Applied Digital Corp. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements This Quarterly Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve substantial risks and uncertainties. In some cases you can identify these statements by forward-looking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek,” “should,” “will,” and “would,” or similar words. Statements that contain these words and other statements that are forward-looking in nature should be read carefully because they discuss future expectations, contain projections of future results of operations or of financial positions or state other “forward-looking” information. Forward-looking statements involve inherent uncertainty and may ultimately prove to be incorrect or false. These statements are based on our management’s beliefs and assumptions, which are based on currently available information. These assumptions could prove inaccurate. You are cautioned not to place undue reliance on forward-looking statements. Except as otherwise may be required by law, we undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or actual operating results. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including, but not limited to: • labor and other workforce shortages and challenges; • our dependence on principal customers; • the addition or loss of significant customers or material changes to our relationships with these customers; • our ability to timely and successfully build new hosting facilities with the appropriate contractual margins and efficiencies; • our ability to continue to grow sales in our hosting business; • concentration of customers in the crypto mining industry, which customer base may decline due to price volatility and uncertainties around regulation policy of cryptoasset prices; and • equipment failures, power or other supply disruptions. You should carefully review the risks described in Item 1A of the Company’s Annual Report on Form 10-K for the year ended May 31, 2022, which was filed on August 29, 2022, as well as any other cautionary language in this Quarterly Report on Form 10-Q, as the occurrence of any of these events could have an adverse effect, which may be material, on our business, results of operations, financial condition or cash flows. Executive Overview The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes and other financial information included elsewhere in this Quarterly Report on Form 10-Q. Business Overview We design, build, and operate Next-Gen datacenters which are designed to provide massive computing power and support high-compute applications. Our first facility was constructed in Jamestown, North Dakota with 100 Megawatts (“MW”) of capacity. We signed an energy services agreement with a utility to power this facility. We provide energized space for customers to host computing equipment. Initially, these datacenters primarily hosted servers serving the Bitcoin network, but these facilities can also host hardware for other applications such as artificial intelligence, protein sequencing, drug discovery, machine learning and additional blockchain networks and applications. During the quarter ended February 28, 2023, we have tested hosting other high-compute applications at our first facility. On March 7, 2023, we announced the energizing of the 180 MW facility in Ellendale, ND. Once fully energized, this location will bring the Company to 280 MW of total hosting capacity across its facilities in North Dakota, all of which are contracted out to customers on multi-year terms. In addition to this facility, we have substantially completed construction on our facility in Garden City, 13 Table of Contents Texas. We have a colocation business model where our customers place hardware they own into our facilities and we provide full operational and maintenance services for a fixed fee. We typically enter into long-term fixed rate contracts with our customers. Trends and Other Factors Affecting Our Business Regulatory Environment We have a material concentration of customers in the crypto mining industry. Our customers’ businesses are subject to extensive laws, rules, regulations, policies and legal and regulatory guidance, including those governing securities, commodities, cryptoasset custody, exchange and transfer, data governance, data protection, cybersecurity and tax. Many of these legal and regulatory regimes were adopted prior to the advent of the Internet, mobile technologies, cryptoassets and related technologies. As a result, they do not contemplate or address unique issues associated with the crypto economy, are subject to significant uncertainty, and vary widely across U.S. federal, state and local and international jurisdictions. These legal and regulatory regimes, including the laws, rules and regulations thereunder, evolve frequently and may be modified, interpreted and applied in an inconsistent manner from one jurisdiction to another, and may conflict with one another. Moreover, the complexity and evolving nature of our business and the significant uncertainty surrounding the regulation of the crypto economy requires us to exercise our judgement as to whether certain laws, rules and regulations apply to us or our customers, and it is possible that governmental bodies and regulators may disagree with our or our customers’ conclusions. To the extent we or our customers have not complied with such laws, rules and regulations, we could be subject to significant fines and other regulatory consequences, which could adversely affect our business, prospects or operations. As cryptoassets have grown in popularity and in market size, the Federal Reserve Board, U.S. Congress and certain U.S. agencies (e.g., the Commodity Futures Trading Commission, the SEC, the Financial Crimes Enforcement Network and the Federal Bureau of Investigation) have begun to examine the operations of cryptoasset networks, cryptoasset users and cryptoasset exchange markets. Other countries around the world are likewise reviewing and, in some cases, increasing regulation of the cryptoasset industry. For instance, on September 24, 2021, China imposed a ban on all crypto transactions and mining. Ongoing and future regulatory actions could effectively prevent our customers’ mining operations and our ongoing or planned co-hosting operations, limiting or preventing future revenue generation by us or rendering our operations and crypto mining equipment obsolete. Such actions could severely impact our ability to continue to operate and our ability to continue as a going concern or to pursue our strategy at all, which would have a material adverse effect on our business, prospects or operations. Critical Accounting Policies and Estimates Our unaudited condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our unaudited condensed consolidated financial statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material. Our significant accounting policies are discussed in Note 3 – Basis of Presentation and Significant Accounting Policies, of the Notes to Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 2022 filed with the SEC on August 29, 2022. Hosting Operation Highlights Applied Digital’s first facility is in Jamestown, North Dakota with capacity of 100 MW. The entire 100 MW of capacity has been fully contracted on multi-year contracts with our customers, providing revenue visibility for 14 Table of Contents the Company. Additionally, the facility is powered through a five-year energy services agreement with a local utility. The facility began energizing in late January 2022 and has over 90 MW online as of February 28, 2023. As previously reported in a Current Report on Form 8-K filed by the Company on July 18, 2022, there was an unexpected equipment failure at the substation powering the facility, resulting in a partial outage of approximately 50%. The power provider completed the required repairs in mid-August, fully restoring power capacity to Jamestown ahead of the schedule for early September. The Jamestown facility was not damaged and remains fully operational and capable of hosting the entire 100 MW of capacity. There have been no reductions or interruptions in service since that time and February 28, 2023. On July 12, 2022, the Company entered into a five-year hosting contract with Marathon Digital Holdings, Inc. ("Marathon") for 270 MW of mining capacity. As a result of this arrangement, the Company will supply Marathon with 90 MW of hosting capacity at its facility in Texas and 180 MW of hosting capacity at its second facility in North Dakota. Marathon has subsequently added 39.6 MW of additional capacity at the Company’s Jamestown, North Dakota facility. Discontinued Operations During the fourth quarter of our last fiscal year, the Company ceased all crypto mining operations and completed the sale of all crypto mining equipment. The results of the crypto mining operations are accounted for as discontinued operations in our unaudited condensed consolidated financial statements. Expansion Opportunities On November 24, 2021, we entered into a letter of intent to develop a facility in Texas using 200 MW of wind power. On April 13, 2022, the Company entered into a 99-year ground lease in Garden City, Texas, with the intent to build our second datacenter facility on this site. On April 25, 2022 the Company began construction on this site. This facility is collocated with a wind farm and upon completion is expected to provide 200 MW of power to hosting customers. The facility is substantially complete and the 200 MW capacity is fully contracted with customers. On August 8, 2022, the Company completed the purchase of 40 acres of land in Ellendale, North Dakota, for a total cost of $1 million. The Company took possession of the land on August 15, 2022, built a hosting facility, and began energizing the site on March 4, 2023. Once fully energized, this location will bring the Company to 280 MW of total hosting capacity across its facilities in North Dakota, all of which are contracted out to customers on multi-year terms. As our hosting operations expand, we believe our business structure may become conducive to a real estate investment trust (“REIT”) structure, comparable to Digital Realty Trust (NYSE: DLR) and Equinix, Inc. (NASDAQ: EQIX), each of which is a traditional datacenter operator, and Innovative Industrial Properties, Inc. (NYSE: IIPR), a specialty REIT that similarly services a new growth industry. We have begun to investigate the possibility, costs and benefits of converting to a REIT structure. On October 13, 2022, the Company entered into a joint venture agreement with Foundry Technologies, Inc. (“Foundry”) to form SAI Computing, LLC (“SAI”). SAI will provide artificial intelligence and machine learning application customers with access to machines and a hosting environment. The Company is currently expanding capacity at the Jamestown, North Dakota datacenter facility to provide access to SAI and its customers. The Company has an 98% ownership interest in SAI and consolidates the entity. On December 14, 2022, the Company began construction of its latest specialized processing center, a 5 MW facility next to the Company’s currently operating 100-MW hosting facility in Jamestown, North Dakota. This separate and unique building, designed and purpose-built for Graphics Processing Units (“GPUs”), will sit separate from the Company’s current buildings and plans to host more traditional high performance computing (“HPC”) applications, such as natural language processing, machine learning, and additional HPC developments. 15 Table of Contents Changes to Equity On April 12, 2022, the Company effected a one-for-six (1:6) reverse split (the “Reverse Stock Split”) of shares of the Company’s common stock, par value $0.001 per share (the “Common Stock”). All references to Common Stock, options to purchase Common Stock, restricted stock units, share data, per share data and related information contained in the unaudited condensed consolidated financial statements have been retrospectively adjusted to reflect the effect of the Reverse Stock Split for all periods presented. No fractional shares of the Company’s Common Stock were issued in connection with the Reverse Stock Split. Any fractional share resulting from the Reverse Stock Split was rounded down to the nearest whole share and the affected holder received cash in lieu of such fraction share. On January 14, 2022, the Company granted restricted stock awards to directors and officers and restricted stock units to certain consultants. Each of these awards and units contained a vesting condition of an effective registration statement covering the resale of the Common Stock underlying these awards. On October 11, 2022, the Securities and Exchange Commission declared the Company’s registration statement covering these awards to be effective. In conjunction with this registration statement being declared effective, awards for approximately 1.1 million shares of Common Stock vested. 16 Table of Contents Results of Operations Comparative Results for the Three and Nine Months Ended February 28, 2023 and 2022: The following table sets forth key components of the results of operations (in thousands) of Applied Digital during the three and nine months ended February 28, 2023 and 2022. Three Months Ended Nine Months Ended February 28, 2023 February 28, 2022 February 28, 2023 February 28, 2022 Revenues: Hosting revenue $ 14,090 $ 1,026 $ 33,354 $ 1,026 Cost of revenues $ 10,533 $ 2,073 $ 28,438 $ 2,073 Gross profit 3,557 (1,047) 4,916 (1,047) Costs and expenses: Selling, general and administrative $ 10,514 $ 1,370 $ 42,727 $ 15,585 Total costs and expenses $ 10,514 $ 1,370 $ 42,727 $ 15,585 Operating loss $ (6,957) $ (2,417) $ (37,811) $ (16,632) Other income (expense): Interest Expense $ (384) $ — $ (1,125) $ — Gain on extinguishment of accounts payable — 80 — 405 Loss on extinguishment of debt — — (94) (1,342) Total other expense, net (384) 80 (1,219) (937) Net loss from continuing operations before income tax expenses (7,341) (2,337) (39,030) (17,569) Income tax benefit (expense) — (60) 280 (274) Net loss from continuing operations (7,341) (2,397) (38,750) (17,843) Net loss from discontinued operations, net of income taxes — (4,048) — (2,870) Net loss including noncontrolling interests (7,341) (6,445) (38,750) (20,713) Net loss attributable to noncontrolling interest (316) — (577) — Net loss attributable to Applied Digital Corporation $ (7,025) $ (6,445) $ (38,173) $ (20,713) Basic and diluted net (loss) gain per share: Continuing Operations $ (0.08) $ (0.04) $ (0.41) $ (0.35) Discontinued Operations $ — $ (0.08) $ — $ (0.06) Basic and diluted net loss per share $ (0.08) $ (0.12) $ (0.41) $ (0.41) Basic and diluted weighted average number of shares outstanding 94,119,944 53,396,920 93,545,687 50,546,048 Adjusted Amounts (a) Adjusted Operating Loss from Continuing Operations (1,017) (2,064) (7,613) (2,289) Adjusted Operating Margin from Continuing Operations (7) % (201) % (23) % (223) % Adjusted Net Loss from Continuing Operations (1,401) (2,044) (8,552) (3,500) Other Financial Data (a) EBITDA (5,030) (2,092) (33,274) (17,324) as a percentage of revenues (36) % (204) % (100) % (1688) % Adjusted EBITDA 910 (1,739) (3,076) (2,981) as a percentage of revenues 6 % (169) % (9) % (291) % Adjusted Gross Profit 4,435 (987) 7,611 (987) as a percentage of revenues 31 % (96) % 23 % (96) % (a) Adjusted Amounts and Other Financial Data are non-GAAP performance measures. A reconciliation of reported amounts to adjusted amounts can be found in the "Non-GAAP Measures and Reconciliation" section of the MD&A. 17 Table of Contents Commentary on Results of Operations Comparative Results for the three months Ended February 28, 2023 compared to the three months ended February 28, 2022 Revenues Hosting revenues increased by $13.1 million, or 1273%, from $1.0 million for the three months ended February 28, 2022 to $14.1 million for the three months ended February 28, 2023. The increase in hosting revenues was driven by a full three months of operation at our first hosting facility in Jamestown, North Dakota. Cost of Revenues Cost of revenues increased by $8.4 million, or 407%, from $2.1 million for the three months ended February 28, 2022 to $10.5 million for the three months ended February 28, 2023. The increase in cost of revenues was primarily driven by driven by a full three months of operation at our first hosting facility in Jamestown, North Dakota. The primary drivers of the change to cost of revenues for the three months ended February 28, 2023 were: • approximately $0.8 million increase in depreciation and amortization expense directly attributable to the property and equipment at the Jamestown, North Dakota hosting facility; • approximately $6.7 million increase in energy costs used to generate our hosting revenues; and • approximately $0.9 million increase in personnel expenses for employees directly working at the Jamestown, North Dakota hosting facility. Operating Expenses Selling, general and administrative expenses increased by $9.3 million, or 782%, from $1.2 million for the three months ended February 28, 2022 to $10.5 million for the three months ended February 28, 2023. The primary drivers of the change to selling, general and administrative expense for the three months ended February 28, 2023 were: • approximately $0.8 million increase in employee salaries and benefits expense not directly attributable to revenues; • approximately $0.3 million increase in professional service expenses incurred to support the growth of the business; • approximately $4.5 million increase in stock-based compensation expense; • approximately $1.0 million increase in depreciation and amortization expense not directly attributable to the Jamestown, North Dakota hosting facility; and • approximately $2.7 million increase in other selling, general, and administrative expenses such as insurance premiums and computer and software expenses, which is directly related to the growth of the Company. Other Expense Interest expense increased $0.4 million, or 100% , from zero for the three months ended February 28, 2022 to $0.4 million for the three months ended February 28, 2023. The increase was driven by the increase in finance leases and change in the Company’s debt obligations between periods. Loss on extinguishment of debt for the three months ended February 28, 2022 and for the three months ended February 28, 2023 was zero for both periods. Income tax benefit 18 Table of Contents The income tax benefit decreased $0.1 million or 100% from a $0.1 million expense for the three months ended February 28, 2022 to a zero for the three months ended February 28, 2023. This change was driven by a change in valuation allowance for the three months ended February 28, 2023 compared to the three months ended February 28, 2022. Loss from Discontinued Operations Loss from discontinued operations decreased $4.0 million, or 100%, from $4.0 million for the three months ended February 28, 2022 to zero for the three months ended February 28, 2023. The change was due to the fact that the Company no longer generates revenues from mining operations. Commentary on Results of Operations Comparative Results for the nine months Ended February 28, 2023 compared to the nine months ended February 28, 2022 Revenues Hosting revenues increased by $32.3 million, or 3150%, from $1.0 million for the nine months ended February 28, 2022 to $33.4 million for the nine months ended February 28, 2023. The increase in hosting revenues was driven by a full nine months of operations at our first hosting facility in Jamestown, North Dakota. Cost of Revenues Cost of revenues increased by $26.3 million, or 1270%, from $2.1 million for the nine months ended February 28, 2022 to $28.4 million for the nine months ended February 28, 2023. The increase in cost of revenues was driven by a full nine months of operations at our first hosting facility in Jamestown, North Dakota. The primary drivers of the change to cost of revenues for the nine months ended February 28, 2023 were: • approximately $2.5 million increase in depreciation and amortization expense attributable to the property and equipment at the Jamestown, North Dakota hosting facility; • approximately $21.9 million increase in energy costs used to generate the hosting revenues; and • approximately $1.9 million increase in personnel expenses for employees directly working at the Jamestown, North Dakota hosting facility. Operating Expenses Selling, general and administrative expenses increased by $27.1 million, or 174%, from $15.6 million for the nine months ended February 28, 2022 to $42.7 million for the nine months ended February 28, 2023. The primary drivers of the change to selling, general and administrative expense for the nine months ended February 28, 2023 were: • approximately $2.9 million increase in employee salaries and benefits expense not directly attributable to revenues; • approximately $2.4 million increase in professional service expenses incurred to support the growth of the business; • approximately $14.5 million increase in of stock-based compensation expense; • approximately $1.9 million increase in depreciation and amortization expense not directly attributable to the Jamestown, North Dakota hosting facility; and 19 Table of Contents • approximately $5.4 million increase in other selling, general, and administrative expenses such as insurance premiums and computer and software expenses, which is directly related to the growth of the Company. Other Expense Interest expense increased $1.1 million, or 100% , from zero for the nine months ended February 28, 2022 to $1.1 million for the nine months ended February 28, 2023. The change is driven by the increase in finance leases and change in the Company’s debt obligations between periods. Loss on extinguishment of debt decreased $1.2 million, or 93%, from $1.3 million for the nine months ended February 28, 2022 to $0.1 million for the nine months ended February 28, 2023. This decrease was driven by the extinguishment of our related party notes payable by conversion to common stock during the nine months ended February 28, 2022, compared to a smaller extinguishment of term debt that was recognized in the nine months ended February 28, 2023. Income tax benefit (expense) Income tax benefit increased $0.6 million or 202% from a $0.3 million expense for the nine months ended February 28, 2022 to approximately $0.3 million benefit for the nine months ended February 28, 2023. This change was driven by a change in valuation allowance for the nine months ended February 28, 2023 compared to the nine months ended February 28, 2022. Loss from Discontinued Operations Loss from discontinued operations decreased $2.9 million, or 100%, from $2.9 million for the nine months ended February 28, 2022 to zero for the nine months ended February 28, 2023. The change was due to the fact that the Company no longer generates revenues from mining operations. Non-GAAP Measures Adjusted Operating Loss and Adjusted Net Loss “Adjusted Operating Loss” and “Adjusted Net Loss” are non-GAAP measures that represents operating loss and net loss, respectively, from continuing operations excluding stock-based compensation and nonrecurring expenses. We believe these are useful metrics as they provide additional information regarding factors and trends affecting our business and provide perspective on results absent one-time or significant non-cash items. However, Applied Digital’s presentation of these measures should not be construed as an inference that its future results will be unaffected by unusual or non-recurring items. Applied Digital’s computation of Adjusted Operating Loss and Adjusted Net Loss may not be comparable to other similarly titled measures computed by other companies, because all companies may not calculate Adjusted Operating Loss and Adjusted Net Loss in the same fashion. Because of these limitations, Adjusted Operating Loss and Adjusted Net Loss should not be considered in isolation or as a substitute for performance measures calculated in accordance with GAAP. Applied Digital compensates for these limitations by relying primarily on its GAAP results and using Adjusted Operating Loss and Adjusted Net Loss on a supplemental basis. You should review the reconciliation of operating loss to Adjusted Operating Loss and net loss to Adjusted Net Loss above and not rely on any single financial measure to evaluate Applied Digital’s business. EBITDA and Adjusted EBITDA “EBITDA” is defined as earnings before interest, taxes, and depreciation and amortization. “Adjusted EBITDA” is defined as EBITDA adjusted for stock-based compensation, gain on extinguishment of accounts payable, loss on extinguishment of debt, and one-time professional service costs not directly related to the Company’s offering and therefore not deferred under the guidance in ASC 340 and SAB Topic 5A. These costs have been adjusted as they are not indicative of business operations. Adjusted EBITDA is intended as a 20 Table of Contents supplemental measure of Applied Digital’s performance that is neither required by, nor presented in accordance with, GAAP. Applied Digital believes that the use of EBITDA and Adjusted EBITDA provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing its financial measures with those of comparable companies, which may present similar non-GAAP financial measures to investors. We also believe EBITDA and Adjusted EBITDA are useful metrics to investors because they provide additional information regarding factors and trends affecting our business, which are used in the business planning process to understand expected operating performance, to evaluate results against those expectations, and because of their importance as measures of underlying operating performance, as the primary compensation performance measure under certain programs and plans. However, you should be aware that when evaluating EBITDA and Adjusted EBITDA, Applied Digital may incur future expenses similar to those excluded when calculating these measures. In addition, Applied Digital’s presentation of these measures should not be construed as an inference that its future results will be unaffected by unusual or non-recurring items. Applied Digital’s computation of Adjusted EBITDA may not be comparable to other similarly titled measures computed by other companies, because all companies may not calculate Adjusted EBITDA in the same fashion. Because of these limitations, EBITDA and Adjusted EBITDA should not be considered in isolation or as a substitute for performance measures calculated in accordance with GAAP. Applied Digital compensates for these limitations by relying primarily on its GAAP results and using EBITDA and Adjusted EBITDA on a supplemental basis. You should review the reconciliation of net loss to EBITDA and Adjusted EBITDA above and not rely on any single financial measure to evaluate Applied Digital’s business. Adjusted Gross Profit “Adjusted Gross Profit” is a non-GAAP measure that represents gross profit adjusted for depreciation expense within cost of revenues. We believe this is a useful metric as it provides additional information regarding gross profit aside from significant non-cash expense in depreciation. However, Applied Digital’s presentation of this measure should not be construed as an inference that its future results will be unaffected by other factors within cost of revenues. Applied Digital’s computation of Adjusted Gross Profit may not be comparable to other similarly titled measures computed by other companies, because all companies may not calculate Adjusted Gross Profit in the same fashion. Because of these limitations, Adjusted Gross Profit should not be considered in isolation or as a substitute for performance measures calculated in accordance with GAAP. Applied Digital compensates for these limitations by relying primarily on its GAAP results and using Adjusted Gross Profit on a supplemental basis. You should review the reconciliation of gross profit to Adjusted Gross Profit above and not rely on any single financial measure to evaluate Applied Digital’s business. 21 Table of Contents Reconciliation of GAAP to Non-GAAP Measures Three Months Ended Nine Months Ended $ in thousands February 28, 2023 February 28, 2022 February 28, 2023 February 28, 2022 Adjusted operating loss Operating Loss from Continuing Operations (GAAP) $ (6,957) $ (2,417) $ (37,811) $ (16,632) Add: Stock-based compensation 4,481 — 26,879 12,337 Add: Gain on Extinguishment of Accounts Payable — (80) — (405) Add: Loss on Extinguishment of Debt — — 94 1,342 Add: Non-recurring professional service costs 365 433 1,437 1,069 Add: One-time electricity charges — — 114 — Add: Other non-recurring expenses 1,094 — 1,675 — Adjusted Operating Loss from Continuing Operations (Non-GAAP) $ (1,017) $ (2,064) $ (7,613) $ (2,289) Adjusted operating margin from Continuing Operations (7.2) % (201.2) % (22.8) % (223.1) % Adjusted net income (loss) Net Loss from Continuing Operations (GAAP) $ (7,341) $ (2,397) $ (38,750) $ (17,843) Add: Stock-based compensation 4,481 — 26,879 12,337 Add: Gain on Extinguishment of Accounts Payable — (80) — (405) Add: Loss on Extinguishment of Debt — — 94 1,342 Add: Non-recurring professional service costs 365 433 1,437 1,069 Add: One-time electricity charges — — 114 — Add: Other non-recurring expenses 1,094 — 1,675 — Adjusted net loss from Continuing Operations (Non-GAAP) $ (1,401) $ (2,044) $ (8,552) $ (3,500) EBITDA and Adjusted EBITDA Net Loss from Continuing Operations (GAAP) $ (7,341) $ (2,397) $ (38,750) $ (17,843) Add: Interest Expense 384 — 1,125 — Add: Income Tax Benefit (Expense) — 60 (280) 274 Add: Depreciation and Amortization 1,927 245 4,631 245 EBITDA (Non-GAAP) $ (5,030) $ (2,092) $ (33,274) $ (17,324) Add: Stock-based compensation 4,481 — 26,879 12,337 Add: Gain on Extinguishment of Accounts Payable — (80) — (405) Add: Loss on Extinguishment of Debt — — 94 1,342 Add: Non-recurring professional service costs 365 433 1,437 1,069 Add: One-time electricity charges — — 114 — Add: Other non-recurring expenses 1,094 — 1,675 — Adjusted EBITDA (Non-GAAP) $ 910 $ (1,739) $ (3,076) $ (2,981) Adjusted Gross Profit Gross profit (GAAP) $ 3,557 $ (1,047) $ 4,916 $ (1,047) Add: Depreciation and amortization in cost of revenues 878 60 2,581 60 Add: One-time electricity charges — — 114 — Adjusted Gross Profit (Non-GAAP) $ 4,435 $ (987) $ 7,611 $ (987) Sources of Liquidity We have primarily generated cash in the last 12 months from the proceeds of our term loans, proceeds from our initial public offering, and the receipt of contractual deposits and revenue prepayments from hosting customers. On April 18, 2022, we received approximately $36 million in net proceeds from the issuance of 8 million shares of Common Stock in conjunction with the closing of our initial public offering. On July 25, 2022, the Company entered into the Starion Loan Agreement. The Starion Loan Agreement provides for the Starion Term Loan. A portion of the proceeds were used to pay down the Vantage term loan that was entered into on March 11, 2022. 22 Table of Contents The remaining proceeds of the term loan will be used for working capital needs for the operation of Phase I of the hosting facility in Jamestown, North Dakota. On November 7, 2022, the Company entered into the Vantage Garden City Loan Agreement. As of February 28, 2023, an aggregate amount of $10.3 million has been advanced under the Vantage Garden City Loan Agreement. The proceeds of the Vantage Garden City Loan will be used for the costs and expenses of a building at the Garden City Facility. See Note 7 - Debt to the unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for more information on the Starion Term Loan and Vantage Garden City Loan. On February 16, 2023, the Company entered into a Starion Ellendale Loan Agreement with Starion Bank. This agreement provides for a term loan in the principal amount of $20,000,000 with a maturity date of February 3, 2028. The loan provides for an interest rate of 7.48% per annum. The proceeds of the loan will be used to fund expansion on the Ellendale Facility. On March 30, 2023, the Company received funding for the Starion Ellendale Loan. The funding, net of issuance fees, totaled $19.8 million. During the three and nine months ended February 28, 2023, we received $32.3 million and $77.0 million, respectively, in payments for future hosting services. During the fiscal year ended May 31, 2022, we generated revenue from crypto mining and co-hosting, but we have incurred net losses from operations. During the three and nine months ended February 28, 2023, we have generated revenue from co-hosting, but have incurred net losses from operations. As of February 28, 2023 and May 31, 2022, we had cash of $22.9 million and $46.3 million, respectively, and an accumulated deficit of $94.2 million and $56.1 million, respectively. Funding Requirements We have experienced net losses through the periods ended February 28, 2023. Our transition to profitability is dependent on the successful operation of our co-hosting facilities. We believe that amounts we received from proceeds from our term loans, proceeds from our initial public offering, and revenue payments we have begun to achieve in our co-hosting operations since our first co-hosting facility was brought online in February 2022, after planned expenditures with respect to the items described in the section titled “ Expansion Opportunities” above, will be sufficient to meet our working capital needs for at least the next 12 months and all of the Company’s known requirements and plans for cash. We have based our estimates as to how long we expect we will be able to fund our operations on assumptions that may prove to be wrong, and we could use our available capital resources sooner than we currently expect, in which case, we would be required to obtain additional financing sooner than currently projected, which may not be available to us on acceptable terms, or at all. Our failure to raise capital as and when needed would have a negative impact on our financial condition and our ability to pursue our business strategy. We expect that our general and administrative expenses and our operating expenditures will continue to increase as we continue to expand our operations and as we bear the costs of being a public company. We believe that the significant investments in property and equipment will begin to decrease during calendar 2023 as we complete construction of additional capacity. We also expect that our revenues will increase as we continue to bring online additional capacity at our Jamestown, North Dakota, Garden City, Texas, and Ellendale, North Dakota locations. 23 Table of Contents Summary of Cash Flows The following table provides information about Applied Digital’s net cash flow (in thousands) for the nine months ended February 28, 2023. Nine Months Ended $ in thousands February 28, 2023 February 28, 2022 Net cash provided by operating activities $ 54,144 $ 4,228 Net cash used in investing activities (96,314) (35,588) Net cash provided by financing activities 18,792 31,571 Net change in cash and cash equivalents (23,378) $ 211 Cash and cash equivalents at beginning of year 46,299 $ 11,750 Cash and cash equivalents at end of period $ 22,921 $ 11,961 Commentary on cash flows for the nine months Ended February 28, 2023 Operating Activities The net cash provided by operating activities of $54.1 million for the nine months ended February 28, 2023 consisted primarily of the following: • $26.9 million non-cash adjustment for stock-based compensation expense; • $26.8 million increase in customer deposits due to the Company executing new contracts during the period; and • $43.7 million increase in deferred revenue due to prepayments due to prepayments from new contracts as well as more cash being received than revenue recognized during the period. The above factors were partially offset by the $38.8 million loss from continuing operations Investing Activities The net cash used in investing activities of $96.3 million for the nine months ended February 28, 2023 was driven by the increase of purchases of property and equipment related to the construction of the Company’s Garden City, Texas and Ellendale, North Dakota facilities. Financing Activities The net cash provided by financing activities of $18.8 million for the nine months ended February 28, 2023 was primarily driven by: • $25.6 million in proceeds from the Starion Term Loan and the Vantage Garden City Loan; and • $4.1 million in equity contributions to 1.21 Gigawatts, a subsidiary of the Company, by noncontrolling interest. These above factors were partially offset by the extinguishment of the Vantage term loan totaling $7.1 million. 24 Table of Contents Commentary on cash flows for the nine months Ended February 28, 2022 Operating Activities The net cash provided by operating activities of $4.2 million for the nine months ended February 28, 2022 consisted primarily of: • $12.3 million non-cash expense adjustment for stock-based compensation expense; • $1.3 million non-cash adjustment for loss on the extinguishment of debt; • $4.5 million increase in accounts payable and accrued liabilities due to the timing of payments; • $2.1 million increase in customer deposits; and • $2.9 million increase in deferred revenue. These above factors were partially offset by: • $2.1 million increase to prepaid expense and other current assets due to the timing of payments; and • $17.8 million in loss from continuing operations Investing Activities The net cash used in investing activities of $35.6 million for the nine months ended February 28, 2022 consisted of: • $28.2 million in purchases of property and equipment related to the construction of the Company’s Jamestown, ND facility; and • $7.4 million in purchases of equipment related to the Company’s discontinued operations. Financing Activities The net cash provided by financing activities of $31.6 million for the nine months ended February 28, 2022 represents proceeds from the issuance of preferred stock $34.5 million, partially offset by issuance costs of $2.9 million. Item 3. Quantitative and Qualitative Disclosures About Market Risk Not Applicable