Hut 8 Mining Corp. (NASDAQ:HUT) Q3 2022 Earnings Conference Call November 10, 2022 10:00 AM ET
Company Participants
Jaime Leverton – Chief Executive Officer
Shane Downey – Chief Financial Officer
Conference Call Participants
Joseph Vafi – Canaccord Genuity
Gus Gala – Truist
Bill Papanastasiou – Stifel
Chris Brendler – D.A. Davidson
Kevin Dede – HCW
Operator
Welcome to the Hut 8’s Third Quarter Analysts 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.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 the applicable securities legislation regarding the future performance of Hut 8’s Mining Corp. and its subsidiaries. The statements 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
Thanks so much, Karlen. 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 US$20,000 range. With the benefit of hindsight, it’s clear that we were prescient 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 re 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-mined, 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, huddling continues to be the right approach for Hut 8 and our shareholders, particularly as we get closer to the next halving, we believe we’ll see Bitcoin go up and to the right, which will further enhance our balance sheet.
In the meantime, our stack sets 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 three 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
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 Bitcoin 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 site 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 operations, all of which are incremental year-over-year.
Of note, with respect to our operations, late yesterday, we delivered a notice of 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 make 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 operation 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 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 imports 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 non-cash 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 non-cash loss of $2.9 million on revaluation of warrants liability.
Reflecting the operating results discussed previously, Hut 8 achieved the adjusted EBITDA of $2.1 million for Q3 2022 compared with $30.7 million in the prior year period. Turn to the 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 out-the-market equity program with maximum proceeds of up to US$200 million or approximately C$270 million. To-date, we’ve raised US$2 million or approximately C$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 non-recourse 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 and reserve. Our conservative approach to balance sheet management means we’ve been able to continue our long-term huddle strategy. We have not sold any Bitcoins since early 2021.
With that, I will turn the call back to Karlen for analyst Q&A.
Question-and-Answer Session
Operator
Thank you. Ladies and gentlemen, we’ll now conduct a question-and-answer session. [Operator Instructions] Your first question comes from Joseph Vafi from Canaccord Genuity. Joseph, please go ahead.
Joseph Vafi
Hi, good morning, everyone. 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 2022 and 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
I’ll take that. Thanks so much, Joe. We’ve been transparent since – 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
Got it. I think that short answer goes today a lot. So maybe I’ll just kind of follow up on that Jamie, 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 2023? 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. Thanks a lot.
Jaime Leverton
Yes, no, my pleasure. I think the hash rate has continues to surprise us all. I mean, it’s not – it isn’t behaving the way we would’ve thought it would behave, given the continued pressure on the price of Bitcoin and the increases we’ve seen in the energy markets. So really difficult to predict whether it’ll 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 this space that are struggling on the leverage side of their business. So I do think over the next six to 12 months, we inevitably will see consolidation.
Joseph Vafi
Great. Thanks for those comments and thoughts, Jamie.
Jaime Leverton
My pleasure. Thanks, Joe.
Operator
Your next question comes from Gus Gala from Truist. Gus, please go ahead.
Gus Gala
Hi, Jamie. I wanted to follow up on Validus. I mean, it seems – I just want to get the sense, does this maybe push strategically, 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 offered a price there not be able to like 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? Thanks.
Jaime Leverton
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 unfolds, of course, we’ll share them.
Gus Gala
Got you. But do we consider getting further vertical? I mean, just strategically we have, there’s a bit of a nice pile cash there. I know that things are distressed out there. It just plays into that type of question.
Jaime Leverton
Yes, 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.
Gus Gala
Got you. That’s super helpful. And I mean, 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
That’s an incredibly difficult question. Again, it’s really – it’s opportunity specific. So I don’t think – I think it’s fair to say there’s more distress in the mining space right now. But I’ll continue to look at opportunities in both areas, again, looking for the best strategic alternatives.
Gus Gala
Thank you. Appreciate the call, Jaime.
Jaime Leverton
My pleasure. Thanks.
Operator
Your next question comes from Bill Papanastasiou from Stifel. Bill, please go ahead.
Jaime Leverton
Good morning, Bill.
Bill Papanastasiou
Hey, good morning. Thanks for taking my questions and nice print today. We’ve seen a lot of crazy events happen in the space this week, especially when it comes from the two exchanges FTX and Binance. We also have a lot of miners distress in this space. Just wondering what your – what you think the implications to what’s going on, what happened this week will be on the Bitcoin mining space, especially when it comes to the distress miners. We’ve heard news from Core Scientific and Argo, and probably we’ll continue to hear more news on that end. Just wonder what your perspective is. Thanks.
Jaime Leverton
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 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
Great. Thank you. And then, congrats on wrapping up the hashrate capacity to nearly 3.1 exahash a hash. 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
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.
Bill Papanastasiou
Okay, great. That’s all the questions I have. Thanks guys.
Jaime Leverton
No, problem. Thanks, Bill.
Operator
Your next question comes from Chris Brendler from D.A. Davidson. Chris, please go ahead.
Jaime Leverton
Good morning, Chris.
Chris Brendler
Hi. Thanks. I’d like to – I think I heard that the cost per coin went down 30% sequentially, and I just wanted to know if you could sort of give us 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
Yes. I’ll let Shane take that one.
Shane Downey
Perfect. Yes, 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’s 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, war 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 was a big sort of quarterly sequential drivers that would be the biggest piece.
Chris Brendler
Okay. And then like the summer weather versus winter weather, does that also have an impact? Like, should we expect to go back up in the fourth quarter or stay around here?
Shane Downey
Well, that gets to a broader question that 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 as of now, we’ve been comforted in seeing things sort of normalized relative to where they were in the middle part of this year.
Chris Brendler
Okay. One last one for me. Along the same lines, if look at the gross margin in the HPC business came down a little bit. Was that power related or something else?
Shane Downey
On the HPC side, no, I would say not power related. We continued to – the rationalizations that we sort of announced and spoke to as part of our Q2 earnings really taking hold here in Q3, i.e., it was very late in Q2 that 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 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.
Chris Brendler
Yes. So it’s nice to have a little diversification these days. Thanks a lot, Shane. Appreciate it.
Shane Downey
Pleasure.
Operator
Your next question comes from Kevin Dede from HCW. Kevin, please go ahead.
Kevin Dede
Thank you.
Jaime Leverton
Good morning, Kevin.
Kevin Dede
Hi. Hi. Hi. Hi, Shane. Thanks for having me. Can we drill in a little bit pardon upon 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
Yes. So as we’ve 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
So of that 25, is it all running now? How much of it ran through the third quarter, do you think they just pulled…
Jaime Leverton
It is running now and it…
Kevin Dede
Oh, it’s running. Okay. Okay.
Jaime Leverton
It’s running right now and it has been running consistently through – it ran consistently throughout the third quarter.
Kevin Dede
Okay. So have you filled all 25 megawatts? Is it at full capacity?
Jaime Leverton
It is yes.
Kevin Dede
With that sort of the – yes, okay, with the M30 machines? Okay.
Jaime Leverton
Yes.
Kevin Dede
All right. That helps a lot. Thanks Jamie. On the…
Jaime Leverton
No problem.
Kevin Dede
Yes. 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
The Zenlayer partnership, which we announced a few weeks ago and we actually had a great – a great meeting with the team in Toronto, two weeks ago now. The hardware is still being delivered, so the environments we don’t expect to be stood up for, I’d 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
Okay. Is your team responsible for the sales and marketing there or is that all Zenlayer?
Jaime Leverton
It’s combined. The teams work together.
Kevin Dede
Okay. Are those machines, do you think the ones that’ll be directed toward rendering zero proof and other HPC applications? And could you give us sort of a run through on how that partnership – the financial side of that partnership looks for Hut 8?
Jaime Leverton
So the Zenlayer partnership is, it’s really more bare metal. It’s not the GPUs that, that we’ve repurposed into the data center. So those are two 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
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
No.
Kevin Dede
Okay, too early.
Jaime Leverton
It’s too soon to give guidance, Kevin. We’re trialing a number of different types of workloads and applications with those GPU’s. So, no, I can’t give you guidance this morning.
Kevin Dede
Any other variance on the ETH mining side though, have you considered?
Jaime Leverton
We’ve looked at other alternative chains. We haven’t found 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
Okay. Can you speak at all to capacity utilization at the HPC sites; say the end of 2Q versus the end of 3Q?
Jaime Leverton
I don’t have those metrics, Kevin, but what I will do is find – we’ll pull them and share them when we have them. I just – I don’t have them at my fingertips. That’s a good question.
Kevin Dede
Okay, thanks. Just remind me please though, Jamie, 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 a 100 or something, I can’t remember?
Jaime Leverton
Yes. The PPA was for up to 100 megawatts with the first phase being 35 megawatts.
Kevin Dede
Okay. Okay. Have you considered at all, I guess given how the energy market’s royal juice sort of trying to hedge your, your power costs in Alberta?
Jaime Leverton
We have explored options, none that we’ve pursued at the present time.
Kevin Dede
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
Yes. I mean we were hopeful that 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 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.
Kevin Dede
Appreciate it Jaime. I think the potential for the tether on hedge is pretty ugly too, so I think everyone on the call is with you on that. Thank you very much.
Jaime Leverton
Thank you.
Kevin Dede
Really appreciate it.
Jaime Leverton
Thanks, Kevin. Our pleasure.
Operator
There are no further questions at this time. I’ll turn it back to you for closing remarks.
Jaime Leverton
Okay. Thank you so much, Karlen. 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.
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