A TLDR of Chia Network Inc.’s Financial Statements, with an opinion

Recently, Chia Network Inc.’s (CNI) Confidential Draft S-1 Registration Statement was made public. When I caught wind of it, I was quite interested in the company’s consolidated financial statements and my hope is that you find this informative and provides you with a new or different perspective to help you come to your own conclusion about CNI’s financial position.

To lightly qualify myself, I am an accountant by trade and have just under 8 years of experience preparing and presenting financial statements with the goal of helping businesses understand their financial story.

Before jumping into these, these financials are dated March 31st, 2024 meaning they are a year old. As such, it is more than likely that the financial position CNI is in today is different than reflected in the S-1.

Consolidated Balance Sheet

The basic premise of a “Balance” Sheet, as stated in the name, is that it all balances! This financial statement is just a simple math equation:

Assets - Liabilities - Mezzanine Equity = Stockholders Equity/(deficit)

In other words, you can think about it as all of the money and value the company has, minus the company’s outstanding payables, debt and obligations, which totals the company’s “book value” or what it is worth on paper.

Starting at the top, we have our assets sitting at $9m. This is a decline of $7m from the previous year. This decline is primarily due to the decreasing cash balance compared to the year prior. Nothing out of the ordinary here for a self classified pre-revenue “Emerging growth company”.

A notable account here is the $4.1m balance in other non-current assets. In CNI’s case, this almost entirely represents incremental costs relating to the legal, accounting and underwriting costs of their efforts towards IPO totaling $3.6m as of March 31st. These costs were capitalized as an asset due to the future value an IPO generates for CNI. This balance will eventually be offset against the net proceeds received from the IPO.

Do you notice anything missing in their assets section? What about their $250m strategic reserve (prefarm)? We do see Digital asset holdings of $9k (mainly what remains of an equity contribution from an investor that paid in BTC) but why is the strategic reserve missing?

Let’s take a look at this note on page 272/273 to the consolidated Financial Statements:

”The Company’s digital assets also include 21 million XCH held in its Strategic Reserve that was set-up when in March 2021, just after the blockchain launch, the Company pre-coded and a third-party farmer created a block pursuant to the Chia protocol, which included 21 million XCH that the Company since then owned and controlled (the “Strategic Reserve”). The costs that the Company incurred during the creation of the blockchain infrastructure itself, which led to the creation of the XCH in the Strategic Reserve, including direct labor costs, office lease expenses, costs of computer and servers, travel and other costs, were related to the overall activities of the Company and creation of the entire Chia blockchain, rather than solely to the creation of XCH to be held in the Strategic Reserve. Accordingly and pursuant to the guidance in ASC Topic 350, Intangibles, Goodwill and Other, the XCH held in the Strategic Reserve is carried as a digital asset at zero cost as indefinite-lived intangible assets. Upon disposal of any XCH held in the Strategic Reserve, the Company records a realized gain as the difference between a zero cost value and total cash proceeds received from such disposal. Net realized (gains)/losses on sale of digital assets are reflected within operating expenses and (gains)/losses in the consolidated statements of operations.”

In sum, the XCH in the strategic reserve has no value on their balance sheet and is represented at a cost basis of zero. The zero value, as CNI notes, is simply a precoded balance of the reserve that a third-party farmer agreed to by participating in consensus. The company eventually recognizes the value from the prefarm through selling XCH.

Continuing to the Liabilities, we saw a minor increase year over year with the main driver relating to an increase in accounts payable (outstanding bills to vendors). I do not find anything significant to dive deeper into here as I simply find it favorable that they have not taken on direct debt/loans to finance operations. 

However, there is a note to the financials on page 283 that is easy to miss but VERY important relating to Western Digital’s redemption of their $10m convertible note back in December 2022.

Western Digital’s redemption was detrimental to CNI’s cash position that likely shifted decision making to be more conservative. To put this into perspective, $10m represents roughly 6 months worth of operating expenses or prefarm sales.

I will echo a point made in one of “Black Swan events” in the article Chia Network’s Draft S-1: Top 10 Takeaways. In speculating, it is very possible that there was another fundraising round in the pipeline. This is important to note as part of the terms of the convertible note is if CNI had another equity financing greater than $25m, the convertible note would convert into equity shares. With the collapse of FTX, it more than likely spooked not only Western Digital, but also potential investors in participating in another raise. All this to say that the potential impact of the FTX collapse was not only a $10m cash payment to Western Digital, but also no cash received from investors that could have carried CNI to IPO without any prefarm sales. 

Mezzanine Equity is the next section. This is a little complicated but I will do my best to boil it down. Mezzanine equity brings the value of CNI down due to contingencies set forth in their Series C fundraising round. The contingencies in this case are milestones with a deadline that if not achieved could result in CNI making a cash payment to investors in return for the Series C equity, if exercised. If the contingencies are satisfied, the balance will no longer have a negative effect on their balance sheet and will be rolled into Stockholders equity in the same way a contribution would.

Series C shareholders own redeemable convertible preferred stock. Redeemable is the key point here as this raise was the only one classified as redeemable. Redeemable means that Series C holders could exercise their redemptive option to sell their shares back to CNI under certain conditions mentioned below. 

“Series C redeemable convertible preferred stock (or any shares of common stock issued upon conversion) is redeemable by the holder if the Company’s equity shares are not listed on a U.S. stock exchange prior to June 30, 2025, or Chia Network Inc. Notes to the Consolidated Financial Statements (in thousands, except digital asset tokens, per share data and share amounts) 12. Stockholders’ deficit and mezzanine equity (continued) F-23 within a two-year period after the Company’s equity shares are listed on a U.S. stock exchange and the value of the equity shares fails to exceed 65% of the XCH price times the number of XCH held by the Company on that date, for a 30-day period. As the Series C convertible preferred stockholders control the redemption, the Series C convertible preferred stock is classified as mezzanine equity”

TLDR: Series C investors can exercise their right to redeem their shares for debt if CNI:

1. Does not IPO prior to June 30th, 2025 
2. (and) maintain a market cap above the USD value of CNI’s strategic reserve holdings within two years of the IPO

With $52m on the line, I believe it is safe to assume that CNI is highly motivated to ensure that not only does the IPO occur before this deadline, but also works to ensure that CNI continues creating value in the couple of years post IPO. Before you sound the alarm bells, I hold the opinion that it would be wildly stupid for Series C stakeholders to force CNI to pay them out with an IPO right around the corner (allegedly). The notable list of investors in the Series C round are also investors in the other non-redeemable rounds and would therefore be effectively taking a big loss on their other investments due to the detrimental impact redeeming those shares would have on CNI. 

Nonetheless, pushing IPO past this date is still not an ideal place to be in and could result in Series C stakeholders gaining unwanted leverage over the company.

Now onto the last portion of our balance sheet: Stockholders Deficit sitting at $-47.8m. Ideally, the Stockholder value is not negative but as stated above, the main reason for this is due to the Mezzanine Equity balance.

As of March 31st, 2024, CNI has received $141m of investment consisting of $89m for their Series A, B, and D rounds and $52m of contingent investment from their redeemable Series C round (contingent on IPO and favorable valuation as explained earlier). $29.8m of additional paid in capital consists mostly of Stock-based compensation awarded. The $-167m Accumulated deficit represents the net cumulative loss since the company’s inception. 

Consolidated Statements of Operations

Another term for Statement of Operations is the profit and loss, or income statement. This financial statement details all revenue, direct costs of revenue, and operating expenditures. 

Starting with revenue, this is broken up into two sections: Professional services and subscription and support. $71k of professional services account for $71k and decreased year over year due to smaller customer contracts for implementation services. CNI notes in its discourse with the SEC that as of December 31st, 2023, “[professional services] revenue has consisted entirely of professional services to three customers.” Subscription and support revenue consisted of $119k. CNI Stated this amount represents services provided for “node and application hosting and support for one customer”. They also expect over time subscription and support should become a larger component of their overall revenue mix as it grows along with the number and scale of their customers’ projects.

To no surprise, revenue is pretty sparse given that they are still working on acquiring customers. The biggest addition to revenue on the horizon will likely be the launch of Permuto Capital. 

Next, we have our Cost of revenue. This is sitting at $266k and consists primarily of labor costs directly associated with the revenue generated. For the past twelve months, labor costs exceeded revenue leading to a Gross loss of $76k. It is important to note that the cost of revenue is inclusive of stock-based compensation which in this case makes up roughly 15% of total cost of revenue. This is a sizable amount that does not have an impact on their cash flow. In adjusting this amount out, their Gross loss is cut in half. 

Our next section consists of Operating expenses (OPEX) and (gains)/losses. In total, we see the total amount sitting at around $20m. This section will be most helpful in determining a rough estimate of what the company’s run rate is. Or in other words, the total costs to run the company.

What we want to look at here are R&D, Sales and Marketing, and G&A totaling $30m and adjust it to get a better picture of what the impact to OPEX cash flow is. To do so, we will need to take out roughly one third of the total cost of these three accounts as they include stock-based compensation which as stated earlier, does not affect cash flow. This leaves us with an average run rate during this time period around $1.6m per month or just under $20m per year. This figure is supported by observing their statement of cashflows used in operating activities. 

With the power of math (and hindsight), we could leverage this information to roughly predict the prefarm sales from March 31st 2024 to March 31st 2025. During this period, CNI sold almost 1 million XCH for a total of $20.7m USD valued based on the day it was marked for sale (shoutout xch.ninja) which as we know is quite close to CNI’s run rate of $20m per year. 

Based on the past 4 months of XCH marked for sale we saw average per month proceeds of about $1.6m. It is safe to say that this will continue until CNI can add revenue. My expectation is that if the launch of Permuto goes well, we will likely see substantial revenue added and therefore the sale of XCH will be minimal at the very worst. 

With regards to estimating CNI’s potential Net Income for fiscal year 2024, I would expect it to be the same or slightly worse given the efforts towards ramping up for Permuto.

Conclusion

So what is the story and takeaway here? Are we bullish or bearish on the information presented? Well, I will start by saying that the nature of financials we looked at together are a statement of fact deriving from a series of financial events. Most of you reading (or holding XCH) will know that the story thus far has been objectively bearish thus far. But I suspect it doesn’t mean that it’s over. CNI is still in the midst of writing their story and there is a clear path forward. If the stars align in favor of our bags, we could see the next couple of chapters include a successful Permuto Capital launch, significant revenue for CNI, full blocks, multi billion dollar IPO valuation, and roadsters in our garages by the end of this year.