Hut 8 Corp. (HUT) Q1 2019 Earnings Report, Transcript and Summary

Welcome to the Hut 8 Mining First Quarter Teleconference call. My name is Sylvia and I’ll be your operator for today's call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. [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.

Thank you very much. Welcome everybody. Good morning to the Hut 8 Mining Q1 call. Let me just start-off with the sort of an overview here and then I'll turn it over to Jimmy to walk through the financials and then we'll take questions. We had revenue of $12.1 million for Q1. We mined 2,405 bitcoin, while mining economics improved in April start to-date 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 or some more details on that in MD&A. Despite that with the higher costs, we still manage to decrease our price per bitcoin to 3,950 in Q1. And so we see that the benefits of our cost reductions in our electricity optimizations have been successful. In addition we also reduced our overhead by $200,000 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 us. We estimated about $5 million. So while we may be lost a little bit of revenue, there was some coin. We think we're pretty effective there in keeping costs fairly low by not mining that period of time when the energy price was peaking when we had this very weird cold weather that's flowed through the Western part of Canada. As part of the other thing we remain committed to solely mining bitcoin, it's a question we get as often as possible in 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 you see in the press release, our operations today are stronger than ever and we feel very confident and are 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, sorry for the Q1 quarter that resulted in $12.1 million in revenue. At today's Bitcoin price, that would 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 that even if we used our cost price of $3,950 per coin, $30 million of revenues, you can see that will have significant impact on our margins based on what's happening today. And again these are 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 their costs 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's 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'd 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.

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 two periods increased by 10% while the amount of bitcoin mined increased by 194%. The reason for the difference in bitcoin mined to revenue was primarily due to the decrease in average bitcoin price in Q1 2019 of US$3800 from the same period of the prior year of US$10,600. While average difficulty rates increased by over 120% between Q1 2019 and the same period of the prior year. The site operating costs for the year were $12.6 million and the cost to mine each bitcoin was US$3950. 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 Jumbo site smaller portion of our Medicine Hat site which is exposed to market natural gas prices. We've seen the natural gas market return to normal in March 2019. The Hut 8 team is working hard to keep a lean cost structure which has shown that the expenses for the first quarter of 2019 excluding non-cash share based compensation were $774,000 compared to 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. Cash 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 a 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 will now pass the call back over to Andrew.

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

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from [Indiscernible] Securities.

Hey guys. Good morning. I know we just spoke a couple 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 savings, you said $5 million, I assume that was $5 million in the quarter right not annualized?

Correct. So that's not a savings number. What that number is it's electricity optimization. So as I've said before the price of electricity is way more volatile than the price of bitcoin, believe it or not. And so it'll go from $0.02 a kilowatt hour to $2 a kilowatt hour in the 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 an hour and a half a day and it's that savings of not mining for an hour and a half a day that ended up saving us incremental potential costs of about $5 million.

Okay. So could you say what your percentage uptime was during the quarter in terms of mining or are we thinking like you're up 98% of the time still or does that optimization keeping it down to that?

Still very high like even on super cold days like we were still going to be up 90% of the time, right. I mean it’s we’re talking about an hour and a half 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.

Okay. And then it's fairly predictable, so if you want to schedule any downtime mean and see you can do it in the same periods too, right?

No, the weather is not predictable. But we do trial and like I said it’s short periods of time and 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 that time although if the weather is minus 40 degrees outside sometimes it's hard to do that also.

Got it. Okay. Just another question when we think about capacity expansion before we get to the capital, from a technology perspective are you guys tied to only using big three 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?

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 were seeing even with the older equipment that we have been depreciating two years like we did the math, we do the math every week. But those boxes are still hugely profitable and even though they're coming up on two years, we see no reason even need to update that now even though we have that option. So it's tricky. But keep in mind Bitfury owns a good chunk of the company and they've 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 S-18 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 of those new machines that are available is pretty low. I think that the other things that come with that as well is that one of the benefits of using the BlockBoxes is that we can locate them in pretty remote areas like some of the reasons and some of the new sites and things that we're looking at. It's somewhat stranded energy in remote places. If you're using other equipment, generally speaking you've got to build up an entire facility. You've got to build a site or retrofit a site and that's time consuming. It's expensive and it could take twelve months. And frankly you don't know where the market's going to be in twelve months. The cheapest Bitcoin you're going to mine is the Bitcoin you mine today and so we're still feeling pretty good about the equipment that we have. And we're in talks with the guys at period, 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 you said, it goes both ways.

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're looking at creative ways of finding financing. What are your options. What have you thought up in the last couple of weeks and what else can you share in terms of any potential ways to expand capacity?

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 then we think that we'll be able to get another three 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 and 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're exploring different things. There's nothing here that I would sort of reveal to anybody that that's material.

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's been ripping here. What price do you start looking at converting some of that coin to fear to redeploy and then how do you make that kind of decision?

Yes, I think part of it. I mean we're well in excess of the covenant here, the covenant is not an issue. It's things that we've thought about but there's 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, we could still provide that exposure to investors and then reinvest some into new projects that would make sense but I wouldn't say we're quite there yet.

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

Well, hindsight's always 2020. You never know. So when we started Hut 8, it was with the purpose of being solely a Bitcoin miner, 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'm sure people are aware but there's only four 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 there and you have to find people and you're competing against a lot of people. So that would mean sort of additional investments in marketing, hiring people doing things. But 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 puts about people have approached us to see if we would sell them a portion of our Hash rate. So those are kind of things we've looked at when we talk about creative ways of potentially financing, could we sell some Hash rate, the price per 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 for pound basis. This year, I think our strategy of holding has benefitted us a lot where 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 the sudden the digital assets that we hold start becoming a real big warchest over time. And at that point, we start contemplating the balance becomes big enough to sort of value to become the first crypto company to provide a dividend. Do we sell some of that conversion to Fiat as a hedge. Do we convert to Fiat and build up new sites. But I would say Deepak we're not quite there yet. The company is at 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.

Thanks. 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 only guy in the call, you guys 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?

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

Okay. I don’t want to get ahead of ourselves here because you ever see yourself looking at Bitfury BlockBoxes in other parts of the world in terms of consolidating build more of international operations?

Yes, we have to see, I mean look this is all a good news story but you got to remember like five, six weeks ago we were all at a very different situation. So it's been a very positive upside surprise. One of the things that we have talked about with Bitfury 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 two years life. But as I said before, we're looking at our current older version which is the first 17 BlockBoxes that we took on in December 2017 and in the current market even though those are 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's nothing that's material here that I'd be looking to disclose to the market.

Okay. That makes sense. Okay. Thanks again for taking my questions. Hopefully we have continued mining economics for a while, so you guys can start accumulating some value.

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 economics standpoint, this is a very healthy time.

Yes, it makes sense. Okay. Thanks so much, Andrew. I appreciate your thoughts.

Our following question comes from Dan [ph].

Hey Dan.

If your line is on mute, please unmute yourself.

There we go. Now I’m off mute. Thanks Andrew for hosting the call. You said something 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?

Yes, I think there's a few things. So what you got to remember Dan there’s always a lag. And so what you saw happen in 2017 was that the price of Bitcoin runs but the Hash rate is not like guys would just turn on the light and the Hash rate comes on. You've got to go out buy equipment, build a facility get it going and what you saw happen at the end of 2017 and you know what unfortunately happened in the 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 six or seven months there 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 there'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 here saying things I'm hearing is that the 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 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 others a bitcoin mining on their grey list of things that they want to get rid off. Generally what happens is if you 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'll be mining twice as many coin on a daily basis, if China falls true with this. But number two, if you're 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 six to 12 months. I think the China trade war as well, if I'm not mistaken I think there's 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 it 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 owning whole bunch of mining equipment and increase the Hash rate, it will go up. There's 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 order things, the Hash rate is going to go lag behind by six to seven months and then it's going to spike up huge as everybody goes on line and then that'll bring margins back to normal. It’s just a cyclical process and I think we'll see it again.

And why is, what’s the issue with Taiwan Semi?

Sorry, can you repeat the question?

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

Taiwan Semiconductor is producing a lot of stuff. What I understand is that they just didn't secure space. So Taiwan Semi that's where Apple manufactures their chips for the iPhones 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, 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 four weeks because the price of bitcoin doubled and say we changed our minds, dropped the iPhone and start building our chips.

Okay. It wasn't something I didn't know. I was interpreting you were saying something different. Thank you very much, Andrew.

You're welcome.

We have no further questions.

Okay. Well, thanks everyone. As always you can reach us, our contact information is on the Web site. And we're always available for questions. So look forward to talking in three months.

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