Hut 8 Mining Corp

TSX:HUT

Earnings Call Transcript 2020-Q2

[Operator]

Welcome to the second quarter 2020 earnings call. My name is Hilda, and I'll be your operator for today. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Mr. Jimmy Vaiopoulos. Sir, you may begin.

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Thank you. Hi, everyone. This is Jimmy Vaiopoulos, interim CEO of Hut 8. Before continuing, I'd like to remind everyone that all amounts in the financial statements and disclosed on this call are in Canadian dollars unless stated otherwise. This was a difficult quarter in many respects and positive in others. We started the quarter in the fallout of the novel coronavirus pandemic and the shelter-in-place orders that shook global capital markets and bitcoin. It took almost until May for bitcoin to recover to pre-coronavirus bitcoin price levels. We then were braced for the bitcoin halving event on May 11, where the bitcoin block reward was reduced by 50%. We saw subsequent drop in network difficulty by 15% shortly after, but it quickly recovered to pre halving levels in June. This was not just difficult for Hut 8 but all bitcoin miners across the industry. In the second quarter of 2020, Hut 8 mined 795 bitcoin, resulting in revenue of $9.2 million. This decreased from the same period of the prior year due to reasons I mentioned, primarily the bitcoin halving event. Mining profit margin for the quarter was 7% -- 6%. Despite the difficult quarter, we were able to maintain positive mining operations after all operating expenses as we keep a lean and flexible operating strategy. We benefited from the increase in bitcoin price this quarter of 42% from over USD 6,400 to over USD 9,100 at the quarter end, resulting in a $10.1 million revaluation gain. This shows that our strategy of mining and holding bitcoin is paying off and is a strategy we plan to continue. We had positive net income of $2.8 million and negative adjusted EBITDA of $86,000, showing a near breakeven quarter from an EBITDA perspective. Our balance sheet remains strong with a working capital surplus of $16.4 million, including $7.4 million that was committed to make a purchase of bitcoin mining equipment. Beyond this, we've also had many positive developments that occurred both during the second quarter and subsequently. This includes closing an oversubscribed $8.3 million round, where 100% of the net proceeds are committed to purchase 275 petahash of the latest generation equipment from MicroBT. We now have a possession of 1,000 M31s and 1,000 M31s plus units, which are on their way to the Medicine Hat facility and will be up and running in the next 3 weeks. We're also preparing for the 1,600 M30s units that will be arriving later this year as well. In addition, transferring the management of the Medicine Hat site from Bitfury to Hut 8, which saves us over $500,000 per year, we'll be transferring the management of the Drumheller site at the end of this month, which will provide even more savings. We negotiated our loan agreement with Genesis to reduce the annual interest rate from 9.85% to 8.5% as long as bitcoin is over USD 6,500, saving Hut 8 approximately $500,000 per year. We're also transferring the Clarke chips from Drumheller to Medicine Hat, which will combine our most efficient equipment that we have on-site currently with our best electricity price to increase mining margins. And finally, Hut 8 has stepped into hosting, starting with 6 BlockBoxes, which diversifies our income with more recurring revenue, and this brings a large potential for future growth as it is a natural extension of our core business. I'll now pass the call back over to the operator and open it up to Q&A.

[Operator]

[Operator Instructions] We have a question from [ Edison Lei ].

[Unknown Analyst]

The first question is related to the new hosting agreement that you guys have with the clients at Medicine Hat. I was wondering if you can give a little bit more color on the contract, what the payment terms are, how long the contracts are for, anything there would be great. And then I have a quick follow-up on that.

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Sure. We haven't put out all the details here yet just for confidentiality reasons. But what I'll say about it is, it is a long-term contract. These are latest generation equipment that we are hosting. So the intent is that these will be profitable for some time. This is lower risk for us in the sense that we do have fluctuations in our electricity price, and those electricity prices are flowed through whatever they are to the clients. And there is a fee on top of that, but we haven't disclosed that at this time.

[Unknown Analyst]

Okay. Just to clarify, so there's no risk at all on the fluctuations in electricity price there, and there isn't risk on the payment as well. It's paid in USD or CAD.

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Exactly. Paid in CAD. And of course, we've done our calculations to make sure we're making a fair margin on top of that, and we have collateral over the units as well. So there is lowered risk in terms of even a downturn in being paid.

[Unknown Analyst]

Okay. That's definitely -- that's really helpful. Obviously, it's a major shift in your strategy, going from a pure-play mining company to doing hosting as well. So I was wondering if you could talk about the shift there. Is there a long-term revenue target mix between hosting and mining?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

No, it's a good question, and this is our first client that we've signed up. So we're in the early stages. So in terms of mining -- in terms of hosting, I don't see this limiting or putting -- this should not limit our self mining side of our business at all, this is all in addition to. And so we'll always prioritize. And if we are able to self-mine, that's where our capacity is going to go to. We want to continually grow that business as fast as possible. But with excess capacity and with our ability to source new sites, we think it's a very natural extension. We're used to running sites where we've run some of the biggest sites in the world, and we have access to very cheap energy and good jurisdictions. So people want access to that. And so with our excess capacity and ability to find new sites, we think this could be a growth back on top of our self mining. We don't have a mix in mind. We intend to grow both as much as we can, but then we've still yet to see the appetite on both sides just because it is such a volatile market to be able to predict the mix just yet.

[Unknown Analyst]

Okay. Awesome. The next question is related to the halving event in the quarter. Obviously, Q2 was the first quarter post rewards halving. How did you guys manage capacity after the rewards were cut by 50%. And then what happened post-Q2 in terms of utilization? If you can kind of give some percentages there, that would be great and also what you're seeing in terms of the general mining community. Are miners shutting off because of the halving? Any color there would be great.

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

For sure. So I've mentioned this before, we are very -- we weren't, of course, prepared for the halving, but we were watching every minute what the difficulty rate is, what the bitcoin price is, electricity price. And we're constantly adjusting and have our foot on and off the throttle in between standby eco and full mode for all our miners at all times. And so after halving, we saw a lot of volatility in the difficulty rate, and so we were watching that very closely. We did see a lot -- we had expected approximately 25% drop because we have seen in mid-March when bitcoin price dropped by more than half. We saw over 25% drop in difficulty. So we thought that, that was a good test for what the halving event may be. But with a drop of only 15% and reversing back after that, it's clear that a lot of the miners that we expected to shut off didn't shut off. And we have a good idea also in terms of the new equipment that's coming to site. When we did our last order, we had talked to many different manufacturers, especially the large ones, and we understand the capacity and it's quite limited actually. And so there's a few speculative things that have been said in terms of why the hash -- difficulty rate has remained high and some of them being the wet season in China was exceptionally good this year, which is going to be finishing soon and also the limited demand from the coronavirus around the world, which is -- we should expect to drop electricity prices globally as well. Both speculative, hard to prove but could be answers as to why the difficulty rate has remained as high as it has. And so for Hut 8, we did limit our capacity for periods of time there. For example, in March, we had to temporarily go to standby mode for some of our equipment there just because there was such a sudden drop that difficulty couldn't adjust, and it was very similar for the halving event, right? It took some time for the difficulty to adjust. And so we did have to adjust down our -- some of the production on our older equipment for a period of time in there, which is why you see a smaller amount of bitcoin mined there because we are kind of adjusting down to these times. But with the bitcoin price returning and bitcoin economics returning, especially after Q2 where we see bitcoin hitting 52-week highs, our equipment is all running in those periods of good bitcoin economics recently.

[Unknown Analyst]

Okay. That's really helpful. I wanted to jump over to the cost reductions that you guys press released recently. Can you guys -- can you give the new run rate for your new operating costs post this transfer of site? And was that $0.5 million already included in the $2 million that you guys previously announced in January? Or is this on top of that?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Yes. So this affects different levels, I would say. So we have the operating level, which a lot of the transfer of management at our sites is going to affect, so we're going to see an improving mining margin related to those. And then you do have the reduction in interest rate that we're paying, which is separate from our G&A and our operating costs, which is where we're going to see a $500,000 savings bottom line there. And then you have our overhead, which -- we are going to see slight improvements from $2 million that we have there. I would say close to $1.75 million is a better run rate for overhead costs at this point, as we've been again slowly making ourselves as lean a company as possible in trying to be a low cost, lean bitcoin miner. And so we really focus internally on our cost per bitcoin as much as we can.

[Unknown Analyst]

Okay. One more question for me and I'll pass the line. I was wondering if you could quantify the margin accretion or efficiency gain from the transfer of Clarke chips. So if you were able to transfer them today, what would be the percentage increase there for efficiency gain?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Yes. So in terms of -- so just to be clear there, so the efficiency of equipment doesn't change, but we do have better pricing in Medicine Hat. So what we're doing is we're taking our most efficient equipment and putting it in a spot that has better pricing, which means that we can run it in a level between full and eco much longer than it would be at a different site, and so efficiency remains unchanged. And it's a bit difficult to put a number on it right now in terms of dollar value of the benefit mostly because we've yet to see where the steady state of electricity prices in Drumheller are. They're a lot more fixed in Medicine Hat, so we have a good idea there. But they've been quite volatile mostly to our benefit. And so it's a bit difficult right now to put a number to that. But very soon we will as we see things steady out as everything is opening back up in many respects.

[Operator]

Our next question comes from [ Ivan Garabevan ].

[Unknown Analyst]

I have 2 questions. One, I've noticed that the cost of bitcoin in U.S. dollars in the last 2 quarters basically was $8,400 and $7,800. I'm wondering what is the primary driver behind this. Is it strictly the difficulty level? Or is there more since it's significantly higher than historical costs? And also can you give us an update on who's going to be the next CEO? How did that search go?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Sure. So -- and just to clarify, your first question was about cost of bitcoin, right?

[Unknown Analyst]

Yes. Cost of bitcoin, it was $8,411 in Q1 and just about $7,800 in Q2.

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Perfect. So in terms of our cost of bitcoin, there's a lot of -- the main 3 factors that affect that are the bitcoin price, the network difficulty rate and our electricity price. Those are the main 3. There is, of course, the more efficient equipment that we start putting online, for example, this new equipment that we purchased that -- a good chunk that we have in possession. And so that is going to be reducing our cost per bitcoin quite significantly just because they're much more efficient equipment than especially some of our older stuff. And so that will reduce the 2. So efficiency of equipment would be kind of the fourth on that list. And so the way that we also calculate our cost of bitcoin, some other competitors just use electricity. We want to provide a fulsome numbers. We put our full operating costs, which are employees on-site and everything related to actually bringing that bitcoin to the company. And so a lot of these measures that we're doing in terms of reducing costs at site are also going to be reducing the cost per bitcoin as well. So it's another factor that I would mention. So does that answer your question there? And I can move on to question #2 as well. I'll take that as yes.

[Unknown Analyst]

Yes.

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Thank you. In terms of the second point, the first thing I'll mention about the CEO search is that I'm not an active part in it. So I can only speak to a certain level to it. The Board, I know, is active in the search. It is taking some time as it is a key decision. But thinking through, I think that's about all I can say. They are actively working on it, and it is a priority to them. But I don't have more detailed information that I personally have or even can disclose. So I'll have to leave it there.

[Unknown Analyst]

Okay. I have one final question. The sites that you operate are awesome. And I'm just wondering, in terms of expansion, aside from swapping out the actual machines, is it possible to either expand the site either horizontal or even vertically because they are essentially cardboard containers that possibly could be stacked up. I'm just wondering how much you can expand capacity physically.

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Yes. So in terms of vertical, there was -- I remember a question that came up one time. And there it provides -- it causes certain difficulties because a big part of managing those BlockBoxes and our mining equipment is airflow and managing the heat and cold that exist in there. And so we put actually a lot of engineering into the pressure of those boxes and how the air flows and we have heat corridors and cold -- hot corridors and cold corridors between each of the boxes. When you start stacking on top of each other, the heat from one box is going to go into the one above it. And then you start losing some benefits because obviously you never want this equipment to overheat. And so we have a good design here. And the way that we have it, where it's all spread out, keeps it -- keeps our costs low because we're using a lower cost way of keeping the chips at the right temperature. One thing I'll say here, so for example, in Medicine Hat, we have over 10 -- around 10 acres there, and our cost is around $1,400 per month. So it's very minimal when you take the scale of our operations. There's nothing around us there. Like we can get more land if we wanted it. The biggest thing is constraint of electricity and capacity there. And so we feel -- so at our sites, we are at capacity. There are ways that we have thought through and talked about ways to increase that if we wanted. But land is the easiest thing to deal with in the whole thing. The hardest part is just getting more electricity. And we also make sure that we have other sites that we're always keeping in mind and the electricity in sites or stuff that we do have access to. But it's a good question.

[Operator]

Our next question comes from [ Frank Sukumari ].

[Unknown Analyst]

I'm just trying to understand the rationale for the company issuing deferred units and restricted units to yourself and the Board vis-à-vis the traditional stock options that are provided? And secondly, what are the terms and conditions of those units?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Yes. So the -- I'll start with the DSUs. So the DSUs are to the Board. And it's actually something you see in many public companies. And the thought there, you still provide alignment with the Board. And you can get something similar with stock options, but DSUs for the Board also provide similar tax incentives as well. But it's getting ownership into the director's hand so that there's alignment between shareholders and the Board. There is -- long term, we want to get the Board members to have a minimum amount of ownership as well. So this gets them that over time. And then in terms of the RSUs, which were to myself, this is all related to my role as interim CEO. This has been the way that we have -- this is much quite common again for CEOs across many different industries. I do have stock options as well, and we do utilize stock options. And so that is a powerful tool in terms of alignment. So we feel RSUs do have a similar effect and also put ownership in addition to the stock options. So in combination, we feel we're using a good mix.

[Unknown Analyst]

What are the terms for RSUs and the DSUs?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Yes. So typically, whenever they are issued, they -- at the CEO and director level, it takes a year to vest. So that's in stock options vest over 3 different years. So whenever you see those getting issued, they'll vest a year later. And if it's a bigger package, it will invest over 3 years for the year-mark.

[Unknown Analyst]

Okay. So these ones are for 1 year?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

1 year, that's right.

[Operator]

[Operator Instructions] We have a question from [ Andreas Palmer ].

[Unknown Analyst]

I've got -- my first question, is what is the book value of your current mining equipment?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Yes. So on the balance sheet, we have it's about $21 million. And so that's from -- when we take our equipment, it's depreciated over 2 years and our infrastructure is over 4 years. So just to give you some context there.

[Unknown Analyst]

Okay. And this $21 million do not include plant and new mining equipment, which you just acquired. This is not included in it yet.

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

That's right, exactly. So yes, at June 30, this was days after we closed the financing, we had not put in an order or received the equipment and installed it. So once that gets installed, that's going to then go into our plant and equipment.

[Unknown Analyst]

Okay. Next question which I have, your website shows 952 petahashes at the moment. I think it's that at the moment and probably does not include yet your new equipment. My question is, when do you think -- what kind of time frame can you double your hash rate?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

So the question was double the hash rate? Or sorry, was the question double the hash rate? Or the question was when do we think we can actually get these new miners that we ordered installed?

[Unknown Analyst]

No, no. When do you consider that you have got 2,000 petahashes?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Yes. In terms of -- so our recent order is going to add 200 petahash to our production. And -- but in terms of 2 exahash or 2,000 petahash, it's hard to put an actual date on that. There's multiple factors that depend on -- that matter in terms of when we can do that. Our ambitions are there and over time, with more efficient equipment, it's going to be easier to get to those higher numbers. But this time, unfortunately, I can't put a date to it that I can confidently hold myself to.

[Unknown Analyst]

What other constraints or what enables you to buy new equipment? I think you have some locked-up bitcoins. So you're probably going to use this, or you're still acquiring a stake in bitcoin? Or will you free this up to buy new mining equipment? Is there a plan for this?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Yes. So we have -- our strategy is we want to give exposure to both bitcoin holdings and mining. In terms of smaller amounts, I can see us -- especially if bitcoin goes much higher than where it is today, we will definitely use some of that bitcoins that we have at some level. And it will be a discussion because at all times, we want to make sure that we're giving people exposure through bitcoin. And we also -- it's tough as well because you want to make sure when bitcoin goes up, the price of mining equipment also goes up. So we don't want to be selling bitcoin at a time where equipment is expensive. We want to make sure we're timing the market so that we're taking advantages of times where bitcoin goes up, taking advantage of times where equipment is cheap and the payback is much faster. But we do keep all these factors in mind. And so with a higher bitcoin price, that does give us much more flexibility in terms of expansion as well. Again, timing is to be determined. Another constraint is there is a certain amount of capital that's out there that wants more exposure to bitcoin mining. So similar to the way that we did that raise, not that it's in our sights, but that is another potential. And then with our hosting, that wouldn't be self mining but that would also increase our footprint as a bitcoin miner as well. But I mean, to answer your question, we want to get there as soon as possible. We want to increase our self mining capacity.

[Operator]

Our next question comes from Deepak Kaushal.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Sorry, I joined a bit late, so if I ask any repeat questions, I apologize. But I wanted to get your sense of the M&A environment now that we're well past halving and with kind of the COVID environment. What kind of changes are you seeing? And how are you guys thinking about M&A these days? Is it in the playbook?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Yes. So we always keep an open mind in terms of all the different ways that we can grow. And so just speaking at a high level, here's our view. 8 years ago, there's a lot of basement miners, and that was the way that people mined bitcoin. And then big scale was -- it was crazy for someone to open up a 2-megawatt facility and actually go to more of an industrial level.And so now past this having, we're going to see a lot more bigger industrial scale operations, similar to what we have now, where the 2 to 5 megawatts are -- it could be very difficult to be profitable at that scale. It's very tough to get a good price at that level and get the economies of scale. And so we're going to be seeing a lot more companies coming to our size and beyond that also wanting to become a public company. So the value of our paper has some value to many other companies that want to grow or be part of something bigger and get those economies of scale. And so there are definitely opportunities out there, people who have latest generation equipment and steady cash flows and potential for accretive transactions. It's just a question of -- I mean, there's lots of questions around that. But yes, we're -- we always keep an open mind to these types of transactions. And yes, there are opportunities out there.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Okay. And then just a quick follow-up. When we think of your expansion geographically, are you -- do you have enough in the vicinity you're in, in the province of Alberta? Or are you looking further in -- in other regions in Canada or even in the U.S.? What's your sense of that?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Yes. So we're very happy with the sites we have now, but we also always keep a pipeline of potential new sites as there may be good opportunities to expand beyond our current capacity. What I'll say is we are definitely focused within North America. That's where we see a lot of our investors want to see our hash power in jurisdictions that are well understood and safe. And that's something that's important to us. But yes, we definitely are looking for the cheapest power and best sites all around. And if the opportunity were to present itself, where we could take advantage of one of those, we would, of course, always consider it. And so that pipeline is very important to us. We think that there's a lot of value and making sure that we can think beyond what we're currently mining.

[Deepak Kaushal, Director and Technology & Communications Analyst]

Got it. And then just my last question, if I may. So reading your press release last night and your movement of chips, Clarke chips to Medicine Hat, but you're also doing the hosting facility arrangement at Medicine Hat. Can you just walk us through the rationale behind that? I would have assumed if you're moving your most efficient chips to Medicine Hat where the electricity price is cheaper and more stable, you want to move the hosting facilities to Drumheller where it's more variable and pass that on to the customer. What's the rationale there behind that?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Yes. We wanted to keep it also compelling for the client as well. And so with a bit cheaper energy in Medicine Hat, we're able to -- that factors into the decision in choosing Hut 8 over other competitors because there are others that provide hosting and have fixed fees. Drumheller is still competitive. It's just a question of Medicine Hat is more competitive, and then signing on our first client and we think there's potential beyond this at Drumheller and beyond. But we want to make this as compelling as we could for both us and the client, and we thought Medicine Hat was the best spot for that.

[Operator]

We have a follow-up question from [ Ivan Garabevan ].

[Unknown Analyst]

A simple question, do you have any plans to list the company on either NASDAQ or the New York Stock Exchange?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

No immediate plans. I've been definitely watching the companies that are on the NASDAQ and what they have done and keep a close eye on what our options are, and so that is something I have in my mind. No immediate plans, nothing that's just around the corner. But as we grow, we do see that that's kind of the next organic expansion in our life as a public company and so with other companies leading the way there. And also just to note, as a TSX company that we are, we do have an expedited path. I think it's to NASDAQ. And so this is an option to us. We just want to make sure it's at the right time and well thought out.

[Unknown Analyst]

Okay. And one last question, in your playbook with respect to expanding capacity, especially in buying equipment, do you foresee issuing new shares in order to finance that acquisition of the equipment? Or are you going to use the incremental value of bitcoin in order to finance that?

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

It depends. So similar to before the raise, I said we always keep an open mind. If we think that we can -- if there's a big appetite and there is capacity that we have and we could think -- and we believe we can provide value in bringing -- issuing new shares for this, then we stay open-minded to that. But we do want to grow our self mining. We do believe that our bitcoin holdings are going to be quite valuable over time. This is a strategy that eventually it may. And so we -- it could be a mix, it could be one or the other. It's hard to say at this time, but we do stay open-minded.

[Operator]

And at this moment, we don't see further questions. Thank you.

[Demetrios Vaiopoulos, Interim Chief Executive Officer]

Thank you, everyone, for joining the call and the questions, and we look forward to staying in touch.

[Operator]

Thank you. Ladies and gentlemen, this concludes today's conference. We thank you for participating. You may now disconnect.