Hut 8 Corp.: Form 10-Q for the period ended Sep 30, 2023

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis relates to USBTC’s business prior to the consummation of the Business Combination, which was consummated after the end of the quarterly period ended September 30, 2023, and should be read in conjunction with (a) the unaudited condensed consolidated financial statements and related notes contained elsewhere in Part I, Item 1, “Financial Statements” of this Quarterly Report, (b) Part II, Item 1A “Risk Factors” of this Quarterly Report and (c) the sections titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations of USBTC” and USBTC audited consolidated financial statements and related notes included New Hut’s prospectus dated November 9, 2023 filed with the Securities and Exchange Commission (the “Prospectus”). As discussed in the section above titled “Cautionary Statement Regarding Forward-Looking Statements,” the following discussion contains forward-looking statements that are based upon our current expectations, including with respect to our future revenues and operating results. New Hut’s actual results may differ materially from those anticipated in such forward-looking statements as a result of various factors. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included under Part II, Item 1A below and the Prospectus.

USBTC operated on a June 30, 2023 fiscal year basis. Capitalized terms used in this section and not defined herein have the respective meanings given to such terms elsewhere in this Quarterly Report. Numbers and percentages presented throughout this discussion and analysis may not always add up to equivalent totals and/or to 100% due to rounding. References to digital asset mining and crypto asset mining are interchangeable and are meant to have the same meaning.

Overview of USBTC

USBTC is an industrial-scale operator of Bitcoin mining sites. The company’s strategy is to design, build, and operate sites where there is access to low-cost and sustainable sources of electricity. The company operates four sites across the United States with access to approximately 730 MW of electricity and fully built out rack space.

USBTC has several revenue streams: self-mining, hosting, managed infrastructure operations, and equipment sales. Self-mining refers to all USBTC-owned machines that contribute computing power to mining pools in exchange for Bitcoin. Hosting refers to USBTC operating third party-owned machines at its sites in exchange for a hosting fee. Managed infrastructure operations refers to USBTC operating third-party-owned Bitcoin mining sites in exchange for a property management fee. Equipment sales refers to USBTC selling mining or infrastructure equipment to third-parties.

USBTC owns and operates Alpha Site on leased property in Niagara Falls, New York with access to approximately 50 MW of electricity. USBTC also owns a 50% interest in a joint venture with NextEra Energy, Inc. (the “King Mountain JV”). The King Mountain JV owns the Echo Site, a Bitcoin mining site in Upton County, Texas with access to approximately 280 MW of electricity. The Echo Site is co-located behind-the-meter at a wind farm.

USBTC is the site operator for three Bitcoin mining sites through its US Managed Infrastructure Operations (“USMIO”) subsidiaries. USMIO leads all aspects of site operations, including accounting, curtailment, and customer relations if the site owner is also a hosting provider. The Charlie Site is located in Kearney, Nebraska and has access to approximately 100 MW of electricity. The Delta Site is located in Granbury, Texas and currently has access to approximately 300 MW of electricity. The third site is the Echo Site owned by the King Mountain JV, which has access to approximately 280 MW of electricity. USBTC views its managed infrastructure operations business as a strategic partnership with its clients; the company structures its property management agreements to incentivize the long-term growth and sustainability of its clients’ sites.

The Business Combination

USBTC entered into the Business Combination Agreement on February 6, 2023. Pursuant to the terms of the Business Combination Agreement, effective November 30, 2023, USBTC became a wholly-owned subsidiary of New Hut.

The Business Combination was accounted for under the acquisition method and USBTC was treated as the acquiror for financial statement reporting purposes. As a result, the financials included elsewhere in this Quarterly Report as well as the discussion in this section relate to USBTC’s financials for the three months ended September 30, 2023 prior to the consummation of the Business Combination.

Business Updates

Self-Mining

As of September 30, 2023, USBTC operates approximately 30,200 machines for its self-mining business (approximately 3.1 EH/s). For the three months ended September 30, 2023, USBTC mined approximately 553 Bitcoin compared to 766 for the three months ended September 30, 2022. Cryptocurrency mining net revenue was approximately $15.6 million for the three months ended September 30, 2023 compared to $16.3 million for the three months ended September 30, 2022.

Hosting services

As of September 30, 2023, USBTC hosted 8,500 machines for customers. Hosting services revenue was $0.4 million for the three months ended September 30, 2023 compared to $13.6 million for the three months ended September 30, 2022.

One of USBTC’s hosting clients defaulted on its contract during the three months ended September 30, 2022, which resulted in a termination of the contract without an obligation to refund, and USBTC recognized the remaining deferred revenue of $13.1 million with respect to such client.

Equipment sales

Equipment sales revenue was nil for the three months ended September 30, 2023 compared to $3.6 million for the three months ended September 30, 2022.

King Mountain JV

On December 6, 2022, one of USBTC’s subsidiaries acquired a 50% membership interest in the King Mountain JV and assumed the King Mountain JV’s senior Note (the “King Mountain JV Senior Note”). USBTC acquired the 50% membership interest through a competitive auction process in connection with the Chapter 11 bankruptcy filing of Compute North. The King Mountain JV has self-mining and hosting operations at the King Mountain location. USBTC has concluded that the King Mountain JV will be accounted for with the equity method of accounting. USBTC’s 50% portion of monthly distributions from the King Mountain JV will be swept to pay down the King Mountain JV Senior Note. For additional information on the King Mountain JV Senior Note, see below.

Self-mining revenue, hosting services revenue and cost reimbursement revenues for the King Mountain JV was $6.7 million, $13.3 million and $12.3 million, respectively, for the three months ended September 30, 2023, which represented 100% of the King Mountain JV’s revenue during the period.

King Mountain JV Senior Note

One of USBTC’s subsidiaries assumed the King Mountain JV Senior Note with a provisional fair value estimate of approximately $95.1 million as part of the consideration paid to acquire an equity membership interest in the King Mountain JV on December 6, 2022. The estimated fair value represents a discount of approximately $1.7 million from the carryover basis of the King Mountain JV Senior Note. The discount is being amortized over the term of the King Mountain JV Senior Note into interest expense. The assumed balance includes assumed accrued but unpaid interest of approximately $8.7 million.

The stated interest on the King Mountain JV Senior Note accrues at a rate per annum equal to the lesser of (a) a varying rate per annum equal to the sum of (i) the prime rate as published in The Wall Street Journal, plus (ii) 12.0% per annum, (b) 15.25% per annum and (c) the maximum rate of non-usurious interest permitted by Law. USBTC has the option to defer the interest until maturity of the King Mountain JV Senior Note under a paid-in-kind (“PIK”) payments option. USBTC has elected to apply the PIK payment option. Accordingly, the interest increases the principal amount of the King Mountain JV Senior Note. PIK interest is payable upon maturity in April 2027, unless or until any portion or all of the King Mountain JV Senior is prepaid under the prepayment option discussed below. USBTC is also subject to post-default interest of an additional 2% upon occurrence of an event of default. The higher interest rate applies from the date of non-payment until such amount is paid in full. As of September 30, 2023, the interest rate on the King Mountain JV Senior Note was 15.25%.

USBTC has the option to prepay the King Mountain JV Senior Note in whole or in part without premium or penalty. Any prepayment would be accompanied by all accrued and unpaid interest on the principal amount prepaid. The King Mountain JV Senior Note is secured by a first priority security interest in the USBTC subsidiary’s membership interest in the King Mountain JV.

As of September 30, 2023, approximately $84.3 million in principal and PIK interest, net of a $1.4 million discount, was outstanding under the King Mountain JV Senior Note, with payment of principal and PIK interest due upon the first to occur of (a) the date that is five years from origination on April 8, 2022, (b) the date of any event of dissolution of the King Mountain JV and (c) the date of the closing of certain events specified in the King Mountain JV’s governing documents.

Managed Infrastructure Operations

Two USBTC subsidiaries entered into property management agreements (“PMAs”) in November 2022 with an institutional investor focused on renewable energy assets. USBTC entered into these agreements following a formal request for proposal (RFP)-driven process in connection with the Chapter 11 bankruptcy filing of Compute North, through which the institutional investor became the owner of two digital asset mining sites.

Each of these PMAs has five-year terms whereby each subsidiary charges a monthly fixed fee and has the ability to pass-through certain additional costs for the operations, management, support, and administrative functions of operating a Bitcoin mining site for a third-party customer. The sites that USMIO manages under these PMAs are the Charlie Site and Delta Site.

On December 6, 2022, one of the USMIO subsidiaries assumed a PMA for a Bitcoin mining site owned by the King Mountain JV, which is the Echo Site. This PMA has a ten-year term, including a charge of a monthly fixed fee in addition to certain pass-through costs for the operations, management, support, and administrative functions of operating a Bitcoin mining site for the King Mountain JV.

USMIO subsidiaries currently charge a market rate of approximately $3,000 per MW per month based on nameplate capacity for its property management services and currently intends to continue this pricing in any future PMA. In addition to the monthly fixed fee, further cash flows may be driven from incentives bonuses, energy management services and reimbursement of passthrough costs. However, certain existing agreements, specifically the King Mountain JV, are based on historical contracts and pricing that was adopted as a part of the King Mountain JV acquisition.

Management fees revenue and cost reimbursements revenue were $3.4 million and $2.3 million, respectively, for the three months ended September 30, 2023 compared to nil and nil for the three months ended September 30, 2022.

Recent Developments and Significant Transactions

Debt

Term Loan

In December 2022, USBTC entered into a $10.0 million term-loan with a third party. The maturity date is December 5, 2027 and the interest rate was 6% per annum. Interest is payable in kind as an addition to, and capitalization on, the outstanding principal. The term-loan is secured by certain assets of USBTC and does not have financial covenants.

In May 2023, USBTC renegotiated its $10.0 million term-loan with the third party. The interest rate was increased to 18% and a mandatory prepayment was added following consummation of the Business Combination.

Restructuring and Financing

NYDIG

On July 27, 2021, USBTC entered into a Master Equipment Financing Agreement (“MEFA”) with Arctos Credit, LLC (“Arctos”). Pursuant to the MEFA, Arctos advanced the approximately $9.1 million to finance USBTC’s purchase of certain equipment, in exchange for repayment of the principal and interest by July 25, 2023. Additionally, USBTC granted Arctos a security interest in certain of its assets, as further described in the MEFA, pursuant to a security agreement dated as of July 27, 2021 (the “Security Agreement”).

On December 27, 2021, USBTC executed an amendment to the MEFA (the “MEFA Amendment” and together with the MEFA, the “Credit Agreement”) with NYDIG Trust Company LLC pursuant to which (i) NYDIG replaced Arctos as the “Lender” under the MEFA, being granted full rights of such party under the Credit Agreement, (ii) NYDIG replaced Arctos as “Secured Party” under the Security Agreement, being granted the full rights of such party under the Security Agreement, (iii) NYDIG made additional advances to USBTC and (iv) USBTC granted NYDIG additional security interests in certain of its assets, as further described in the MEFA Amendment.

In connection with a restructuring of its debt obligations with NYDIG, USBTC (and certain of its subsidiaries) entered into an asset purchase agreement dated as of February 3, 2023 with NYDIG (and certain of its subsidiaries or other affiliates) (“APA”) pursuant to which USBTC transferred the USBTC Assets to NYDIG in full satisfaction of the MEFA Debt owed under the Credit Agreement and release of the security interests granted pursuant to the Security Agreement. Additionally, USBTC and NYDIG entered into certain other agreements to effectuate the purposes of, and the transactions contemplated by, the APA including (i) a Real Estate Purchase and Sale Agreement dated as of February 3, 2023 pursuant to which USBTC transferred certain real property to NYDIG and (ii) an Assignment and Assumption Agreement dated as of February 3, 2023 pursuant to which NYDIG transferred its rights as “Lender” under the Credit Agreement to USBTC in exchange for the USBTC Assets transferred to NYDIG under the APA.

As of February 3, 2023, USBTC owes no amount under the MEFA to NYDIG and NYDIG holds no remaining security interests in the assets of USBTC such that NYDIG is no longer considered a debt finance partner or secured party of USBTC.

Anchorage

On March 31, 2022 and April 26, 2022, respectively, USBTC entered into certain loan agreements with Anchorage Lending CA, LLC(“Anchorage”) (“Original Loan Agreements”). Pursuant to the Original Loan Agreements, Anchorage advanced $50.0 million to USBTC to finance USBTC’s acquisition of certain business equipment. Pursuant to the Original Loan Agreements, USBTC agreed to repay the principal plus interest. Additionally, USBTC granted Anchorage a security interest in certain of its assets, including certain USBTC miners, as further described in the Original Loan Agreements.

In connection with a restructuring of its debt obligations with Anchorage, USBTC (and certain of its subsidiaries) entered into a loan, guaranty and security agreement dated as of February 3, 2023 (the “Refinanced Loan Agreement”) with Anchorage pursuant to which (i) USBTC transferred certain of its assets to US Data Guardian LLC (“USDG”), (ii) USDG became the “Borrower” under the Original Loan Agreement, (iii) Anchorage obtained a security interest in certain assets, including 23,500 USBTC miners and the Alpha Site and all its property and assets, of USBTC, USDG, and U.S. Data Technologies Group Ltd. (“USDTG”) and (iv) the parties agreed to repay the outstanding loan amount to Anchorage. Additionally, USBTC, USDG, and USDTG, as applicable, entered into certain other agreements with Anchorage to effectuate the purposes of, and the transactions contemplated by, the Refinanced Loan Agreement including (i) a subscription agreement by and between USBTC and Anchorage, dated as of February 3, 2023, pursuant to which Anchorage acquired 2,960,000 shares of USBTC common stock; and (ii) an asset purchase agreement by and between USBTC and USDG dated as of February 3, 2023 pursuant to which USBTC transferred certain of its assets to USDG pursuant to the Refinanced Loan Agreement. Pursuant to the Refinanced Loan Agreement, the outstanding loan amount and interest is to be repaid on a monthly basis through profits (revenue from Bitcoin mined and sold less costs for energy or hosting, insurance, taxes, and repair and maintenance of miners) generated from those certain USBTC miners underlying Anchorage’s security interest, as further specified in the Refinanced Loan Agreement. USBTC is not required to generate a minimum amount of profit, nor is USBTC required to make a minimum monthly payment if no profit is generated. If profit in any month is not sufficient to generate a payment, interest continues to accumulate and is added to the total amount to be repaid. The Refinanced Loan Agreement has a 5-year term, and the principal balance and any additional interest is due as a balloon payment on or before February 2, 2028.

The Refinanced Loan Agreement was amended in April 2023 and only accrues interest on the outstanding principal balance and not on any PIK interest from prior periods.

Investment in Fahrenheit LLC and Celsius Bankruptcy Bid

On April 10, 2023, a USBTC subsidiary invested in Fahrenheit LLC (“Fahrenheit”), a joint venture formed for the purposes of bidding on the management rights of a new entity to be formed and vested with certain assets of Celsius Network LLC (“Celsius”) in connection with Celsius’ bankruptcy auction. On May 25, 2023, Fahrenheit won the auction and was awarded the right to manage and operate the assets of Celsius in exchange for a management fee of $20.0 million per year as part of a five-year agreement with Celsius, subject to the approval of the bankruptcy court. In addition, USBTC, acting separately through its USMIO business, won the right to enter into one or more operating and services agreements with the restructured company, in exchange for a fee of $15.0 million per year net of certain operating expenses, which is also subject to the approval of the bankruptcy court.

On May 26, 2023, the USBTC subsidiary contributed a portion of the initial $10.0 million cash deposit required in the Fahrenheit bid.

On November 29, 2023, Celsius informed Fahrenheit that it was unable to obtain certain regulatory approvals respecting the proposed transaction involving Celsius and Fahrenheit, and, as a result, Celsius would not move forward with the Fahrenheit-sponsored transaction.

On November 30, 2023, Celsius filed a motion disclosing that USBTC, acting separately through its USMIO business, won the right to enter into one or more operating and services agreements pursuant to a revised transaction structure in exchange for a fee of $20.4 million per year net of certain operating expenses as part of a four-year agreement with the restructured company. This revised transaction remains subject to the approval of the bankruptcy court.

On December 18, 2023, USBTC signed an interim agreement to build out and install mining operations in connection with the Celsius bankruptcy proceedings at a site in Cedarvale, Texas.

The USBTC subsidiary’s portion of the initial $10.0 million cash deposit remains in escrow and is anticipated to be returned due to Celsius not moving forward with the Fahrenheit bid. USBTC’s USMIO contract bid remains subject to approval and, if approved, will become binding.

There can be no assurance that the Celsius bid will obtain the necessary approvals and USBTC may never realize any benefits from the USMIO contract bid.

Entry into AI Infrastructure Market

In October 2023, the board of directors of USBTC (the “USBTC Board”) determined to expand USBTC’s business by entering the AI infrastructure market through its initial purchase order of AI equipment for an aggregate purchase price of approximately $40.0 million. The purchase order is subject to customary terms and conditions, including a limited cancellation option by USBTC prior to the commencement of the AI equipment production. USBTC is currently evaluating alternatives to finance the purchase price of the AI equipment.

Upon receipt of the initial AI equipment, USBTC expects to host the AI equipment in a data center in the United States and ultimately provide underlying AI workload support to individual customers through its AI data center. As of the date of this Quarterly Report, USBTC does not have any AI customers and has not recognized any revenue from its new AI infrastructure business line.

Trends and Key Factors Affecting USBTC’s Performance

Bitcoin Market Price

USBTC’s business is heavily dependent on the spot price of Bitcoin. The prices of digital assets, particularly Bitcoin, have historically experienced substantial volatility. Changes in the market price of Bitcoin may have little or no correlation to identifiable market forces, and may be subject to rapidly changing investor sentiment. Bitcoin may be valued based on various factors, including its acceptance as a means of exchange by consumers and producers, scarcity, market demand, and media reporting.

Halving

Changes to the quantity of Bitcoin rewarded per block could directly impact USBTC’s operating results. The Bitcoin network is subject to periodic scheduled changes in the quantity of Bitcoin rewarded per block, known as halving. It is anticipated that the current Bitcoin reward will decrease by half in early 2024, according to estimates of the rate of block solution calculated by Bitcoinclock.com. This halving process will repeat until the total amount of Bitcoin rewards issued reaches 21 million and the theoretical supply of new Bitcoin is exhausted, which is expected to occur around 2140. Potential future halving may decrease the amount of Bitcoin rewards that USBTC receives, and there is no guarantee the price of Bitcoin will adjust accordingly.

USBTC aims to mitigate the impacts of halving by maintaining a breakeven profitability floor far below the network average. To do so, it has developed and implemented a curtailment algorithm that maximizes the marginal profitability of its machines. USBTC has also implemented standard operating procedures to maximize the operational efficiency of its sites, such as preventative maintenance and cleaning of equipment. USBTC believes it is positioned to secure energy hedges that further protect its mining economics from the impact of the halving. USBTC believes that these steps can enable it to maintain survivability above its competitors and mitigate the downside risk of decreased rewards.

Network Difficulty

Additional mining machines deployed onto the Bitcoin network increase the network hashrate. Increased network hashrate reduces the time spent mining new blocks. To keep the time interval between new blocks fixed at approximately 10 minutes, the Bitcoin network adjusts its “network difficulty” every 2,016 blocks (or roughly every two weeks) such that more hashes are needed to mine a new block. Difficulty is often denoted as the relative difficulty with respect to the genesis block, which required approximately 2Ù32 hashes. Changes in network difficulty can adversely affect USBTC’s revenue and margins.

Ability to source additional mining machines

USBTC’s self-mining business is directly impacted by its ability to increase its hashrate and its resulting share of network rewards. USBTC’s ability to increase its hashrate depends on sourcing additional mining machines at cost-effective prices and lead times.

Ability to access power capacity

Increases in network hashrate drive greater demand for additional mining machines. Additional mining machines require additional power capacity that can be difficult to source at cost-effective prices or within locations that are favorable to Bitcoin mining. USBTC aims to leverage its existing relationships within the energy industry to secure low-cost power capacity.

USBTC’s data centers can also act as a consumer of last resort for wind and solar projects. The growing supply of wind and solar facilities in areas like West Texas has created an imbalance where existing transmission infrastructure cannot support the volume of load generation in periods of high production.

Ability to access capital markets

Bitcoin mining is highly capital intensive. USBTC’s ability to continue scaling infrastructure and expand its fleet of miners will depend on its ability to access the capital markets.

Cost of Electricity

Electricity is one of USBTC’s largest operating expenses. USBTC manages its cost of electricity through participation in various demand response programs, power purchase agreements, and curtailment of miners when electricity prices make it unprofitable to mine Bitcoin. USBTC may also charge its hosting customers for reimbursement of electricity costs that it incurs on behalf of the customer. In the future, USBTC may consider other arrangements such as power hedges to manage its cost of electricity.

Electricity costs may be adversely affected by macroeconomic or geopolitical events. The invasion of Ukraine by Russia in February 2022 has exerted pressure on the global energy market, particularly Europe’s natural gas supply. Higher LNG import needs in Europe have resulted in worldwide supply tensions and higher short-term prices, negatively impacting Europe’s electricity sector. The conflict has added further pressure to supply chain disruptions and has likely supported rising inflation through higher commodity prices. In the United States, USBTC has observed elevated electricity pricing in recent months possibly due to this conflict, although USBTC has no direct operations in Russia or Ukraine. Also, the war between Israel and Hamas has resulted in political and potential economic uncertainty in the Middle East. We will continue to monitor any direct and indirect impacts of these circumstances on our business, financial results and operations, although it is not possible to predict the broader consequences of this ongoing conflict at this time.

USBTC’s cost of electricity, net of demand response payments and electricity cost reimbursements, for the three months ended September 30, 2023 was $1.6 million. Demand response payments and electricity cost reimbursements were nil and $1.1 million, respectively, during the same period. USBTC’s cost of electricity, net of demand response payments and electricity cost reimbursements, for the three months ended September 30, 2022 was $14.3 million. Demand response payments and electricity cost reimbursements were $0.8 million and nil, respectively, during the same period. The decrease was primarily attributable to a decrease in the number of self-mining miners operating in USBTC’s fleet.

Cost to Mine a Bitcoin

USBTC’s profitability in self-mining is heavily dependent upon its cost to mine a Bitcoin, calculated as cost of hosting plus cost of electricity, net of demand response payments and electricity cost reimbursements, in the period, divided by Bitcoin mined in the period. USBTC’s management views the company’s cost to mine a Bitcoin as a key indicator of gross profitability, while also monitoring the price of Bitcoin. USBTC’s cost to mine a Bitcoin for the three months ended September 30, 2023 was approximately $19,000 compared to approximately $18,700 for the three months ended September 30, 2022. The increase was primarily attributable to an increase in network difficulty. During the three months ended September 30, 2023, the price of Bitcoin ranged from approximately $25,100 to approximately $31,400. During the three months ended September 30, 2022, the price of Bitcoin ranged from approximately $18,500 to approximately $24,400.

USBTC’s management does not expect a significant impact to this metric as a result of the Business Combination. However, the company has also assessed forward energy pricing from quoted prices in the futures market which suggests a decrease in electricity pricing in the near future relative to the most recent market conditions.

Key Operating and Financial Indicators

In addition to the financial results, USBTC uses the following key operating indicators to evaluate the business, identify trends and make strategic decisions.

The following table presents USBTC’s key operating indicators for the three months ended September 30, 2023 and 2022. Adjusted EBITDA, included in the below table, is a Non-GAAP measure. For the definition of Adjusted EBITDA and a reconciliation to USBTC’s most directly comparable financial measure calculated and presented in accordance with GAAP, please see “Results of Operations” below.

Hashrate

USBTC operates mining hardware or “miners” which provide computing power to mining pools, which aggregate this computing power with other miners to attempt to create new blocks in the Bitcoin blockchain. Computing power is measured in “hashrate” or “hashes per second.” A “hash” is a single computation run by a miner to attempt to create a new block in the Bitcoin blockchain.

Creating new blocks in the Bitcoin blockchain is analogous to a lottery system where every hash is equivalent to a dice roll, and successfully creating a new block is equivalent to winning the lottery. The more dice rolls, or hashes per second a miner provides, the greater the probability of success that a miner creates a new block. “Network hashrate” is the combined hashrate of the Bitcoin network; similarly, the greater the share of a pool’s hashrate compared to the rest of the network, the greater the probability of success that a pool creates a new block. Pools that create a new block earn the Bitcoin reward. The pool then distributes USBTC’s pro-rata share of Bitcoin earned to USBTC based on the computing power USBTC contributes.

USBTC’s goal is to increase the hashrate it operates and to deploy, host, and operate miners with profitable hashrate-to-power cost profiles.

Bitcoin mined

USBTC’s management sees total Bitcoin mined as a key metric for its business. Trends in total Bitcoin mined are impacted by USBTC’s ability to deploy additional miners for self-mining, and also by USBTC’s ability to maintain high miner uptime and efficiency. USBTC monitors this metric over monthly and quarterly periods. As of September 30, 2023, USBTC has self-mined approximately 4,453 Bitcoin. Self-mined Bitcoin earned for the three months ended September 30, 2023 and 2022 (on a quarterly and monthly basis) is summarized in the table below:

Net income (loss)

USBTC recorded a net loss of $4.4 million for the three months ended September 30, 2023 compared with net loss of $0.6 million for the three months ended September 30, 2022. The increase in net loss was primarily driven by the decrease in hosting services revenue. One of USBTC’s hosting clients defaulted on its contract during the three months ended September 30, 2022, which resulted in a termination of the contract without an obligation to refund, and USBTC recognized deferred revenue of $13.1 million.

Adjusted EBITDA

Adjusted EBITDA is a non-GAAP financial measure. USBTC defines Adjusted EBITDA as net income (loss) before interest, taxes, depreciation and amortization, further adjusted by depreciation and amortization embedded in the equity in earnings (losses) from USBTC’s unconsolidated joint venture, the removal of non-recurring transactions, the impairment of long-lived assets and stock-based compensation expense in the period presented. USBTC relies on Adjusted EBITDA to evaluate its business, measure its performance, and make strategic decisions. USBTC’s board and management team use Adjusted EBITDA to assess USBTC’s financial performance because it allows them to compare USBTC’s operating performance on a consistent basis across periods by removing the effects of USBTC’s capital structure (such as varying levels of interest expense and income), asset base (such as depreciation and amortization) and other items (such as non-recurring transactions mentioned above) that impact the comparability of financial results from period to period. USBTC presents Adjusted EBITDA because it believes it provides useful information regarding the factors and trends affecting its business in addition to measures calculated under GAAP. Adjusted EBITDA is not a financial measure presented in accordance with GAAP. USBTC believes that the presentation of this non-GAAP financial measure will provide useful information to investors and analysts in assessing its financial performance and results of operations across reporting periods by excluding items it does not believe are indicative of its core operating performance. Net income (loss) is the GAAP measure most directly comparable to Adjusted EBITDA.

USBTC’s non-GAAP financial measure should not be considered as an alternative to the most directly comparable GAAP financial measure. You are encouraged to evaluate each of these adjustments and the reasons USBTC’s management considers them appropriate for supplemental analysis. In evaluating Adjusted EBITDA, you should be aware that in the future USBTC may incur expenses that are the same as or similar to some of the adjustments in such presentation. USBTC’s presentation of Adjusted EBITDA should not be construed as an inference that its future results will be unaffected by unusual or non-recurring items. There can be no assurance that USBTC will not modify the presentation of Adjusted EBITDA in the future, and any such modification may be material. Adjusted EBITDA has important limitations as an analytical tool and you should not consider Adjusted EBITDA in isolation or as a substitute for analysis of USBTC’s results as reported under GAAP. Because Adjusted EBITDA may be defined differently by other companies in USBTC’s industry, its definition of this non-GAAP financial measure may not be comparable to similarly titled measures of other companies, thereby diminishing its utility.

For a reconciliation to USBTC’s most directly comparable financial measure calculated and presented in accordance with GAAP, please see “Results of Operations.”

Critical Accounting Estimates

USBTC’s management’s discussion and analysis of its financial condition and results of operations is based on its consolidated financial statements, which have been prepared in accordance with GAAP and requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, contingent assets and liabilities, each as of the date of the consolidated financial statements, and revenues and expenses during the periods presented. On an ongoing basis, USBTC’s management evaluates their estimates and assumptions, and the effects of any such revisions are reflected in the consolidated financial statements in the period in which they are determined to be necessary. Actual outcomes could differ materially from those estimates in a manner that could have a material effect on its consolidated financial statements.

Our significant accounting policies are described in more detail in Note 3 to USBTC’s unaudited condensed consolidated financials included in Part I, Item 1 of this Quarterly Report. USBTC believes that the accounting policies discussed in Note 3 are critical to understanding its historical and future performance as these policies involved a greater degree of judgment and complexity.

Stock-Based Compensation Expense

Stock-based compensation expense represents the cost of the grant date fair value of equity awards recognized over the requisite service period of the awards (usually the vesting period) on a straight-line basis. USBTC estimates the fair value of equity awards using the Black-Scholes option pricing model and recognize forfeitures as they occur. Estimating the fair value of equity awards as of the grant date using valuation models, such as the Black-Scholes option pricing model, is affected by assumptions regarding a number of variables, including the risk-free interest rate, the expected stock price volatility, the expected term of stock options, the expected dividend yield and the fair value of the underlying common stock on the date of grant. Changes in the assumptions can materially affect the fair value and ultimately how much stock-based compensation expense is recognized. These inputs are subjective and generally require significant analysis and judgment to develop. See Note 3 to USBTC’s unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report for information concerning certain of the specific assumptions USBTC used in applying the Black-Scholes option pricing model to determine the estimated fair value of its stock options granted during the three months ended September 30, 2023 and 2022.

As of September 30, 2023, excluding $0.1 million of unrecognized compensation expense related to 146,250 options that will vest upon the completion of an initial public offering or merger event (“IPO options”), there was $1.2 million of total unrecognized compensation expense related to the unvested stock options, which is expected to be recognized as expense over a weighted average period of approximately 1.1 years.

The following section provides information on USBTC’s stock options and restricted stock grants.

Common Stock Valuations

USBTC is required to estimate the fair value of the common stock underlying its equity awards when performing fair value calculations. The fair value of the common stock underlying its equity awards was determined on each grant date by USBTC’s board, taking into account input from management and independent third-party valuation analyses. All options to purchase shares of USBTC’s common stock are intended to be granted with an exercise price per share no less than the fair value per share of its common stock underlying those options on the date of grant, based on the information known to USBTC on the date of grant. In the absence of a public trading market for its common stock, on each grant date USBTC develops an estimate of the fair value of its common stock in order to determine an exercise price for the option grants. USBTC’s determinations of the fair value of its common stock were made using methodologies, approaches and assumptions consistent with the American Institute of Certified Public Accountants Accounting and Valuation Guide: Valuation of Privately Held Company Equity Securities Issued as Compensation, or the Practice Aid.

The board of directors exercises judgment and considers numerous objective and subjective factors to determine the best estimate of the fair value of its common stock including: (i) independent valuations performed at or near the time of grant; (ii) rights, preferences, and privileges of USBTC’s convertible preferred stock relative to those of its common stock; (iii) prices of convertible preferred stock sold by USBTC to third-party investors in arms-length transactions; (iv) USBTC’s actual operating and financial performance at the time of the option grant; (v) likelihood of and time frame associated with achieving a liquidity event, such as an initial public offering or a merger or acquisition of USBTC’s business; (vi) the value of comparable companies with respect to industry, business model, stage of growth, financial risk or other factors; (vii) USBTC’s stage of development and future financial projections; and (viii) the lack of marketability of USBTC’s common stock.

The Practice Aid prescribes several valuation approaches for setting the value of an enterprise, such as the cost, income and market approaches, and various methodologies for allocating the value of an enterprise to its common stock. The cost approach establishes the value of an enterprise based on the cost of reproducing or replacing the property less depreciation and functional or economic obsolescence, if present. The income approach establishes the value of an enterprise based on the present value of future cash flows that are reasonably reflective of USBTC’s future operations, discounting to the present value with an appropriate risk-adjusted discount rate or capitalization rate. The market approach is based on the assumption that the value of an asset is equal to the value of a substitute asset with the same characteristics. Each valuation methodology was considered in USBTC’s valuations.

In determining the fair value of USBTC’s common stock underlying its stock option grants during the three months ended September 30, 2023 and 2022, USBTC estimated the enterprise value of its business using various methodologies, including, but not limited to, an Option Pricing Model (“OPM”) backsolve method, an OPM adjusted backsolve method, a Probability Weighted Expected Return Model, the Guideline Public Company Method, and the Discounted Cash Flow method. These enterprise values were then allocated to the various classes of securities in USBTC’s capital structure at each valuation date using an OPM. The concluded value for common stock from the OPM then had a Discount for Lack of Marketability applied to it to conclude to the value of common stock on a non-marketable, non-controlling basis at each respective valuation date.

Options Granted

The following table sets forth, by month of grant, the number of shares subject to options granted during the three months ended September 30, 2023 and 2022, the per share exercise price of the options and the fair value of common stock per share on each grant date:

(1) The exercise prices for these grants were based upon the fair market value associated with a preliminary 409(A) valuation report provided to the USBTC Board. The subsequent final 409(A) valuation report as of the grant date, received after the grant date, included a lower fair market valuation.

(2) The August 2022 option grants exercise price was based on a preliminary 409(A) valuation report. The options had a higher exercise price than the subsequently issued final 409(A) valuation report which indicated a fair value of $0.01. The USBTC Board decided not to change the original exercise prices following receipt of the final 409(A) valuation report.

Restricted Stock Granted

The following table sets forth, by grant date, the number of shares of restricted common stock granted from USBTC’s during the three months ended September 30, 2023 and 2022 and the per share estimated fair value of the restricted stock:

Results of Operations

Comparison of the Three Months Ended September 30, 2023 and 2022

The following tables summarize USBTC’s results of operations and Adjusted EBITDA for the three months ended September 30, 2023 compared to the three months ended September 30, 2022:

Adjusted EBITDA schedule:

37

Revenue

Digital asset mining

Revenue was $15.6 million for the three months ended September 30, 2023 compared to $16.3 million for the three months ended September 30, 2022. Revenues from digital asset mining are impacted significantly by volatility in Bitcoin prices, as well as increases in the Bitcoin blockchain’s network hashrate resulting from the growth in the overall quantity and quality of miners working to solve blocks on the Bitcoin blockchain, and the difficulty index associated with the secure hashing algorithm employed in solving the blocks.

During the three months ended September 30, 2023, the price of Bitcoin ranged from approximately $25,100 to approximately $31,400. During the three months ended September 30, 2022, the price of Bitcoin ranged from approximately $18,500 to approximately $24,400.

Mining equipment sales

Mining equipment sales were nil for the three months ended September 30, 2023 compared to $3.6 million for the three months ended September 30, 2022. USBTC has not entered into any mining equipment sale agreements in the three months ended September 30, 2023.

Hosting services

Hosting services revenue was $0.4 million for the three months ended September 30, 2023 compared to $13.6 million for the three months ended September 30, 2022. USBTC launched its hosting services business in March 2022.

One of USBTC’s hosting clients defaulted on its contract during the three months ended September 30, 2022, which resulted in a termination of the contract without an obligation to refund, and USBTC recognized the remaining deferred revenue of $13.1 million with respect to such client.

Management fees and cost reimbursements

Management fees and cost reimbursement revenues were $3.4 million and $2.3 million, respectively, for the three months ended September 30, 2023 compared to $nil for both, for the three months ended September 30, 2022. USBTC launched its managed infrastructure operations business in November 2022. USBTC entered into two property management agreements in November 2022, and one property management agreement in December 2022.

Costs and expenses

Costs of revenues (exclusive of depreciation and amortization)

Included in cost of revenues are energy costs, hosting and network management, labor costs associated with the installation of mining equipment and facility costs. Services costs of revenues for the three months ended September 30, 2023 decreased $3.5 million to $11.8 million from $15.3 million during the three months ended September 30, 2022. The largest component of USBTC’s services cost of revenues is energy and hosting costs, which represented approximately 98.2% and 95.5% of its services cost of revenues for the three months ended September 30, 2023 and 2022, respectively. Services cost of revenues decreased in the three months ended September 30, 2023 compared to the same period last year due to a decrease in energy and hosting costs during the current fiscal year.

Mining equipment costs of revenue for the three months ended September 30, 2023 were $nil compared to $3.1 million for the three months ended September 30, 2022. USBTC did not enter into any mining equipment sale agreements during the three months ended September 30, 2023.

Depreciation and amortization

Depreciation and amortization expense was $4.5 million and $5.8 million for the three months ended September 30, 2023 and 2022, respectively. On December 31, 2022 USBTC recorded an impairment charge of approximately $63.6 million. Additionally, in February 2023, USBTC settled its MEFA Debt. As part of the settlement and extinguishment, USBTC exchanged approximately $39.5 million of property and equipment. Both of these transactions resulted in a decrease in the depreciable asset base for the three months ended September 30, 2023 compared to the three months ended September 30, 2022.

General and administrative expenses (exclusive of stock-based compensation)

General and administrative (“G&A”) expenses include, but are not limited to, corporate payroll, legal fees, professional fees related to USBTC’s auditors and other contracted services, security services and insurance premiums. G&A expenses for the three months ended September 30, 2023 increased $2.6 million to $5.6 million from $3.0 million during the three months ended September 30, 2022, excluding stock-based compensation expense as discussed below. Payroll costs represented, 40.9% and 35.7%, legal fees represented 12.4% and 5.9%, other professional fees including security services represented 14.4% and 15.8%, and insurance costs represented 3.0% and 10.7% for the three months ended September 30, 2023 and 2022, respectively. The $2.6M increase in G&A expenses is mainly due to increased legal and professional fees in the three months ended September 30, 2023, primarily related to the Business Combination, as well as increased payroll costs due to increased headcount related to USBTC’s two PMAs entered into in November 2022 and third PMA entered into in December 2022.

Stock-based compensation

Stock-based compensation was $0.3 million and $2.8 million for three months ended September 30, 2023 and 2022, respectively. The expense in both periods primarily related to restricted stock grants and stock grants to certain employees, advisors and consultants.

Impairments of digital assets

Impairments of digital assets was $0.7 million and $1.3 million for the three months ended September 30, 2023 and 2022, respectively. Impairment results from declines in the lowest intra-day price of Bitcoin during the period it is held.

Interest expense

Interest expense was $5.7 million and $4.0 million for the three months ended September 30, 2023 and 2022, respectively. The increase in interest expense is related to the addition of the TZRC Secured Promissory Note and the Third Party Note in December 2022, as described in the “Liquidity and Capital Resources” section below.

Equity in earnings of unconsolidated joint venture

Equity in earnings of unconsolidated joint venture was $2.1 million and $nil for the three months ended September 30, 2023 and 2022, respectively. USBTC acquired the 50% membership interest in the King Mountain JV on December 6, 2022.

Income Tax

For the three months ended September 30, 2023, USBTC recognized income tax provision of $0.1 million. USBTC’s effective income tax rate was (1.4%) for the three months ended September 30, 2023. The difference between the effective tax rate and the expected statutory rate was a result of stock-based compensation and related changes in the valuation allowance.

USBTC’s effective tax rate for the three months ended September 30, 2022 was (128.6%), which differs from the U.S. Federal income tax rate of 21.0% primarily due to stock-based compensation and related changes in the valuation allowance.

Net Operating Loss Carryforwards

As of September 30, 2023, USBTC had federal net operating loss carryforwards of approximately $70.8 million. The federal net operating losses can be carried forward indefinitely, but utilization is subject to an 80% taxable income limitation.

Liquidity and Capital Resources

USBTC’s earnings, cash flows and ability to meet any debt obligations will depend on the cash flows resulting from its operations, proceeds from sales of cryptocurrency and access to capital markets. USBTC’s cash needs historically were primarily for growth through acquisitions and working capital to support equipment financing and the purchase of additional miners. Cash needs for operations have historically been financed with cash generated from operations, sales of USBTC’s mined Bitcoin or financings. We currently anticipate that USBTC’s current cash on hand, proceeds from sales of cryptocurrency and ongoing operations will be sufficient to meet its requirements for at least the next 12 months from the date of issuance of these financial statements.

Cash Flows

USBTC has incurred net losses since its inception. As of September 30, 2023 and 2022, USBTC had cash and cash equivalents of approximately $12.7 million and $21.4 million, respectively. The following table summarizes USBTC’s cash flows for the periods indicated:

Operating Activities

Net cash provided by (used in) operating activities was $2.2 million and ($7.4) million for the three months ended September 30, 2023 and 2022, respectively.

Net cash provided by operating activities for the three months ended September 30, 2023 resulted from a net loss and related adjustments of ($0.6) million in addition to changes in working capital of $2.8 million. Net cash used in operating activities for the three months ended September 30, 2022 resulted from a net loss and related adjustments of ($8.2) million offset by changes in working capital of $0.8 million.

Investing Activities

Net cash provided by investing activities was $15.3 million and $5.9 million for the three months ended September 30, 2023 and 2022, respectively. Cash increases for the three months ended September 30, 2023 were primarily due to $15.5 million in proceeds from the sale of Bitcoin, offset by ($0.2) million in purchases of property and equipment. Cash increases for the three months ended September 30, 2022 were primarily due to $15.7 million in proceeds from the sale of Bitcoin, offset by ($9.0) million in deposits on miners and ($1.0) million in purchases of property and equipment.

Financing Activities

Net cash (used in) provided by financing activities was ($15.1) million and $1.8 million for the three months ended September 30, 2023 and 2022, respectively. Cash used for the three months ended September 30, 2023 was primarily due to ($15.1) million in repayment of notes payable. Cash increases for the three months ended September 30, 2022 was primarily due to $4.2 million in proceeds from notes payable, offset by ($2.5) million in repayment of notes payable.

NYDIG

On July 27, 2021, USBTC entered into the MEFA with Arctos, subsequently amended on December 27, 2021 with NYDIG replacing Arctos as lender. Please see “Business Updates - Restructuring and Financing” above.

Anchorage

On March 31, 2022 and April 26, 2022, USBTC entered into the Original Loan Agreements with Anchorage, subsequently restructured on February 2, 2023 pursuant to the Refinanced Loan Agreement. Please see “Business Updates - Restructuring and Financing” above.

King Mountain JV Senior Note

On December 6, 2022, one of USBTC’s subsidiaries acquired a 50% membership interest in the King Mountain JV and assumed the King Mountain JV’s Senior Note. Please see “Business Updates - King Mountain JV Senior Note” above.

Equipment Purchase Transactions

USBTC did not make any equipment purchase transactions during the three months ended September 30, 2023 and 2022.

Market Price Risk of Bitcoin

New Hut holds a significant amount of Bitcoin; therefore, it is exposed to the impact of market price changes in Bitcoin on its Bitcoin holdings. This exposure would potentially affect the following items:

• New Hut accounts for its Bitcoin holdings as indefinite lived intangible assets and records impairment charges whenever the carrying value of Bitcoin holdings on the balance sheet exceeds the lowest intra-day price. Subsequent recovery of Bitcoin prices would not impact the carrying value of Bitcoin on the balance sheet, as recovery of previously recorded impairment charges are not allowed under current U.S. GAAP.
• Declines in the fair market value of Bitcoin will impact the cash value that would be realized if New Hut were to sell its Bitcoin for cash, therefore having a negative impact on its liquidity.

As of September 30, 2023, prior to the consummation of the Business Combination, USBTC held 54 Bitcoin and the fair value of a single Bitcoin was approximately $27,000. Therefore, the fair value of USBTC’s Bitcoin holdings as of September 30, 2023 was approximately $1.5 million.

Credit Risk

New Hut’s digital assets subject to lending arrangements are exposed to credit risk. New Hut limits its credit risk by loaning the digital assets to counterparties that are believed to have sufficient capital to meet their obligations as they come due based on New Hut’s review of their size, credit quality and reputation. As of the date of this Quarterly Report, the Company has not incurred a material loss on any of its digital assets subject to lending arrangements, as there were no digital assets subject to lending arrangements. As of each reporting period, New Hut assesses if there are significant increases in credit risk requiring recognition of a loss or write-down. Such loss or write-down would be reflected in the fair value of the digital assets subject to lending arrangements. While New Hut intends to only transact with counterparties that it believes to be creditworthy, there can be no assurance that a counterparty will not default and that New Hut will not sustain a material loss on a transaction as a result.

New Hut limits its cash exposure to credit loss by placing its cash with high credit quality financial institutions. New Hut uses the digital asset custodial services of BitGo Trust Company Inc. (“BitGo”), NYDIG Trust Company LLC (“NYDIG”), and Coinbase, Inc. (“Coinbase”). New Hut does not self-custody its Bitcoin.

Interest Rate Risk

Interest rate risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate because of changes in market interest rates. New Hut’s exposure to interest rate risk relates to its ability to earn interest income on cash balances denominated in foreign currency at variable rates. Changes in short term interest rates will not have a significant effect on the fair value of New Hut’s cash account.

In addition, while the interest rates on the majority New Hut’s loans are fixed in nature and have limited exposure to changes in interest rates, the King Mountain JV Senior Note maintains a variable interest rate, which includes a maximum interest rate of 15.25%. As a result, changes in the market interest rate could have an effect on New Hut’s operations over certain periods. For more information regarding the King Mountain JV Senior Note, see Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Updates—King Mountain JV.”

Liquidity Risk

Liquidity risk is the risk that New Hut will not be able to meet its financial obligations as they fall due. New Hut currently settles its financial obligations out of cash and digital assets. New Hut has a planning and budgeting process to help determine the funds required to support New Hut’s normal spending requirements on an ongoing basis and its expansionary plans.

New Hut has an uncommitted US$50.0 million open term revolving credit facility with Galaxy Digital LLC (“Galaxy”) which, upon posting digital asset collateral, New Hut may draw on as an additional source of liquidity. As of September 30, 2023, the facility has an outstanding balance of $nil and no collateral has been posted in connection with the facility.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of New Hut’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and regulations promulgated thereunder) as of September 30, 2023. Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the SEC. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate, to allow for timely decisions regarding required disclosure. Based on that evaluation, management concluded that, as of September 30, 2023, New Hut’s disclosure controls and procedures were not effective due to the material weaknesses discussed below.

In connection with the preparation of USBTC’s consolidated financial statements as of June 30, 2022 and for the fiscal year ended June 30, 2022, USBTC’s management and its independent registered public accounting firm identified material weaknesses in internal controls over accounting for revenue related transactions, accounting for income taxes, accounting for equity method investments and accounting for complex transactions. USBTC has taken steps, and New Hut’s continues to take steps, intended to remediate the material weaknesses, including:

• Expanding the accounting and finance functions by hiring additional employees within the accounting and finance departments of New Hut;
• Engage third-party firms to assist USBTC in its income tax preparation and equity accounting processes, and its accounting for complex revenue and other transactions;
• Implementing additional controls relating to revenue recognition and impairment process on a go forward basis; and
• Implementing an oversight process where third-party firms are managed by senior team members and reliance on any third-party reports is reviewed and approved by authorized personnel at New Hut.

New Hut expects the steps identified above intended to remediate the material weaknesses to be completed by December 31, 2023.

Changes in Internal Control Over Financial Reporting

Other than as described above, there has been no change in internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), during the three months ended September 30, 2023 that has materially affected, or is reasonably likely to materially affect, New Hut’s internal control over financial reporting.

Factors that could cause New Hut’s actual results to differ materially from those results in this Quarterly Report are any of the risks applicable to New Hut, USBTC and Hut 8 described in the sections titled “Risk Factors” either contained in or incorporated by reference into the Prospectus. Any of these factors could result in a significant or material adverse effect on New Hut’s results of operations or financial condition. Additional risk factors not presently known to us or that we currently deem immaterial may also impair our business or results of operations. As of the date of this Quarterly Report, there have been no material changes to the risk factors applicable to New Hut, USBTC and Hut 8 previously disclosed in the Prospectus. We may, however, disclose changes to such factors or disclose additional factors from time to time in our future filings with the SEC.