we are still feeling pretty good about the equipment that we have. And we are in talks with the guys at Bitfury. The equipment there keeps improving in terms of their chips and the hash rate. So we're always looking at other products. We haven't seen a real reason there to go back to them and try and get out of the exclusivity. Like I said, it goes both ways.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Got it. And then -- and you also need kind of capital if you want to expand. You mentioned -- I think you mentioned in the last conference call, you are looking at creative ways of finding financing. What are your options? What have you thought of in the last couple of weeks? And what else can you share in terms of any potential ways to expand capacity?

[Andrew Kiguel, President, CEO & Director]

Well, one of the things we're looking at is getting some additional megawatts out of the city of Medicine Hat without any additional capital spend. So we've been creative there in sort of dealing with them. And we think that we'll able to get another 3 megawatts out of the city without any incremental capital and then just pushing some of our machines a little bit harder. So that's one way. We're always looking at sites. I mean there's nothing I have here to disclose. But obviously, we think that this is the best time to potentially expand when the price of the equipment is low and competition for new sites is low. But I would say we are exploring different things. There is nothing here that I would sort of reveal to anybody that's material.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. So one of the other options is -- you have a big bitcoin balance. I know you have a covenant on the debt. Like at what price -- bitcoin has been ripping here. What price do you start looking at converting some of that coin to fiat to redeploy? And then how do you make that kind of decision?

[Andrew Kiguel, President, CEO & Director]

Yes. I think part of it -- I mean we are well in excess of the covenant here. The covenant is not an issue. It's things that we have thought about, but there is nothing out here right now. I think at the end of the day, the reason people invest in Hut 8 or at least the message we try and provide is we provide a proxy via the public markets for exposure to bitcoin. I think if our digital assets got to be so large where we could still provide that exposure to investors and then reinvest some into new projects, that would make sense, but we're -- I wouldn't say we're quite there yet.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. And we've seen some other Canadian miners diversify into hosting services or mining of the service or staking. Others are selling the coins as they mine and just being a cash flow machine -- fiat cash flow machine. What are your thoughts on those strategies? I know that that's not what you're thinking of at this time is the message, but what do you think of those strategies from a value perspective?

[Andrew Kiguel, President, CEO & Director]

Well, hindsight is always 20/20. You never know. So when we started Hut 8, it was with the purpose of being solely a bitcoin miner and mining on behalf of investors. At certain points of last year, that strategy looked bad. Currently, today, the strategy looks quite good. So things change. The thing with hosting, we want to keep the company lean, and I am sure people are aware, but there is only 4 employees at Hut 8. Like, we keep things very lean here. And if you start getting into things like hosting, then you start partially becoming a marketing company, because then you have to go out, then you have to find people and you are competing against a lot of people. So that would mean sort of additional investments in marketing, hiring people, doing things. When at the end of the day, what we really want to do is continue to provide that proxy for being a bitcoin miner. Some of the things we have been approached about, people have approached us to see if we would sell them a portion of our hash rate. Those are kind of things we've looked at. So when we talk about creative ways of potentially financing, could we sell some hash rate? And the price for hash rate right now has gone up. So we look at that stuff. But again, in terms of other miners, everybody has a different strategy. If you had a strategy last year where you mined and sold everything that you did, it's probably still a tough year, but you probably did better than we did on a pound-per-pound basis. This year, I think our strategy of holding has benefited us a lot when we've seen the price of bitcoin go from $3,200 or so at the beginning of the year to, I think, it hit $8,900 at the beginning of the week and it's currently trading at about $8,700. So that strategy benefits us where all of a sudden the digital assets that we hold start becoming a real big war chest over time. And at that point, we start contemplating to -- if the balance becomes big enough, you start evaluating like, do you become the first crypto company to provide a dividend? Do we sell some of that? Convert it into fiat as a hedge? Do we convert to fiat and build out new sites? But I would say, Deepak, we are not quite there yet. The company is in a very strong position right now. But I wouldn't say we're in a strong enough -- in a position where I would want to diverge from the strategy of mining and holding.

[Deepak Kaushal, Director and Technology & Communications Analyst]

That makes sense to me. It's helpful answer. And I don't necessarily disagree with that strategy. I think I agree with that. Just one last question if I may. I'm usually the only guy on the call. You guys have 85 BlockBoxes. Can you give us a sense of the broader universe of BlockBoxes out there? Like how prevalent are these things? And what's kind of your share in North America of BlockBoxes? Do you have a sense of the in situ resource that's Bitfury-based to the extent that you can share that?

[Andrew Kiguel, President, CEO & Director]

Yes. Totally. So to our knowledge, there are 85 BlockBoxes, and then prior to Hut 8 being established, there was about another 24 BlockBoxes, the majority of which are in Drumheller. And those are owned by Bitfury. And that's it. So there is nobody outside of Hut 8 that we're aware of. And I don't think -- we talked to the Bitfury. We have a very good relationship with them. I don't think there is any other BlockBoxes in North America other than the ones that we own and then the older models that they own. And they're all -- the ones that Bitfury owns are primarily in Drumheller, right next to our facility. Like, it's actually all just one big facility, and we own a certain amount of boxes and they own the other ones. And so we get some economies of scale there as they are the guys to do the operations in terms of staffing, maintenance and all those types of things.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. I don't want to get ahead of ourselves here, but could you ever see yourself looking at Bitfury BlockBoxes in other parts of the world in terms of consolidating a globe -- more of an international operation?

[Andrew Kiguel, President, CEO & Director]

Yes. We have to see. I mean look, this is all a good news story, but you got to remember like, 5, 6 weeks ago, we were all in a very different situation. So it's been a very positive upside surprise. One of the things that we have talked about with Bitfury is seeing if there is an ability to bend in some of the existing boxes, and those are things we do diligence on. It's all older technology stuff, so it's coming up on about 2 years life. But as I said before, we're looking at our current older version, which is of the first 17 BlockBoxes that we took on in December 2017. And in the current market, even though those are our least efficient boxes, so -- I always divide up the first 17 are the least efficient, that's our most expensive bitcoin that we mine, but it's still in this market making a ton of money. And so it could be a possibility that we look to bend in there and that could be another 25 megawatts there. So we're exploring all types of different things right now. But like I said, there is nothing that's material here that I'd be looking to disclose to the market.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. That makes sense. Hopefully, we have continued current mining economics for a while, so you guys can start accumulating some value. So...

[Andrew Kiguel, President, CEO & Director]

Yes, like I said, the one thing that I would sort of say is, I can say that in Q2, our price per bitcoin has come down from Q1, and the price of bitcoin has more than doubled here. And so from a mining economic standpoint, this is a very healthy time.

[Operator]

Our following question comes from Dan from Toroso.

[Dan Weiskopf]

You said something pretty powerful, and I'm not sure I can get my arms around it, but maybe you could speculate if you would. You said that the price of bitcoin went up 112%, but hash went up 5%. I mean how do we get our arms around that hash rate? Is there something that we should be looking at, specifically from the vantage point of outsiders looking in, to assess where that hash rate is going?

[Andrew Kiguel, President, CEO & Director]

Yes. I think there is a few things, so -- what you got to remember, Dan, is there's always a lag. And so what you saw happen in 2017 was that the price of bitcoin runs, but the hash rate has not like, guys can just turn on the light and the hash rate comes on. Like, you got to go out, buy equipment, build the facility, get it going. And what you saw happen in the end of 2017 and what unfortunately happened in the crypto winter of 2018 is, everybody ordered all their equipment to get their hash rate going at the end of 2017 at prices of $20,000, so everybody overpaid for equipment then. The mining economics for 6 or 7 months, they were phenomenal. And then 2018 comes, the price plummets and you're stuck with all this equipment. I think we're seeing sort of that again here, where the hash rate is unable to keep up with the price of bitcoin. I think it's one of the things. So you've got guys trying to manufacture, but as I said earlier, my understanding -- and again this is somewhat just hearsay and things I'm hearing, is that Bitmain, which is the biggest manufacturer of equipment, was unable to secure space at Taiwan Semiconductor. So that means that the availability of getting the equipment, there's going to be a lag. I think the second thing is, in China, they put the bitcoin mining -- and China still remains probably one of the largest -- I wouldn't be surprised if they control 50%, 60% of bitcoin mining in the world. And the government there has just put, amongst other things, bitcoin mining on their gray list of things that they want to get rid of. And generally, what happens is if they put it on the list, it's going to happen. That's extremely positive for Hut 8 for a couple of reasons. Because the hash rate goes down by 60% or 50%, that just means we will be mining twice as many coin on a daily basis if China follows through with this. But number two, if you are in China and you're looking to get into mining and the government has just put out this decree, you're going to think twice about buying equipment that might get shut down in 6 to 12 months. I think the China trade war as well -- if I'm not mistaken, I think there is a new tariff on technology, which mining equipment falls under, of 23%, 24% on any equipment coming in from China to the U.S. If you look at the U.S. as being potentially the bigger buyers here of equipment as in terms of new hash rate growing, again that's going to dissuade people as the price goes up of buying Chinese equipment from importing into the U.S. And so I think a combination of those things and some of the hurt and pain that happened in 2018, is I think leading people to not sort of go crazy and start ordering a whole bunch of mining equipment and increase the hash rate. It will go up. There is still a bunch of used stuff out there. But I think it's going to -- what happened in 2017 is going to happen again. You're going to see the price of bitcoin go parabolic here. The mining margins are going to be insane. And then the hash rate is -- people will order things, the hash rate is going to go lag behind by 6 to 7 months, and then it's going to spike up huge as everybody goes online. And then that will bring margin back to normal. It's just a cyclical process, and I think we'll see it again.

[Dan Weiskopf]

And why is -- what's the issue with Taiwan Semi?

[Andrew Kiguel, President, CEO & Director]

Sorry, can you repeat the question?

[Dan Weiskopf]

What's the issue with Taiwan Semi as far as why they are not producing?

[Andrew Kiguel, President, CEO & Director]

Taiwan Semiconductor is producing a lot of stuff. What I understand is that they just didn't secure space. So Taiwan Semi -- like that's where Apple manufactures their chips for the iPhone. Like everybody is fighting to get in there. And so because crypto winter last year was so bad and everybody was unsure what was going to happen to the crypto price, I don't think a lot of the large ASIC chip manufacturers went in and put down the money to secure the facilities. And so other people moved in, so AMDs and all these other guys. Like, there's a lot of things that can be built there, and they only have a certain amount of capacity. And so if that capacity at Taiwan Semiconductor wasn't booked, then you can't just go in, in the last like 4 weeks because the price of bitcoin doubled and say, "We changed our mind. Drop the iPhone and start building our chips."

[Dan Weiskopf]

I got you. I got you. Okay. There wasn't something I didn't know. I wasn't sure if you were saying something different.

[Operator]

We have no further questions.

[Andrew Kiguel, President, CEO & Director]

Okay. Well, thanks, everyone. As always, you can reach us. Our contact information is on the website, and we are always available for questions. So look forward to talking in 3 months.

[Operator]

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