Applied Digital Corp. 10-K

Item 8. Financial Statements and Supplementary Data Consolidated Financial Statements Report of Independent Registered Public Accounting Firm (PCAOB ID # 688 ) 36 Consolidated Balance Sheets 38 Consolidated Statements of Operations 39 Consolidated Statements of Stockholders' Equity 40 Consolidated Statements of Cash Flows 41 Notes to Consolidated Financial Statements 43 See Accompanying Notes to the Consolidated Financial Statements 36 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and Board of Directors of Applied Digital Corporation Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Applied Digital Corporation (the “Company”) as of May 31, 2023 and 2022, the related consolidated statements of operations, stockholders’ equity and cash flows for each of the two years in the period ended May 31, 2023, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of May 31, 2023 and 2022, and the results of its operations and its cash flows for each of the two years in the period ended May 31, 2023, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion. Critical Audit Matters Critical audit matters are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. We determined that there are no critical audit matters. /s/ Marcum LLP Marcum LLP We have served as the Company’s auditor since 2020. New York, NY August 2, 2023 See Accompanying Notes to the Consolidated Financial Statements 37 APPLIED DIGITAL CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets (In thousands, except number of shares and par value data) May 31, 2023 May 31, 2022 ASSETS Current Assets: Cash and cash equivalents $ 28,999 $ 38,798 Accounts receivable 82 227 Prepaid expenses and other current assets 16,678 1,337 Total current assets 45,759 40,362 Property and equipment, net 195,593 64,260 Operating lease right of use asset, net 1,290 1,110 Finance lease right of use asset, net 14,303 5,298 Other Assets 7,012 8,950 TOTAL ASSETS $ 263,957 $ 119,980 LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities: Accounts payable and accrued liabilities $ 14,776 $ 13,260 Current portion of operating lease liability 320 191 Current portion of finance lease liability 5,722 813 Current portion of term loan 7,950 1,333 Customer deposits 36,370 9,524 Current deferred revenue 48,692 3,877 Sales and use tax payable 1,630 — Total current liabilities 115,460 28,998 Deferred tax liability — 540 Long-term portion of operating lease liability 1,005 936 Long-term portion of finance lease liability 8,334 4,374 Long-term portion of term loan 33,222 5,897 Long-term related party loan 35,257 — Other long-term related party liabilities 1,000 — Total liabilities 194,278 40,745 Commitments and contingencies (Note 11) Stockholders’ deficit: Common stock, $ 0.001 par value, 166,666,667 shares authorized, 100,927,358 shares issued and 95,925,630 shares outstanding at May 31, 2023, and 97,837,703 shares issued and 97,801,407 shares outstanding at May 31, 2022 101 98 Treasury stock, 5,001,728 shares at May 31, 2023 and 36,296 shares at May 31, 2022, at cost ( 62 ) ( 62 ) Additional paid in capital 160,194 128,293 Accumulated deficit ( 100,716 ) ( 56,070 ) Total stockholders’ equity attributable to Applied Digital Corporation 59,517 72,259 Noncontrolling interest 10,162 6,976 Total Stockholders' equity including noncontrolling interest 69,679 79,235 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 263,957 $ 119,980 See Accompanying Notes to the Consolidated Financial Statements 38 APPLIED DIGITAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations (In thousands, except share and per share data) Fiscal Year Ended May 31, 2023 May 31, 2022 Revenues: Hosting revenue $ 55,392 $ 8,549 Cost of revenues $ 44,388 $ 9,506 Gross profit 11,004 ( 957 ) Costs and expenses: Selling, general and administrative $ 55,059 $ 19,941 Total costs and expenses $ 55,059 $ 19,941 Operating loss $ ( 44,055 ) $ ( 20,898 ) Other income (expense): Interest Expense $ ( 1,980 ) $ ( 112 ) Gain on extinguishment of accounts payable — 406 Loss on extinguishment of debt ( 94 ) ( 1,342 ) Total other expense, net ( 2,074 ) ( 1,048 ) Net loss from continuing operations before income tax expenses ( 46,129 ) ( 21,946 ) Income tax benefit (expense) 523 ( 540 ) Net loss from continuing operations ( 45,606 ) ( 22,486 ) Net loss from discontinued operations, net of income taxes — ( 1,044 ) Net loss including noncontrolling interests ( 45,606 ) ( 23,530 ) Net loss attributable to noncontrolling interest ( 960 ) ( 10 ) Net loss attributable to Applied Digital Corporation $ ( 44,646 ) $ ( 23,520 ) Basic and diluted net loss per share: Continuing Operations $ ( 0.49 ) $ ( 0.39 ) Discontinued Operations $ — $ ( 0.02 ) Basic and diluted net loss per share $ ( 0.49 ) $ ( 0.41 ) Basic and diluted weighted average number of shares outstanding 93,976,233 57,121,096 See Accompanying Notes to the Consolidated Financial Statements 39 APPLIED DIGITAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity For the Years Ended May 31, 2023 and 2022 (In thousands, except per share data) Series C Convertible Preferred Stock Series D Convertible Preferred Stock Total Mezzanine Equity Series A Convertible Preferred Stock Series B Convertible Preferred Stock Common Stock Treasury Stock Additional Paid in Capital Accumulated Deficit Stockholders’ Equity Noncontrolling interest Total Equity Shares Amount Shares Amount Amount Shares Amount Shares Amount Shares Amount Shares Amount Balance, May 31, 2021 660,000 $ 15,135 — $ — $ 15,135 27,195 $ 3,370 17,087 $ 1,849 1,511,061 $ 2 ( 36,296 ) $ ( 62 ) $ 13,881 $ ( 21,623 ) $ ( 2,583 ) $ — $ 12,552 Extinguishment of debt — — — — — — — — — 5,083,828 5 — — 3,473 — 3,478 — $ 3,478 Issuance of dividends to preferred stock — — — — — 60,822 6,082 29,772 2,979 — — — — — ( 8,946 ) 115 — $ 115 Conversion of series A and B preferred stock — — — — — ( 88,017 ) ( 9,452 ) ( 46,859 ) ( 4,828 ) 28,765,308 29 — — 14,251 — — — $ — Service agreement stock compensation — — — — — — — — — 18,036,723 18 — — 12,319 — 12,337 — $ 12,337 Issuance of Series D preferred stock — — 1,380,000 34,500 34,500 — — — — — — — — — — — — $ 34,500 Issuance Costs of Series D preferred Stock — — — ( 2,927 ) ( 2,927 ) — — — — — — — — — — — — $ ( 2,927 ) Preferred Stock Dividends Accrued 25,633 641 53,587 1,340 1,981 — — — — — — — — — ( 1,981 ) ( 1,981 ) — $ — Conversion of Series C and D preferred stock ( 685,633 ) ( 15,776 ) ( 1,433,587 ) ( 32,913 ) ( 48,689 ) — — — — 36,440,783 36 — — 48,653 — 48,689 — $ — Initial public offering of common stock — — — — — — — — — 8,000,000 8 — — 39,992 — 40,000 — $ 40,000 Offering costs of initial public offering — — — — — — — — — — — — — ( 4,276 ) — ( 4,276 ) — $ ( 4,276 ) Contributions by noncontrolling interest — — — — — — — — — — — — — — — — 6,986 $ 6,986 Net Loss — — — — — — — — — — — — — — ( 23,520 ) ( 23,520 ) ( 10 ) $ ( 23,530 ) Balance, May 31, 2022 — — — — — — — — — 97,837,703 98 ( 36,296 ) ( 62 ) 128,293 ( 56,070 ) 72,259 6,976 79,235 Issuance of common stock - vesting of awards — — — — — — — — — 2,615,550 3 — — ( 171 ) — ( 168 ) — $ ( 168 ) Issuance of common stock - restricted stock awards — — — — — — — — — 474,105 — — — — — — — $ — Stock-based compensation — — — — — — — — — — — — — 32,072 — 32,072 — $ 32,072 Common stock forfeited — — — — — — — — — — — ( 4,965,432 ) — — — — — $ — Capital contribution to noncontrolling interest — — — — — — — — — — — — — — — — 4,146 $ 4,146 Net Loss — — — — — — — — — — — — — — ( 44,646 ) ( 44,646 ) ( 960 ) ( 45,606 ) Balance, May 31, 2023 — — — — — — — — — 100,927,358 101 ( 5,001,728 ) ( 62 ) 160,194 ( 100,716 ) 59,517 10,162 69,679 See Accompanying Notes to the Consolidated Financial Statements 40 APPLIED DIGITAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows (In thousands) Fiscal Year Ended May 31, 2023 May 31, 2022 CASH FLOW FROM OPERATING ACTIVITIES Net loss attributable to Applied Digital Corporation $ ( 44,646 ) $ ( 23,520 ) Net loss from discontinued operations, net of income taxes — ( 1,044 ) Net loss attributable to noncontrolling interest ( 960 ) ( 10 ) Net loss from continuing operations ( 45,606 ) ( 22,486 ) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and Amortization 7,267 1,120 Gain on extinguishment of accounts payable — ( 406 ) Loss on extinguishment of debt 94 1,342 Stock-Based Compensation 32,072 12,337 Lease Expense 347 328 Non-cash interest expense 410 — Changes in assets and liabilities: Accounts receivable 145 ( 227 ) Prepaid expenses and other current assets ( 766 ) ( 1,331 ) Customer deposits 26,846 9,524 Deferred revenue 44,815 3,877 Deferred Tax ( 540 ) 540 Accounts payable and accrued liabilities ( 6,265 ) 6,417 Other Assets 364 ( 1,450 ) Lease Assets and Liabilities ( 118 ) — Payments of operating leases ( 330 ) ( 310 ) Net cash provided by operating activities of continuing operations 58,735 9,275 Net cash used in operating activities of discontinued operations — ( 10,147 ) NET CASH PROVIDED BY(USED IN) OPERATING ACTIVITIES 58,735 ( 872 ) CASH FLOW FROM INVESTING ACTIVITIES Purchases of property and equipment and other assets ( 128,721 ) ( 54,974 ) Deposits on equipment ( 2,557 ) — Investments in private companies ( 810 ) — Net cash used in investing activities of continuing operations ( 132,088 ) ( 54,974 ) Net cash provided by investing activities of discontinued operations — 9,103 NET CASH USED IN INVESTING ACTIVITIES ( 132,088 ) ( 45,871 ) CASH FLOW FROM FINANCING ACTIVITIES Initial public offering of common stock — 40,000 Issuance of preferred stock — 34,500 Repayment of finance leases ( 3,353 ) ( 221 ) Preferred stock issuance costs — ( 2,927 ) Common stock issuance costs — ( 4,276 ) Term loan payoff ( 7,056 ) — Proceeds from issuance of term loan 45,650 7,324 Term Loan Issuance Costs ( 567 ) ( 94 ) Proceeds from issuance of related party term loan 36,500 — Related party term Loan Issuance Costs ( 1,548 ) — Loan Payments ( 2,977 ) — Payments of employee restricted stock tax withholdings ( 168 ) — Noncontrolling interest contributions 4,147 6,986 Net cash provided by financing activities of continuing operations 70,628 81,292 Net cash provided by financing activities of discontinued operations — — CASH FLOW PROVIDED BY FINANCING ACTIVITIES 70,628 81,292 NET (DECREASE ) INCREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH ( 2,725 ) 34,549 CASH, CASH EQUIVALENTS, AND RESTRICTED CASH, BEGINNING OF PERIOD (See Note 3) 46,299 11,750 CASH, CASH EQUIVALENTS, AND RESTRICTED CASH, END OF PERIOD (See Note 3) $ 43,574 $ 46,299 Less: cash, cash equivalents, and restricted cash of discontinued operations — — Cash, cash equivalents, and restricted cash of continuing operations $ 43,574 $ 46,299 See Accompanying Notes to the Consolidated Financial Statements 41 Consolidated Statements of Cash Flows (In thousands) Fiscal Year Ended May 31, 2023 May 31, 2022 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest Paid $ 1,570 $ 112 Income Taxes Paid $ 18 $ — SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES Non-cash dividends paid in-kind $ — $ 11,042 Operating right-of-use assets obtained by lease obligation $ 397 $ 1,288 Finance right-of-use assets obtained by lease obligation $ 12,331 $ 5,418 Fixed assets in accounts payable $ 7,399 $ 6,998 See Accompanying Notes to the Consolidated Financial Statements 42 Notes to the Consolidated Financial Statements 1. BUSINESS AND ORGANIZATION Applied Digital Corporation, f/k/a Applied Blockchain, Inc. (the “Company”) is a designer, builder and operator of next-generation digital infrastructure. The Company has three primary business streams, artificial intelligence (“AI”) cloud services, high performance computing (“HPC”) datacenter hosting, and crypto datacenter hosting. For the fiscal year ended May 31, 2023, the Company has only had operational activity in the crypto datacenter hosting business. The Company was originally incorporated in Nevada in May 2001. On November 14, 2022, the Company changed its corporate name from Applied Blockchain, Inc. to Applied Digital Corporation. 2. LIQUIDITY AND FINANCIAL CONDITION As of May 31, 2023, the Company had approximate cash and cash equivalents of $ 29.0 million and negative working capital of $ 69.7 million. Historically the Company has incurred losses and has relied on equity and debt financings to fund its operations. Based on an analysis of cash flows, current net working capital, and expected operations revenue, the Company believes its current cash on hand is sufficient to meet its operating and capital requirement for at least next twelve months from the date these financial statements were issued. 3. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation: The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (“GAAP”). The accompanying consolidated financial statements of the Company include the accounts of the Company and its wholly owned and controlled subsidiaries. Consolidated subsidiaries results are included from the date the subsidiary was formed or acquired. Noncontrolling interests in consolidated subsidiaries in the consolidated financial statements represent non-controlling stockholders' proportionate share of the operations in such subsidiaries. Intercompany investments, balances and transactions have been eliminated in the consolidated financial statements. The Company’s consolidated operating subsidiaries include the Company's wholly-owned subsidiaries, the Company's interest in Highland Digital Holdings LLC, and the Company's majority interests in Sai Foundry Computing LLC, as well as 1.21 Gigawatts LLC. Use of Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the balance sheet and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ significantly from those estimates. The most significant accounting estimates inherent in the preparation of the Company’s financial statements are: • The valuation allowance associated with the Company’s deferred tax assets. • The probability assessment associated with performance conditions in share based payment awards Cash and Cash Equivalents The Company considers all highly liquid investments with an original maturity of three months or less at the date of acquisition to be cash equivalents. Our cash equivalents in excess of federally insured limits potentially subject us to concentrations of credit risk, although we believe they are subject to minimal risk. Restricted Cash 43 The Company has restricted cash related to its letters of credit totaling $ 14.6 million. The Company is required to keep these balances in separate accounts for the duration of the letter of credit agreements, which last through the first quarter of calendar 2024 . The following tables reconciles cash and cash equivalents and restricted cash to presentation on the balance sheet as of May 31, 2023, and May 31, 2022. (in thousands) May 31, 2023 May 31, 2022 Cash and cash equivalents $ 28,999 $ 38,798 Restricted cash included in prepaid expenses and other current assets 14,575 — Restricted cash included in other assets — 7,501 Total Cash, Cash Equivalents, and Restricted Cash $ 43,574 $ 46,299 Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. The cost of maintenance and repairs is charged to operations as incurred, whereas significant improvements that extend the life of an asset are capitalized. Lease Accounting The Company determines whether an arrangement contains a lease at the inception of the arrangement. If a lease is determined to exist, the term of such lease is assessed based on the date on which the underlying asset is made available for the Company’s use by the lessor. The Company’s assessment of the lease term reflects the non-cancelable term of the lease, inclusive of any rent-free periods and/or periods covered by early-termination options which the Company is reasonably certain of not exercising, as well as periods covered by renewal options which the Company is reasonably certain of exercising. The Company also determines lease classification as either operating or finance at lease commencement, which governs the pattern of expense recognition and the presentation reflected in the consolidated statements of operations over the lease term. For leases with a term exceeding 12 months, a lease liability is recorded on the Company’s consolidated balance sheet at lease commencement reflecting the present value of its fixed minimum payment obligations over the lease term. A corresponding right-of-use (“ROU”) asset equal to the initial lease liability is also recorded, adjusted for any prepaid rent and/or initial direct costs incurred in connection with execution of the lease and reduced by any lease incentives received. For purposes of measuring the present value of its fixed payment obligations for a given lease, the Company uses its incremental borrowing rate, determined based on information available at lease commencement, as rates implicit in its leasing arrangements are typically not readily determinable. The Company’s incremental borrowing rate reflects the rate it would pay to borrow and incorporates the term and economic environment of the associated lease. For the Company’s operating leases, fixed lease payments are recognized as lease expense on a straight-line basis over the lease term. For leases with an initial term of 12 months or less, any fixed lease payments are recognized on a straight-line basis over the lease term and are not recognized on the Company’s consolidated balance sheet as an accounting policy election. Leases qualifying for the short-term lease exception were insignificant. Variable lease costs are recognized as incurred. Assets and liabilities related to operating leases are presented in separate captions from those relating to finance leases. For the Company's finance leases, expense is split between amortization and interest expense. Variable lease costs are recognized as incurred. Assets and liabilities related to finance leases are presented in separate captions from those relating to operating leases. Revenue Recognition The Company recognizes revenue in accordance with ASC 606, Revenue from Contracts with Customers ("ASC 606"). The Company provides energized space to customers who locate their hardware within the Company’s co- 44 hosting facility. All hosting performance obligations are achieved simultaneously by providing the hosting environment for the customers’ operations. Hosting revenue is recorded monthly in fixed amounts, net of credits for non-performance, based on the terms of the hosting agreements. Any ancillary revenue for maintenance or installation services is at a point in time when the Customer has received the full service. As these services support the hosting operation as a whole, all revenue is within the hosting revenue caption. Customer contracts include advance payment terms. Advanced payments are recorded as deferred revenue until the related service is provided. Stock-based compensation Restricted Stock Awards The Company has granted restricted stock awards to officers and directors. Each of the awards vests upon the completion of service conditions for specified times and a performance condition for the occurrence of an effective registration statement covering the resale of the shares of Common Stock comprising the stock award with the Securities and Exchange Commission (the “SEC”). The Company has recognized the cost of the restricted stock-based on the grant date fair value of the awards ratably over the related vesting terms as it is probable that the performance condition for the reserved underlying shares will be met. Restricted Stock Units The Company has granted restricted stock units (“RSUs”) to certain consultants and employees, in all cases as compensatory grants for services rendered to the Company, which contain performance conditions that affect vesting. The Company has recognized the cost of these RSUs based on the grant date fair value ratably for each tranche, as applicable, based on the probability that the performance conditions will be achieved over the related vesting terms. In addition, the Company has granted RSUs to employees as compensation for employment services. The average term of the RSUs granted under the employee incentive plan is three years from grant date, and the only conditions for vesting are service conditions. The Company has recognized the expense of the RSUs based on grant date fair value of the awards ratably over the service period. Income Taxes ASC Topic 740, Income Taxes, (“ASC 740”), clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The benefit of a tax position is recognized in the financial statements in the period during which based on all available evidence, management believes it is most likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim period, disclosure, and transition. Based on the Company’s evaluation, it has been concluded that there are no significant uncertain tax positions requiring recognition in the Company’s consolidated financial statements. Segment Information The Company’s chief operating decision maker, the chief executive officer, reviews discrete financial information presented on a consolidated basis for purposes of regularly making operating decisions, allocation of resources, and assessing financial performance. Accordingly, the Company has one operating and reporting segment. Recent Accounting Pronouncements The Company continually assesses any new accounting pronouncements to determine their applicability. When it is determined that a new accounting pronouncement affects the Company’s financial reporting, the Company 45 undertakes a study to determine the consequences of the change to its consolidated financial statements and assures that there are proper controls in place to ascertain that the Company’s consolidated financial statements properly reflect the change. The Company has determined that there are no recently issued pronouncements that are currently applicable to the Company. Reclassifications Within the Consolidated Financial Statements certain immaterial amounts have been reclassified to conform with current period presentation. The Company has reclassified restricted cash from cash and cash equivalents to other assets. In addition, the Company has reclassified utility deposits to other assets. These reclassifications had no impact on reported operating income or net income; cash flows from operations, investing, or financing activities; or total assets and liabilities. 4. PROPERTY AND EQUIPMENT Property and equipment consisted of the following as of May 31, 2023 and 2022: (in thousands) Estimated Useful Life May 31, 2023 May 31, 2022 Hosting Equipment Electric Generation and Transformers 15 years $ 4,655 $ 4,338 Other Equipment and Fixtures 6 years 1,685 588 Construction in Progress 106,226 18,305 Information Systems and Software 5 years 21,173 9,608 Land & Building Land 2,152 1,074 Land Improvements 15 years 1,293 1,180 Building 39 years 63,350 30,176 Total cost of property and equipment 200,534 65,269 Accumulated Depreciation ( 4,940 ) ( 1,009 ) Property and Equipment, Net $ 195,593 $ 64,260 Depreciation expense totaled $ 3.9 million and $ 1 million for the years ended May 31, 2023 and 2022, respectively. Depreciation is computed on the straight-line basis for the period assets are in service. Construction in progress represents assets received but not placed into service as of May 31, 2023. 5. REVENUE FROM CONTRACTS WITH CUSTOMERS Below is a summary of the Company’s revenue concentration by major customer for the years ended May 31, 2023 and 2022 46 Fiscal Year Ended Customer May 31, 2023 May 31, 2022 Customer A 24 % — % Customer B 20 % 13 % Customer C 19 % 41 % Customer D 14 % 16 % Customer E 12 % 15 % Customer F 11 % 15 % Total 100 % 100 % Remaining Performance Obligations As of May 31, 2023, the Company had $ 48.7 million in deferred revenue, which represents the Company’s remaining performance obligations. The Company expects to recognize all of this revenue within the next 12 months. Deferred Revenue Changes in the Company's deferred revenue balances for the years ended May 31, 2023 and 2022, respectively, are shown in the following table: (in thousands) Balance at May 31, 2021 $ — Advance billings 12,426 Revenue recognized ( 8,549 ) Other adjustments — Balance at May 31, 2022 $ 3,877 Advance billings 100,072 Revenue recognized ( 55,392 ) Other adjustments 135 Balance at May 31, 2023 $ 48,692 Customer Deposits Changes in the Company's customer deposits balances for the years ended May 31, 2023 and 2022, respectively, are shown in the following table: (in thousands) Balance at May 31, 2021 $ — Customer deposits received $ 9,524 Customer deposits refunded — Other adjustments — Balance at May 31, 2022 $ 9,524 Customer deposits received $ 26,981 Customer deposits refunded — Other adjustments $ ( 135 ) Balance at May 31, 2022 $ 36,370 47 6. RELATED PARTY TRANSACTIONS Related Party Notes Payable See discussion below in Note 7 - Debt, regarding the Company's term loan agreement with B. Riley Commercial Capital, LLC and B. Riley Securities, Inc, both wholly-owned subsidiaries of B. Riley Financial, Inc. Bryant Riley, chairman of the board and co-chief executive officer, of B. Riley Financial, Inc. (Nasdaq: RILY), directly or indirectly through subsidiaries of RILY, held in excess of 5 % of our then outstanding Common Stock beginning in April 2023. The following table illustrates the related party balances on this loan for the fiscal year ended May 31, 2023. (in thousands) Description May 31, 2023 Principal Outstanding $ 36,500 Other long-term liabilities 1,000 Accrued Interest Payable 81 Related Party Revenue The Company has revenue transactions with two related party customers: • Customer A is a subsidiary of an entity which is deemed to beneficially own over 5 % of the Company's outstanding common stock. • Customer B is 60 % owned by an individual who is deemed to beneficially own over 5 % of the Company's outstanding stock. The following tables illustrate related party revenue for fiscal years ended ended May 31, 2023 and May 31, 2022. (in thousands) Related Party Revenue for the Fiscal Year Ended Customer May 31, 2023 May 31, 2022 Customer A $ 8,007 $ 1,417 Customer B $ 6,401 $ 1,268 The following tables illustrate related party deferred revenue and deposits balances as of May 31, 2023 and May 31, 2022. (in thousands) Customer A Balances as of Caption May 31, 2023 May 31, 2022 Deferred revenue $ 1,474 $ 692 Customer Deposits $ 2,450 $ 2,059 48 (in thousands) Customer B Balances as of Caption May 31, 2023 May 31, 2022 Deferred revenue $ 50 $ 262 Customer Deposits $ 1,361 $ 1,171 Related Party Sublease Income For the fiscal years ending May 31, 2023 and May 31, 2022, the Company received sublease income from B. Riley Asset Management, which is also a wholly-owned subsidiary of B. Riley Financial, Inc. Mr. Cummins, the CEO of the Company, is also the President of B. Riley Asset Management. (in thousands) Description May 31, 2023 May 31, 2022 Sublease Income $ 84 $ 80 7. DEBT Below is a summary of the Company’s term loan balances, including current debt and deferred financing fees as of May 31, 2023 and 2022. (in thousands) May 31, 2023 May 31, 2022 Total Outstanding Loan Balances 79,441 7,324 Less: Deferred Issuance Costs ( 3,012 ) ( 94 ) Less: Current portion of Term Loan ( 7,950 ) ( 1,333 ) Less: Long-term related party loan ( 35,257 ) — Long-term portion of Term Loan $ 33,222 $ 5,897 Below is the weighted-average interest rate for the Company's term loans as of May 31, 2023 and 2022. May 31, 2023 May 31, 2022 Weighted-average interest rate 13.4 % 5.0 % Remaining Principal Payments Below is a summary of the remaining principal payments due over the life of the term loans as of May 31, 2023. (in thousands) Year Principal Payments FY24 $ 9,394 FY25 46,586 FY26 10,780 FY27 8,550 FY28 4,131 Thereafter — Total Term Loan Remaining Payments $ 79,441 49 Starion Term Loan On July 25, 2022, APLD Hosting, LLC, a wholly-owned subsidiary of the Company, entered into a loan agreement with Starion Bank and the Company as Guarantor (the “Starion Loan Agreement”). The Starion loan agreement provides for a term loan (the “Starion Term Loan”) in the principal amount of $ 15 million with a maturity date of July 25, 2027. The Starion Loan Agreement provides for an interest rate of 6.50 % per annum. The Starion Loan Agreement contains customary covenants, representations and warranties and events of default. The Company is not subject to financial covenants under the Starion Loan Agreement until May 31, 2024. At that time, the Company will be subject to a debt service coverage ratio. Deferred financing costs related to the Starion Term Loan total $ 0.1 million. The City of Jamestown, North Dakota and Stutsman County’s Economic Development Fund provides a multimillion-dollar economic development program, available to assist with expanding or relocating businesses. As part of financial packages, the Jamestown Stutsman Development Corporation (JSDC) makes direct loans, equity investments, and interest buy-downs to businesses. The Company has entered into an agreement with JDSC and Starion Bank which buys down the Company’s interest rate to 1.5 % for a period of 13 months through a loan and community bond (the “Starion Term Loan Buy-Down”). The loan totals $ 0.2 million and bears an interest rate of 2 %, and the bond totals $ 0.5 million. In connection with the Starion Loan Agreement, the Company repaid all of the outstanding balance on the March 11, 2022 loan agreement between the Company and Vantage Bank Texas. This loan agreement included a promissory note agreement for $ 7.5 million for a five year term with an interest rate of 5 % per annum. Vantage Garden City Loan On November 7, 2022, APLD – Rattlesnake Den I, LLC, a wholly-owned indirect subsidiary of the Company, entered into a loan agreement with Vantage Bank Texas and the Company, as guarantor, which agreement provides for a term loan in the principal amount of $ 15 million (the “Vantage Garden City Loan Agreement”). The loan pursuant to the Vantage Garden City Loan Agreement will be advanced in 16 installments, with each installment not exceeding approximately $ 0.9 million for the costs and expenses of a building at the Company’s hosting facility in Garden City, Texas (the “Garden City Facility”). The unpaid principal amount of the Garden City Facility will bear interest at a fixed rate of 6.15 % per annum, and the Company may prepay the Garden City Facility, in whole or in part, without the payment of any fee or penalty. The Garden City Facility matures April 26, 2028. The Vantage Garden City Loan Agreement contains customary representations, warranties, covenants and events of default. As of May 31, 2023, an aggregate amount of $ 10.3 million has been advanced under the Vantage Garden City Loan Agreement, with the outstanding balance totaling $ 10.1 million. Total deferred costs related to the issuance of this loan total are $ 0.2 million. Starion Ellendale Loan On February 16, 2023, APLD ELN-01 LLC, a wholly-owned subsidiary of the Company, entered into a Loan Agreement with Starion Bank and the Company as Guarantor (the “Ellendale Loan Agreement”). The Ellendale Loan Agreement provides for a term loan in the principal amount of $ 20 million with a maturity date of February 3, 2028. The Ellendale Loan Agreement contains customary covenants, representations and warranties and events of default. The Ellendale Loan Agreement provides for an interest rate of 7.48 % per annum. The proceeds of the loan under the Ellendale Loan Agreement will be used to fund expansion on the Ellendale, North Dakota hosting datacenter. Total deferred costs related to the issuance of this loan total are $ 0.2 million. As of May 31, 2023, the total balance outstanding under the Ellendale Loan Agreement was $ 19.7 million. B. Riley Loan On May 23, 2023, Sai Computing LLC, a wholly-owned subsidiary of the Company, entered into a Loan and Security Agreement (the "B. Riley Loan and Security Agreement") with B. Riley Commercial Capital, LLC and B. Riley Securities, with the Company as Guarantor. The B. Riley Loan and Security Agreement provides for a term 50 loan of up to $ 50 million in the principal with an interest rate of 9.00 % per annum (the "B. Riley Loan"). The proceeds of the B. Riley Loan will be used to provide additional liquidity to help fund the buildout of the Company’s recently announced AI cloud services platform and datacenters by the Company, and for general corporate purposes and working capital. The B. Riley Loan and Security Agreement contains initial fees of approximately $ 1.5 million that were reduced from the initial funds remitted to the Company. The B. Riley Loan and Security agreement also contains a term fee of $ 1 million that is due upon the Company's initial principal payment. Finally, the B. Riley Loan and Security agreement contains a commitment fee of 3 % on any balance outstanding as of each quarter end beginning with the calendar quarter ending September 30, 2023. As of the date of May 31, 2023, the total outstanding balance of the B. Riley Loan was $ 36.5 million. 8. INCOME TAXES The Company recorded income tax benefit of $ 0.5 million for the year ended May 31, 2023, compared to income tax expense of $ 0.5 million for the year ended May 31, 2022. The Company’s effective tax rate was 1.2 % and ( 2.4 )%, for the years ended May 31, 2023 and 2022 respectively. (in thousands) For the Fiscal Year Ended May 31, 2023 May 31, 2022 Current expense / (benefit) Federal $ — $ — Foreign — — State 18 — Total current expense $ 18 $ — Deferred expense / (benefit) Federal $ ( 540 ) $ 540 Foreign — — State — — Total deferred (benefit) expense $ ( 540 ) $ 540 Total income tax (benefit) expense $ ( 523 ) $ 540 The following table reconciles the statutory rate to our effective tax rate: May 31, 2023 May 31, 2022 Expected income tax expense (benefit) at U.S. Statutory Rate 21.0 % 21.0 % Stock-based compensation ( 6.0 ) % — % State income taxes, net of federal tax benefit — % 4.5 % Change in valuation allowance ( 13.0 ) % ( 27.0 ) % Other, net ( 0.8 ) % ( 0.9 ) % Income tax expense / (benefit) 1.2 % ( 2.4 ) % Deferred income taxes reflect the temporary differences between the amounts at which assets and liabilities are recorded for financial reporting purposes and the amounts utilized for tax purposes. The primary components of the temporary differences that gave rise to the Company's deferred tax assets and liabilities are as follows for the year ended May 31, 2023, and 2022: 51 (in thousands) May 31, 2023 May 31, 2022 Deferred Tax Assets: Net Operating Loss $ 15,137 $ 11,971 Stock-Based Compensation 3,068 — Capitalized Research and Development 897 — Lease Liability 1,875 2,080 Other 360 248 Gross Deferred Tax Assets 21,337 14,298 Less: Valuation Allowances ( 15,697 ) ( 9,346 ) Total Net Deferred Tax Asset $ 5,640 $ 4,953 Deferred Tax Liabilities: Property, Plant, and Equipment $ ( 3,712 ) $ ( 3,407 ) Right of Use Assets ( 1,929 ) ( 2,086 ) Other — — Total Net Deferred Tax Liability ( 5,640 ) ( 5,493 ) Net deferred tax assets (liabilities) $ — $ ( 540 ) The Company had $ 114.8 million and $ 83.6 million of federal and state tax net operating losses at May 31, 2023 and 2022, respectively. At May 31, 2023, $ 99.3 million is available indefinitely to offset future income. The remaining carryforward amounts expire at varying dates beginning in 2028. A valuation allowance is provided when it is more likely than not that some portion or the entire net deferred tax asset will not be realized. The Company has recorded an increase in the valuation allowance of $ 6.3 million and $ 6.2 million as of May 31, 2023 and 2022, respectively. The Company has provided a valuation allowance for the portion of the deferred tax assets that it has determined are not more likely than not to be recognized. The valuation allowance is primarily attributable to deferred tax assets for net operating losses that management believes are more likely than not to expire prior to being realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income of the appropriate character (i.e., capital or ordinary) during the period in which the temporary differences become deductible. Management considers, among other things, the scheduled reversals of deferred tax liabilities and the history of positive taxable income in evaluating the realizability of the deferred tax assets. Management believes that it is not likely that the results of future operations will generate sufficient taxable income to realize its deferred tax assets. Under the provisions of the Internal Revenue Code, certain substantial changes in the Company’s ownership, including a sale of the Company or significant changes in ownership due to sales of equity, may have limited, or may limit in the future, the amount of net operating loss carryforwards that could be used annually to offset future taxable income. The Company is subject to U.S. federal income tax. Tax years ending May 31, 2021 through May 31, 2023 are open to examination by the major taxing jurisdictions to which the Company is subject, as carryforward attributes generated in these years may still be adjusted upon examination by the Internal Revenue Service (IRS) or other authorities if they have or will be used in a future period. The Company is not currently under examination by the IRS or any other taxing jurisdictions for any tax years. 9. STOCKHOLDERS’ EQUITY (DEFICIT) Equity Plans On October 9, 2021, the Company’s board of directors approved two equity incentive plans, which the Company’s stockholders approved on January 20, 2022. The two plans consist of the 2022 Incentive Plan, previously referred to 52 in the Company’s SEC filings as the 2021 Incentive Plan (the “Incentive Plan”), which provides for grants of various equity awards to the Company’s employees and consultants, and the 2022 Non-Employee Director Stock Plan previously referred to in the Company’s SEC filings as the 2021 Non-Employee Director Stock Plan (the “Director Plan” and, together with the Incentive Plan, the “Plans”), which provides for grants of restricted stock to non-employee directors and for deferral of cash and stock compensation if such deferral provisions are activated at a future date. As of May 31, 2023, the Company had issued approximately 0.6 million shares of restricted stock awards and approximately 12.4 million of restricted stock units under the plans. Restricted Stock Awards The following is a summary of the activity and balances for unvested restricted stock awards granted for the fiscal year ended May 31, 2023: Number of Shares Weighted Average Grant Date Fair Value Per Share Outstanding as of May 31, 2022 1,366,666 $ 8.04 Granted 551,605 $ 2.19 Vested ( 1,537,316 ) $ 7.38 Forfeited — $ — Outstanding as of May 31, 2023 380,955 $ 2.22 As of May 31, 2023, total remaining expense to be recognized related to these awards was $ 0.8 million and the weighted average remaining recognition period for the unvested awards was 5 months. Restricted Stock Units The following is a summary of the activity and balances for unvested restricted stock units granted for the fiscal year ended May 31, 2023: Number of Shares Weighted Average Grant Date Fair Value Per Share Outstanding as of May 31, 2022 1,791,666 $ 8.04 Granted 12,391,207 $ 2.28 Vested ( 1,180,525 ) $ 6.41 Forfeited ( 536,413 ) $ 6.71 Outstanding as of May 31, 2023 12,465,935 $ 2.53 As of May 31, 2023, total remaining expense to be recognized related to these awards was $ 31.5 million and the weighted average remaining recognition period for the unvested awards was 24 months. Share Forfeiture On June 6, 2022, through an agreement between the Company and Xsquared Holding Limited (“Sparkpool”), Sparkpool agreed to forfeit shares of Common Stock that had been issued to it pursuant to the service agreement executed on March 19, 2021. Sparkpool had ceased providing the contracted services for the Company, and agreed to forfeit shares to compensate for future services that will not be rendered. As a result of this agreement, 4,965,432 shares of Common Stock were forfeited and returned to the Company and placed in treasury. 53 10. LEASES The Company has entered into leases for hosting equipment, office space, and land. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants. The Company presents operating and finance right of use assets and liabilities separately on the balance sheet as their own captions. The liabilities are split between current and long-term, respectively. The Company presents lease costs as follows: (in thousands) Fiscal Year Ended Lease Type Consolidated Statements of Operations Presentation May 31, 2023 May 31, 2022 Operating lease cost: Operating lease expense Selling, General and Administrative $ 347 $ 328 Short-term lease expense Selling, General and Administrative 187 126 Sublease Income Selling, General and Administrative ( 103 ) ( 159 ) Total operating lease cost $ 431 $ 295 Finance lease expense: Amortization of ROU assets related to revenue production Cost of Sales 554 85 Amortization of ROU assets not related to revenue production Depreciation and Amortization Expense 2,782 26 Interest on finance leases Interest Expense 773 50 Variable finance lease expense Selling, General and Administrative 3 — Total finance lease cost $ 4,112 $ 161 Total Lease Cost $ 4,543 $ 456 The following table represents the Company’s future minimum lease payments as of May 31, 2023: (in thousands) Year Operating Leases Finance Leases Total FY24 $ 445 $ 6,687 $ 7,132 FY25 482 5,429 5,911 FY26 495 348 844 FY27 158 188 346 FY28 — 180 180 Beyond — 87,145 87,145 Total $ 1,580 $ 99,977 $ 101,557 Present value of lease liabilities $ ( 255 ) $ ( 85,921 ) $ ( 86,176 ) Less: Current portion of lease liability $ 320 $ 5,722 $ 6,042 Long-term portion of lease liability $ 1,005 $ 8,334 $ 9,339 Supplemental cash flow and other information related to leases is as follows: 54 Fiscal Year Ended May 31, 2023 May 31, 2022 Weighted-average years remaining (in years) Finance leases 22 57 Operating leases 3 4 Weighted-average discount rate Finance leases 8 % 8 % Operating leases 11 % 13 % The Company has entered into operating leases signed but not yet commenced with total minimum payments of approximately $ 83.1 million to support the Company's AI Cloud service business. The payments are expected to be made over a total of 84 months. The Company has entered into finance leases signed but not yet commenced with total minimum payments of approximately $ 8.5 million. The payments are expected to be made over a total of 30 months. 11. COMMITMENTS AND CONTINGENCIES Commitments As of May 31, 2023, the Company has commitments related to its term loan and lease agreements , which have been disclosed in Note 7 - Debt and Note 10 - Leases , respectively. The Company also has the following commitments: Jamestown Energy Services Agreement The Company has a commitment of approximately $ 28 million related to the energy services agreement for its Jamestown, North Dakota hosting facility. The minimum term of this agreement is five years , and will remain in effect on a year-to-year basis unless terminated by either party by notice given at least 365 calendar days in advance of termination. The commitment is fully due within the next fiscal year, as the company commits to specific power consumption on an annual basis as part of the energy services agreement. Other The Company has other purchase commitments of approximately $ 10.2 million related to the buildout of its AI Cloud hosting services business and insurance premiums. These commitments are expected to be fulfilled within twelve months of May 31, 2023. The Company also has a commitment for 1,024 H100 GPUs to support its AI Cloud services business, which has been subsequently financed through an arrangement totaling approximately $ 41 million over 24 months as discussed in Note 14 - Subsequent Events . Contingencies Letter of Credit As of May 31, 2023 and May 31, 2022, the Company had letters of credit outstanding totaling $ 14.5 million and $ 7.5 million, respectively. As discussed in Note 3 - Basis of Presentation and Significant Accounting Policies , the Company is required to maintain these amounts in separate accounts, and therefore the cash is restricted. Further, the Company had no unused lines of credit as of May 31, 2023 or May 31, 2022, respectively. 55 Mediation The Company has agreed to enter into mediation, tentatively scheduled for August 18, 2023, around the allegations previously announced by the Company on June 23, 2023. The Company estimates the potential range of loss based on such allegations to be $ 0 to $ 1 million. Claims and Litigation From time to time, the Company may be involved in litigation relating to claims arising out of operations in the normal course of business. As of May 31, 2023 and 2022, there were no pending or threatened lawsuits that could reasonably be expected to have a material effect on the results of the Company’s consolidated operations. There are also no legal proceedings in which any of the Company’s management or affiliates is an adverse party or has a material interest adverse to the Company’s interest. 12. EARNINGS PER SHARE Basic net income (loss) per share (“EPS”) of Common Stock is computed by dividing the Company’s net earnings (loss) by the weighted average number of shares of Common Stock outstanding during the period. Diluted EPS reflects the potential dilution that could occur if the securities or other contracts to issue Common Stock were exercised or converted into Common Stock or resulted in the issuance of Common Stock that then shared in the earnings of the entity. Potentially dilutive securities are excluded from the computation of diluted net loss per share as their inclusion would be anti-dilutive. As of May 31, 2023, the Company had approximately 12.8 million shares of granted but unvested restricted stock and restricted stock units that would have a potentially dilutive effect on earnings per share. Earnings per share for the year ended May 31, 2023 and 2022 are shown in the following table: (in thousands, except for share and per share data) Fiscal Year Ended May 31, 2023 May 31, 2022 Net loss from continuing operations $ ( 45,606 ) $ ( 22,486 ) Net loss from discontinued operations, net of income taxes — ( 1,044 ) Net Loss including noncontrolling interests ( 45,606 ) ( 23,530 ) Net Loss attributable to noncontrolling interest ( 960 ) ( 10 ) Net loss attributable to Applied Digital Corporation $ ( 44,646 ) $ ( 23,520 ) Continuing operations $ ( 0.49 ) $ ( 0.39 ) Discontinued operations $ — $ ( 0.02 ) Basic and diluted net loss per share $ ( 0.49 ) $ ( 0.41 ) Basic and diluted weighted average number of shares outstanding 93,976,233 57,121,096 13. DISCONTINUED OPERATIONS During the fiscal year ended May 31, 2022, the Company recognized a net loss from discontinued operations related to the Company's cryptocurrency mining operation. The Company had no results from discontinued operations during the year ended May 31, 2023. Operating results of discontinued operations are summarized below: 56 (in thousands) Fiscal Year Ended May 31, 2022 Cryptoasset Mining Revenue $ 2,987 Cost of Sales 1,611 Gross Profit 1,376 Impairment of Cryptocurrency Assets ( 393 ) Gain on Sale of Fixed Assets 1,229 Loss on Asset Reclass to Discontinued Operations ( 3,256 ) Net Loss from Discontinued Operations $ ( 1,044 ) 14. SUBSEQUENT EVENTS Financing Arrangements The Company entered into a finance arrangement for approximately $ 41 million over 24 months for 1,024 H100 GPUs in connection with its AI Cloud Services business. Additional Debt Financing The Company received an additional $ 3 million in funding from the B. Riley Loan and Security Agreement, bringing the total outstanding loan principal balance to $ 39.5 million. Subsequently, the Company repaid the entire outstanding loan principal balance, along with all outstanding interest and fees. Common Stock Issuance The Company began issuing common stock under an "at the market" sale agreement pursuant to which the Company may sell up to $ 125 million in shares of Common Stock. The Company has sold approximately 7.9 million shares. Net proceeds, less commission fees of approximately $ 2.0 million, are approximately $ 64.7 million. Customer Prepayment The Company has confirmed receipt of a customer prepayment for its AI cloud services business of approximately $ 22.5 million. 57 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None