Hut 8 Mining Corp

TSX:HUT

Earnings Call Transcript 2022-Q3

[Operator]

Welcome to Hut 8's Third 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 the company's website at www.hut8mining.com under the company's SEDAR profile at www.sedar.com and under the company's EDGAR profile at www.sec.gov.

Unless noted otherwise, all amounts referred to during this call are denominated in Canadian dollars. Any comments during this call may include forward-looking statements within the meaning of applicable securities legislation regarding the future performance of Hut 8's 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 quarter ended September 30, 2022, as well as the company's MD&A and annual information form for the year ended December 31, 2021.

I would now like to turn the call over to Hut 8's CEO, Jaime Leverton. Please go ahead.

[Jaime Leverton, executive]

Thanks so much, Colin. Good morning, everyone, and thank you for joining us to discuss Hut 8's financial results for the third quarter of the year. The industry continues to face challenging headwinds, fluctuating energy prices and increasing global hash rate, the Ethereum merge and Bitcoin now in its fifth month of hovering around the USD 20,000 range. With the benefit of hindsight, it's clear that we were [ present ] in taking a balance sheet first approach, which has allowed us to continue operating thoughtfully and strategically.

Throughout the quarter, we remained focused on optimizing operations for both, our mining and high-performance computing businesses. We were successful in reducing our cost per coin by nearly 30% over the second quarter and installed an aggregate of 2,205 new miners at our mining sites during Q3, bringing our operating capacity to 3.07 exahash, which is a 10% improvement over Q2. In our HPC business, we completed renovations and upgrades to our flagship data center in Kelowna, British Columbia and generated $4.4 million in revenue, comprised primarily of monthly recurring revenue from a number of client segments, including the blockchain and emerging technology industry.

Ahead of the Ethereum merge, we redeployed 180 GPU units to the Kelowna data center and are currently redeploying the balance of our fleet to our data centers to explore new opportunities to leverage the hardware, including in the zero-knowledge proof and Layer 2 space.

Moving on to Bitcoin. With the largest self-mine unencumbered reserves of any publicly listed company, we continue to be bullish on Bitcoin in spite of the prolonged downward pressure on the digital asset over the last several months. HODLing continues to be the right approach for Hut 8 and our shareholders, particularly as we get closer to the next having, we believe we will see Bitcoin go up and to the right, which will further enhance our balance sheet.

In the meantime, our stacks us apart from our peers, given the inherent flexibility it affords us as we continue to prudently manage the business going forward. While we still intend to explore opportunities that will allow us to generate additional income from our stack, given the ongoing market instability and risk profile at the present time, we will remain conservative and maintain our stack in cold storage. We have a long-term vision to execute a business strategy with 3 pillars: continuing to mine Bitcoin in a pool environment, maximizing the value of our Bitcoin reserves and growing our HPC data center business. This strategy continues to be the right one for Hut 8. It is keeping us focused through this bear market, and we are in a strong position to continue to make the right decisions for our continued growth.

Before I turn it over to our CFO, Shane Downey, who will review our key financial results, I would like to thank our Board for their ongoing support and guidance, our executive team for their leadership and our team for their execution across the business. To our investors, thank you. We know, it has been a very dynamic time for the broader industry and your support of Hut 8 is very much appreciated.

Shane, over to you.

[Shane Downey, executive]

Great. Thanks, Jaime, and good morning, everyone. Given the challenging macro environment, we produced solid results for Q3 2022. We achieved revenue of $31.7 million for the quarter, an $18.6 million decrease relative to the prior year third quarter of $50.3 million. This year-over-year decrease was driven by the price of bitcoin, which more than offset the expansion of our bitcoin mining fleet and incremental contributions from the high-performance computing business we acquired in Q1 of this year.

We achieved revenue of $27.3 million from digital asset mining activities as we mined 982 new bitcoin. This compares with $47.9 million of digital asset mining revenue in the same quarter of 2021 when we mined 905 bitcoin. We increased our mining capacity by a further 10% in the quarter, while our average cost of mining bitcoins fell by 29% relative to the second quarter of 2022, reflecting favorable power rates combined with our progressively more efficient fleet. Our high-performance computing business contributed an additional $4.4 million of revenue in the quarter, the majority of which is monthly recurring revenue.

Cost of revenue for the quarter was $45.6 million compared to $21.2 million in the prior year and consists of slight operating costs and depreciation. The increased depreciation expense from $5.2 million in Q3 2021 to $25.3 million in Q3 2022 is primarily attributed to the increased number of miners deployed as well as mining infrastructure and data center assets acquired. Site operating costs increased by $4.3 million to $20.3 million from Q3 2021. Within the digital asset mining operation, site operating costs increased by $2 million, consistent with expansion of our mining fleet.

We incurred $2.3 million in operating costs related to the high-performance computing operation, all of which are incremental year-over-year. Of note, with respect to our operations, late yesterday, we delivered a notice of the events of default to Validus Power Corp, a third-party supplier of energy to our North Bay site over failure of Validus to achieve key operational milestones while the dates contemplated under the power purchase agreement. Validus has also demanded that the company made payments for delivery of energy that are higher than those negotiated under the terms of the PPA. We intend to pursue all legal remedies available to us to enforce the terms of the PPA, and we'll share additional updates as appropriate.

In terms of margins, our digital asset mining operations generated mining profit of $9.3 million versus $33.5 million in the prior year period, reflecting the combination of lower bitcoin price and increased on an electricity costs. In light of these external factors, we are generally satisfied with the operating performance in the quarter.

General and administrative costs in Q3 were $11.2 million compared to $10.8 million in the prior year. The increase was due to a combination of higher personnel costs, insurance premiums and other costs largely in support of the high-performance computing line of business. This increase was partially offset by lower sales tax expense and share-based compensation payments expense. Sales tax expense decreased by $2.5 million, primarily related to an overall decrease in the company's purchases and importance of mining equipment relative to the third quarter of 2021.

SG&A expense related to the high-performance computing business was $1.6 million for the quarter. We recorded a net loss of $23.8 million for the quarter compared to net income of $23.4 million in the prior year period. This net loss was primarily driven by lower revenue from digital asset mining operations and higher cost of revenue in the third quarter of 2022. Also impacting the net loss, we recorded a $7.3 million noncash gain on revaluation of our digital assets as a result of the increase in price of bitcoin quarter end over quarter end, and we incurred a noncash loss of $2.9 million on revaluation of our warrants liability.

Reflecting the operating results discussed previously, Hut 8 achieved adjusted EBITDA of $2.1 million for Q3 2022 compared with $30.7 million in the prior year period.

In the terms of financial position, our balance sheet remains healthy with minimal debt and a cash balance of $33 million as of September 30, 2022.

On August 17, 2022, we entered into an equity distribution agreement pursuant to which, we established an aftermarket equity program with maximum proceeds of up to USD 200 million or approximately CAD 270 million. To date, we've raised USD 2 million or approximately CAD 2.6 million in net proceeds under this program.

In light of the challenging capital markets environment generally, combined with ongoing volatility impacting the digital asset space, we remain committed to our conservative approach to balance sheet management. We are pleased with the modest level of nonrecourse equipment financing we have in place and that our substantial digital asset holdings remain fully unencumbered.

Our bitcoin holdings are marked at fair value and totaled $223.4 million as of September 30, 2022, based on 8,388 bitcoin held in reserve. Our conservative approach to balance sheet management means we've been able to continue our long-term HODL strategy. We have not sold any bitcoins since early 2021.

With that, I will turn the call back to Colin for analyst Q&A.

[Operator]

[Operator Instructions] Your first question comes from Joseph Vafi from Canaccord Genuity.

[Joseph Vafi, analyst]

Nice to see your conservative strategy shining right here today. Maybe we'll just start with looking as we are sitting here, getting ready to exit '22, when we look to next year, I mean, there's a lot of uncertainty out there relative to bitcoin, the macro, et cetera. And I know, you're staying conservative. I was just wondering if you could provide some insight for us and what the plan may be for next year in terms of maybe increasing hash rate or power capacity or continuing to diversify the business, maybe over in the high compute side? And then I have a quick follow-up.

[Jaime Leverton, executive]

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

[Joseph Vafi, analyst]

Got it. I think that short answer to us today a lot. So maybe I'll just kind of follow up on that, Jaime. And how do you -- when you look at the industry, there's clearly some distress out there in the industry today. How do you think this industry evolves in '23 given what's happening, do you expect to see merger activity accelerate industry-wide or perhaps some other dynamics? And what do you think happens with this hash rate with bitcoin down here? It's been kind of a very resilient hash rate. So just any comments you have on that would be great.

[Jaime Leverton, executive]

Yes. No, my pleasure. I think, the hash rate has continued to surprise us all. I mean, it's not -- it isn't behaving the way we would have thought it would behave, given the continued pressure on the price of bitcoin and the increases we've seen in the energy market. So really, really difficult to predict whether it will continue kind of defying expectations and continue to climb or start to behave in a more expected manner. So we really -- it's impossible to guide, Joe. It's quite a dynamic situation more so now than I think we've seen in cycles in the past.

And I think, with respect to your first question, inevitably, we will see consolidation in this space. I think, we've seen a number of announcements come out from various parties in the space that are struggling on the leverage side of their business. So I do think, over the next 6 to 12 months, we inevitably will see consolidation.

[Operator]

Your next question comes from Gus Gala from Truist.

[Gustavo Gala, analyst]

I wanted to follow up on Validus. I mean, it seems -- I just want to get the sense, does this maybe push us strategically to consider further -- getting further vertical, maybe look at the power generation side of things. And I just wanted to unpack like the dynamics of what's going on with Validus exactly. Is essentially they are -- they offered a price they are not be able attain in the power markets themselves? Is that essentially like the nature of what's going on? And is there any chance we're able to actually retain that nice pricing they had previously offered?

[Jaime Leverton, executive]

Yes. So it's difficult for us to comment on it, given that it is an active and live negotiation. But as we have updates on how the situation evolves, of course, we'll share them.

[Gustavo Gala, analyst]

But do we consider getting further vertical? I mean, just strategically, we have -- there's a bit of a nice pile -- cash pile there. I know that things are distressed out there. It just plays into that type of question.

[Jaime Leverton, executive]

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

[Gustavo Gala, analyst]

Got you. That's helpful. And I think just as we look into next year, on balance, how are we feeling if we were going to invest in either the HPC business or the self-mining? Right now, where do you think the best returns are?

[Jaime Leverton, executive]

That's an incredibly difficult question, again. It's really -- it's opportunity-specific. And so I don't think -- I think, it's fair to say, there's more distressed in the mining space right now. But I'll continue to look at opportunities in both areas, again, looking for the best strategic alternatives.

[Operator]

Your next question comes from Bill Papanastasiou from Stifel.

[Bill Papanastasiou, analyst]

Nice print today. We've seen a lot of crazy events happened in the space this week, especially when it comes from the 2 exchanges, FTX and Binance. We also have a lot of miners to stress in this space. Just wondering what -- what do you think the implications to what's going on and what happened this week. Will be on the bitcoin mining space, especially when it comes to the distressed miners, we've heard news from Core Scientific and Argo and probably, we'll continue to hear more news on that end. Just wondering what your perspective is.

[Jaime Leverton, executive]

Yes. I think, one of the struggles for the industry right now on the back of what we're seeing happen with FTX, in particular in Alameda, is we really don't understand what the contagion is going to be as a result of that. We don't know where all of the exposed counterparties are. And so for the industry, it's really going to depend where new holes show up. As I mentioned in my opening comments, we've made the determination to continue to keep our stack in cold storage again until we really under -- have a good understanding of where the potential contagion goes and where the counterparty risks are, our view is that we just -- we need to continue to be conservative and let it shake out.

[Bill Papanastasiou, analyst]

Great. And then congrats on wrapping up the hash rate capacity to 3.1 exahash. Just wondering, given the news with North Bay and what's going on there. Has guidance changed at all? Does it still remain at 3.6 exahash by the end of the year?

[Jaime Leverton, executive]

Well, obviously, that becomes a bit fluid, given the North Bay situation. So we're really going to have to wait and see how North Bay plays out.

[Operator]

Your next question comes from Chris Brendler from D.A. Davidson.

[Christopher Brendler, analyst]

I'd like to -- I think I heard that the cost per coin went down 30% sequentially. And I just wondered if you could sort of give you a little more detail on what drove that? Obviously, costs are a huge focus today. Was it sort of moving to North Bay, which sounds like that may not be the case anymore, or is it just lower cost seasonal costs for power? Just help me think about the improvement in cost per coin.

[Jaime Leverton, executive]

Yes. I'll let Shane take that one.

[Shane Downey, executive]

Perfect. Good question, Chris. And it's sort of a combination of the above. So getting operations spun up at North Bay was a modest net contributor there. And the real point though is that as everyone is really aware is almost globally almost that in the Q2 period, there was really a real spike in power costs, natural gas impacting us in a lot of ways as a result of the global macro situation, more in Ukraine and Russia and so forth. And yes, seeing that as we were sort of hoping and expecting, seeing that normalize somewhat in -- over the course of Q3 what was a big sort of quarterly sequential drivers. That would be the biggest piece.

[Christopher Brendler, analyst]

Okay. And then like the summer weather versus winter weather, does that also have an impact? Like should we expect it to go back up in the fourth quarter or stay around here?

[Shane Downey, executive]

Well, that gets to a broader question. Typically, in Alberta, our primary markets, there is some seasonality to power markets, but not particularly large or dramatic. So it's needless to say, unfortunately, it's difficult to handicap in light of the broader uncertainty in global markets today. But again, as of now, we've been comforted in seeing things sort of normalize relative to where they were in the middle part of this year.

[Christopher Brendler, analyst]

Okay. One last one for me. On the same lines, looks like the gross margin in the HPC business came down a little bit. Is that power related or something else?

[Shane Downey, executive]

On the HPC side, no, I would say, not power related. We continue to -- the rationalizations that we sort of announced and spoke to as part of Q2 earnings really taking hold here in Q3, i.e., it was very late in Q2 that some of those sort of product rationalizations occurred. So yes, think of it as sort of a very modest and anticipated impact on margins in Q3 and then really points back to that same message that we've delivered previously that this sort of an intentional move on our part, and we really do think positions us well for growth as we head into 2023.

[Operator]

Your next question comes from Kevin Dede from HCW.

[Kevin Dede, analyst]

Can we drill in a little bit, pardon the pun on North Bay, where -- how much of the almost 3.1 exahash is there? And how much of that is at risk? What sort of timeline do you think you can offer with regard to your negotiation with Validus? And if everything goes sort of the ugly scenario way, I guess, what of that 3.6 target is something that we shouldn't consider hashing, maybe the early part of next year? As much of that as you can quantify, please.

[Jaime Leverton, executive]

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

[Kevin Dede, analyst]

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

[Jaime Leverton, executive]

It is running now. And it...

[Kevin Dede, analyst]

It is running. Okay. Okay.

[Jaime Leverton, executive]

It's running right now. And it has been running consistently through -- it ran consistently throughout the third quarter.

[Kevin Dede, analyst]

Okay. Have -- so have you filled all 25 megawatts? Is that at full capacity? With that...

[Jaime Leverton, executive]

It is. Yes.

[Kevin Dede, analyst]

Yes, okay. With the M30 machines? Okay.

[Jaime Leverton, executive]

Yes.

[Kevin Dede, analyst]

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

[Jaime Leverton, executive]

The Zenlayer partnership, which we announced just few weeks ago, we actually had a great meeting with the team in Toronto, two weeks ago now. We -- the hardware is still being delivered. So the environment, we don't expect to be stood up for -- I have to double check on the timeline, but towards the end of this year is when those environments will be stood up and available to start to be sold into.

[Kevin Dede, analyst]

Okay. Is your team responsible for the sales and marketing there? Or is that all Zenlayer?

[Jaime Leverton, executive]

It's combined. The teams work together.

[Kevin Dede, analyst]

Okay. Is -- are those machines, do you think the ones that will be directed toward rendering zero-proof and other HPC applications? And could you give us sort of a run through on how that partnership or the financial side of that partnership looks for Hut 8?

[Jaime Leverton, executive]

So the Zenlayer partnership is -- it's really more bare metal. It's not the GPUs that we've repurposed into the data centers. So those are 2 different environments. And when we speak about repurposing the GPUs and using them for layer 2 and zero-knowledge proof that's separate from the relationship and partnership with Zenlayer.

[Kevin Dede, analyst]

Okay. Any more insight to how -- I guess, how things translate for you on both accounts, like on the GPU side? Do you have any expectation on what your computing power there could generate in revenue and on the Zenlayer side?

[Jaime Leverton, executive]

No. It's too...

[Kevin Dede, analyst]

Okay. Too early.

[Jaime Leverton, executive]

It's too soon to give guidance, Kevin. We're trialing a number of different types of workloads and applications with those GPUs. So no, I can't give you guidance this morning.

[Kevin Dede, analyst]

Any other variance on the ETH mining side, though? Have you considered?

[Jaime Leverton, executive]

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

[Kevin Dede, analyst]

Okay. Can you speak at all to capacity utilization on -- at the HPC sites, say, the end of 2Q versus the end of 3Q?

[Jaime Leverton, executive]

I don't have those metrics, Kevin, but what I will do is that we'll find -- pull them and share them when we have them. I just -- I don't have them at my fingertips. So that's a good question.

[Kevin Dede, analyst]

Just remind me, please, though, Jaime, what was North Bay slated to be all told. I mean, I seem to remember there was an expansion option for you there? Was it to go to 100 or something? I can't remember.

[Jaime Leverton, executive]

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

[Kevin Dede, analyst]

Have you considered at all, I guess, given how the energy markets [indiscernible] you sort of trying to hedge your power costs in Alberta?

[Jaime Leverton, executive]

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

[Kevin Dede, analyst]

Okay. And given you're very comfortable in cold storage, when do you think, you might consider putting your bitcoin to work again?

[Jaime Leverton, executive]

Yes. I mean, we were hopeful that we'd be in a different position, frankly. But as a result of the incidents that kicked off over the weekend, we just really don't feel comfortable again until we see that contagion run through. So my guess is, we'll revisit towards the end of this year, beginning of next year. But again, very, very much about the state of the market where we think the risks are because, obviously, protecting that stack is critically important.

[Operator]

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

[Jaime Leverton, executive]

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

[Operator]

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