Welcome to the second quarter 2020 earnings call. My name is Hilda and I'll be your operator for today. At this time, all participants are in a listen only mode, and later we will conduct a question and answer session. During the question and answer session, if you have a question, please press star and then one using your touchtone phone. Please note that this conference is being recorded. I will now turn the call over to Mr. Jimmy Vaiopoulos. Sir, you may begin.
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 11th, where the Bitcoin block reward was reduced by 50%. We saw a 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 CAD 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 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 $6,400 to over $9,100 at the quarter end, resulting in a CAD 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 CAD 2.8 million, and negative adjusted EBITDA of CAD 86,000, showing a near breakeven quarter from an EBITDA perspective.
Our balance sheet remains strong with a working capital surplus of CAD 16.4 million, including CAD 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 CAD 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 possession of 1,000 M31S and 1,000 M31S+ units, which are on their way to the Medicine Hat facility and will be up and running in the next three 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 CAD 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 $6,500 , saving Hut 8 approximately CAD 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. Finally, Hut 8 has stepped into hosting, starting with six BlockBoxes, which diversifies our income with more recurring revenue. 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.
Thank you. We will now begin the question and answer session. If you have a question, please press star one using your touchtone phone. If you cancel your request, you can press the pound sign or hash key. If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, for any questions, please press star and then one using your touchtone phone. We have a question from Edson Lai. Please go ahead.
Hey, thanks for taking my question. The first question is related to the new hosting agreement that you guys have with the client at Medicine Hat. I was wondering if you could give a little bit more color on the contract, what the payment terms are, how long the contract's for. Anything there would be great. I have a quick follow-up on that.
For sure. We haven't put out all the details here yet, just for confidentiality reasons. 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 client, and there is a fee on top of that. We haven't disclosed that at this time.
Okay, just to clarify, there's no risk at all on the fluctuations of electricity price there.
That's right.
No risk on the payment as well. It's paid in U.S. dollar or CAD?
Yes, exactly. Paid in CAD. Of course, we've done our calculations to make sure we're making a fair margin on top of that. We have collateral over the units as well. There is a lowered risk in terms of even a downturn in being paid.
Okay. That's definitely helpful. Obviously, it's a major shift in your strategy for going from a pure play mining company to doing hosting as well. I was wondering if you could talk about the shift there, and is there a long-term revenue target mix between hosting and mining?
It's a good question, and this is our first client that we've signed up, so we're in the early stages. In terms of hosting, this should not limit our self-mining side of our business at all. This is all in addition to. 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. 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. People want access to that.
With our excess capacity and ability to find new sites, we think this could be a growth factor on top of our self-mining. We don't have a mix in mind. We intend to grow both as much as we can. We're 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.
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%? What happened post Q2 in terms of utilization? If you can give some percentages there, that would be great. 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.
For sure. I've mentioned this before, we are very, of course, prepared for the halving, but we're 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. After the halving, we saw a lot of volatility in the difficulty rate. We were watching that very closely. 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. We thought that that was a good test for what the halving event may be.
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. 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. There's a few speculative things that have been said in terms of why the 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 you'd expect to drop electricity pricing globally as well.
Both speculative, hard to prove, but could be answers to why the difficulty rate has remained as high as it has. 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 it was such a sudden drop that difficulty couldn't adjust, and it was very similar for the Halving event. It took some time for the difficulty to adjust, we did have to adjust down 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 adjusting down to these times.
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.
Okay. That's really helpful. I wanted to jump over to the cost reductions that Hut 8 has press released recently. Can you give the new run rate for your new operating cost post this transfer of site? Was that half a million CAD already included in the CAD 2 million that you guys previously announced in January, or is this on top of that?
Yeah. This affects different levels, I would say. We have the operating level, which a lot of the transfer of management at our sites is going to affect. We're going to see an improving mining margin related to those. You have the reduction in interest rate that we're paying which is separate from our G&A and our operating costs, which you're going to see a CAD 500,000 saving bottom line there. You have our overhead, which we are going to see slight improvements from CAD 2 million that we have there. I would say close to CAD 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 and trying to be a low-cost, lean Bitcoin miner.
We really focus internally on our cost per Bitcoin as much as we can.
Okay. One more question from 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. If you were able to transfer them today, what would be the percentage increase there or efficiency gain?
Yeah. Just to be clear there, the efficiency of equipment doesn't change, but we do have better pricing in Medicine Hat. 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. 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. It's a bit difficult right now to put a number to that.
Very soon we will, as we see things steady out, as everything is opening back up in many respects.
Okay. Thanks, Jimmy. I will pass the line.
Thank you. Our next question comes from Ivan Garabedian. Please go ahead.
Hi. I have two questions. One, I've noticed that the cost of Bitcoin in U.S. dollars in the last two 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? Because it is significantly higher than historical costs. Also, could you give us an update on who's going to be the next CEO? How's that search going?
Sure. Just to clarify, your first question was about cost of Bitcoin, right?
Yeah, cost of Bitcoin. It was $ 8,411 in Q1 and just about $7,800 in Q2.
Perfect. In terms of cost of Bitcoin, there's a lot of factors. The main three factors that affect that are the Bitcoin price, the network difficulty, and our electricity price. Those are the main three. 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 of it we have in possession. 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. That will reduce it, too. Efficiency of equipment would be the fourth on that list. The way that we also calculate our cost of Bitcoin, some other competitors just use electricity. We want to provide a full sum numbers.
We put our full operating costs, which are employees on site and everything related to actually bringing that Bitcoin to the company. 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. That's another factor that I would mention. Does that answer your question there? I can move on to question number two as well. I'll take that as a yes.
Yeah.
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. Thinking through, I think that's about all I can say, that they are actively working on it, and it is a priority to them. I don't have more detailed information that I personally have or even can disclose. I'll have to leave it there.
Okay. I have one final question.
Sure.
The sites that you operate are awesome. I'm just wondering, in terms of expansion, aside from swapping out the actual machine, is it possible to either expand the site either horizontally or even vertically because they are essentially cargo containers that possibly could be stacked up? I'm just wondering how much you can expand capacity physically.
In terms of vertical, I remember a question that came up one time, and 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. We put actually a lot of engineering into the pressure of those boxes and how the air flows and the heat corridors and cold corridors, 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. You start losing some benefits because obviously you never want this equipment to overheat.
We have a good design here, and the way that we have it, where it's all spread out, 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, for example, in Medicine Hat, we have around 10 acres there, and our cost is around CAD 1,400 per month. It's very minimal when you take the scale of our operations. There's nothing around us there. We can get more land if we wanted it. The biggest thing is constraint of electricity and capacity there. 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. 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 and sites are stuff that we do have access to. It's a good question.
Okay. Thank you very much.
Of course.
Thank you. Our next question comes from Frank Schiraldi. Please go ahead.
Yes, good morning. I'm just trying to understand the rationale for the company issuing deferred units and restricted units to yourselves and the boards vis-a-vis the traditional stock options that are provided. Secondly, what are the terms and conditions of those units?
Yeah. I'll start with the DSUs. The DSUs are to the board, and it's actually something you see in many public companies. The thought there is 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. 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. This gets them that over time. 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 this is actually quite common, again, for CEOs across many different industries.
I do have stock options as well, and we do utilize stock options. That is a powerful tool in terms of alignment, but we feel RSUs do have a similar effect and also put ownership in addition to the stock options. In combination, we feel we're using a good mix.
What are the terms for the RSU and the DSU?
Yeah. Typically, whenever they are issued at the CEO and director level, it takes a year to vest. It's like stock options vest over three different years. Whenever you see those getting issued, they'll vest a year later. If it's a bigger package, it'll vest over three years instead of year mark.
Okay, these ones are for one year.
One year. That's right.
Okay. Thank you.
No problem.
Thank you. As a reminder, if you have any questions, please press star one. We have a question from Andreas Baumann. Please go ahead.
Thank you very much for having me. Thank you very much for receiving my questions. My first question is, what is the book value of your current mining equipment?
Yeah. On the balance sheet, we have it's about CAD 21 million.
Sorry.
Our equipment, it's depreciated over two years, and our infrastructure is over four years. Just to give you some context there.
Okay. The CAD 21 million does not include the new mining equipment which you just acquired. This is not included in it yet.
That's right, exactly. At June 30th, this is days after we closed the financing, we had not put in an order or received the equipment and installed it. Once that gets installed, that's going to then go into our plants and equipment.
Okay. Next question which I have, the website shows 952 petahashes at the moment. I think it's at the moment, and probably it does not include yet your new equipment. My question is, when do you think, what kind of timeframe can you double your hash rate?
The question was double the hash rate? Is 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?
No, by when do you consider that you have the 2,000 petahashes?
Yeah. Our recent order is going to add 200 petahash to our production. In terms of two exahash or 2,000 petahash, it's hard to put an actual date on that. There's multiple factors 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. This time, unfortunately, I can't put a date to it that I can confidently hold myself to.
What are the constraints or what enables you to buy new equipment? I think you have some locked-up Bitcoin, so are you going to probably use this, or are you still acquiring and staking Bitcoin? Will you free this up to buy new mining equipment? Is there a plan for this?
Yeah. Our strategy is we want to give exposure through 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'll definitely use some of that Bitcoin that we have. At some level, it'll be a discussion because at all times, we want to make sure that we're giving people exposure through Bitcoin. It's tough as well because you want to make sure when Bitcoin goes up, the price of mining equipment also goes up. 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 advantage of times where Bitcoin goes up, taking advantage of times where equipment is cheap, and the payback is much faster. We do keep all these factors in mind.
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. Similar to the way that we did that raise, not that it's in our sights, but that is another potential. Then with our hosting, that wouldn't be self-mining, but that would also increase our footprint as a Bitcoin miner as well.
Okay. Thank you.
To answer your question, we want to get there as soon as possible. We want to increase our self-mining capacity.
Okay. Thank you very much.
Okay.
Thank you. Our next question comes from Deepak Kaushal. Please go ahead.
Hi, Jimmy. Sorry, I joined a bit late. If I ask any repeat questions, I apologize. I wanted to get your sense of the M&A environment now that we're well post-halving and we're kind of in a COVID environment. What kind of changes are you seeing? How are you guys thinking about M&A these days? Is it in the playbook?
Yeah. We always keep an open mind in terms of all the different ways that we can grow. Just speaking at a high level, here's our view. Eight years ago, there was a lot of basement miners, and that was the way that people mined Bitcoin. Big scale was crazy for someone to open up a 2 MW facility and actually go to more of an industrial level. Now past this halving, we're going to see a lot more bigger industrial scale operations similar to what we have now, where the 2 MW-5 MW it can be very difficult to be profitable at that scale, because it's very tough to get a good price at that level and get the economies of scale.
We're going to be seeing a lot more companies coming to our size, and beyond that, also wanting to become a public company. The value of our paper has some value to many other companies that want to grow or be part of something bigger and get to the economies of scale. 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. Yes, we always keep an open mind to these types of transactions, and yes, there are opportunities out there.
Okay, just a quick follow-up. When we think of your expansion geographically, do you have enough in the vicinity you're in the province of Alberta, or are you looking further in other regions in Canada or even in the U.S.? What's your sense of that?
Yeah. 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, though 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. Yes, we definitely are looking for the cheapest power and best sites all around. If the opportunity were to present itself where we could take advantage of one of those, we would, of course, always consider it. That pipeline is very important to us. We think that there's a lot of value in making sure that we can think beyond what we're currently mining.
Got it. Just my last question, if I may. Reading your press release last night and your movement of Clarke chips to Medicine Hat, but you're also doing a hosting facility arrangement at Medicine Hat. I would've assumed if you're moving your most efficient chips to Medicine Hat where the electricity price is cheaper, more stable, you'd 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?
Yeah, we wanted to keep it also compelling for the client as well. With a bit cheaper energy in Medicine Hat, 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. In signing on our first client, and we think there's potential beyond this at Drumheller and beyond. 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.
Okay. Well, thanks for taking my questions, and then I'll pass them on.
Thank you. We have a follow-up question from Ivan Garabedian. Please go ahead.
Hi there. Me again. Simple question. Do you have any plans to list the company on either NASDAQ or the New York Stock Exchange?
Yeah, 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. That is something that I have in my mind. No immediate plans, nothing that's just around the corner. As we grow, we do see that. That's kind of the next organic expansion in our life as a public company. With other companies paving the way there, also just to note, as a TSX company that we are, we do have an expedited path. I think it's to the NASDAQ. This is an option to us. We just want to make sure it's at the right time and well thought out.
Okay, one last question.
Yeah.
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 equipment, or are you going to use the incremental value of Bitcoin in order to finance that?
It depends. Similar to before the raise, I'd say we always keep an open mind if we think that if there's a big appetite and there is capacity that we have, and we believe we can provide value in issuing new shares for this, then we stay open-minded to that. 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. 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.
Okay. Thank you very much. Thank you.
Thank you.
Thank you. At this moment, we don't see further questions. Thank you.
Thank you everyone for joining the call and the questions. Yeah, we look forward to staying in touch.
Thank you. Ladies and gentlemen, this concludes today's conference. We thank you for participating. You may now disconnect.