Applied Digital Corporation is a leading designer, builder, and operator of digital infrastructure, providing cost-competitive solutions to customers in the high-performance compute hosting (HPC hosting), cloud services (Cloud services), and datacenter hosting (Datacenter hosting) industries. The company has demonstrated impressive growth, with annual revenue reaching $55,392,000 and annual operating cash flow of $58,735,000. However, the company has also faced challenges, reporting an annual net loss of $45,606,000 and annual free cash flow of -$72,543,000.

Business Overview

Applied Digital's three reportable segments - Datacenter hosting, Cloud services, and HPC hosting - each play a crucial role in the company's overall strategy.

Datacenter Hosting

The Datacenter hosting segment operates datacenters to provide energized space to crypto mining customers. The company's 100 MW facility in Jamestown, North Dakota, has consistently met expectations, operating at full capacity with uninterrupted uptime throughout the quarter. However, the company's 180 MW facility in Ellendale, North Dakota, experienced a power outage starting in January, which the company has since addressed by procuring replacement transformers and related components from North American manufacturers. As of the latest update, the Ellendale facility has been re-energized to approximately 14% of its full capacity, or 25 MW, and the company anticipates the facility will be operating at 65% to 75% of full capacity by the end of May 2024.

Cloud Services

The Cloud services segment provides high-performance computing power for artificial intelligence and machine learning applications. Despite a lack of significant sequential revenue growth due to delays in clusters entering revenue generation, this segment continues to experience rapid growth, as the company advances in fulfilling its existing contracts and exploring new opportunities in its pipeline. The newly-deployed clusters were turned over to customers late in the quarter, which the company expects will provide a significant positive inflection to revenue and EBITDA in the fiscal fourth quarter.

HPC Hosting

The HPC hosting segment designs, builds, and operates next-generation data centers, which are designed to provide massive computing power and support high-performance computing applications within a cost-effective model. During the fiscal second quarter, the company broke ground on its first 100 MW high-performance compute facility in Ellendale, North Dakota. The company has also entered into exclusivity and executed a letter of intent with a US-based hyperscaler for a 400 MW capacity lease, inclusive of the current 100 MW facility and two forthcoming buildings in Ellendale, North Dakota.

Financials

In the latest quarter, Applied Digital reported revenues of $43,348,000, a significant increase from the $14,090,000 reported in the same period of the prior year. This growth was driven primarily by increased capacity across the company's three Datacenter hosting facilities and the contribution of revenue from the Cloud services contracts.

However, the company faced several challenges during the quarter, including power outages at its Ellendale datacenter hosting facility, which had an estimated $4.5 million impact on operating loss. Additionally, the company incurred a $21.7 million loss on the held-for-sale classification related to the sale of its Garden City facility, as well as $4.2 million in accelerated depreciation and amortization related to the disposal of damaged equipment at the Ellendale facility.

As a result of these one-time items, the company reported a net loss of $62,838,000, or $0.52 per basic and diluted share, for the quarter. On an adjusted basis, the company reported a net loss of $28,911,000, or $0.24 per basic and diluted share.

Liquidity

As of the end of the latest quarter, Applied Digital had $41 million in cash, cash equivalents, and restricted cash, and $61.8 million in debt. The company has taken steps to strengthen its balance sheet, including the recent announcement of a $50 million convertible debenture and the sale of its Garden City facility for a maximum cash consideration of approximately $87.3 million.

The company is also working to secure asset-level financing for its Cloud services and HPC hosting segments, which it expects will leave the company in a positive free cash flow position once in place. Specifically, the company has engaged in a process to secure a large debt facility directly at its Cloud services subsidiary to fund GPU purchases, and it is also in the process of securing project-level debt for its Ellendale HPC facility.

Outlook

Despite the challenges faced in the latest quarter, Applied Digital remains confident in its growth trajectory. The company is encouraged by the positive trends it is witnessing across its business and the numerous potential catalysts on the horizon.

In the Datacenter hosting segment, the company is pursuing remedies to recoup lost revenues and additional costs incurred to identify and rectify the outages at its Ellendale facility. Additionally, the sale of the Garden City facility will enable the company to redirect financial and operational resources towards its strategic sites in North Dakota, bolstering its growth initiatives in HPC and Cloud services applications.

In the Cloud services segment, the company is focused on diversifying its customer base beyond the startup community, with a goal of securing more enterprise-level customers. The newly-deployed clusters are expected to provide a significant positive inflection to revenue and EBITDA in the fiscal fourth quarter.

In the HPC hosting segment, the company's 400 MW capacity lease with the US-based hyperscaler represents a significant milestone, and the company is progressing with project-level financing tailored for this investment-grade tenant.

Risks and Challenges

While Applied Digital has demonstrated impressive growth, the company faces several risks and challenges that investors should be aware of.

The regulatory landscape surrounding high-performance computing, artificial intelligence, and blockchain hosting services is evolving rapidly, and the company anticipates increased scrutiny and potential regulation in the near and long term. These developments may significantly impact the company's business and operations in ways that are difficult to predict.

Additionally, the company's business is heavily dependent on a limited number of large customers, with its top seven customers accounting for a significant portion of its revenue. The loss of any of these key customers could have a material adverse effect on the company's financial performance.

The continuing commoditization of HPC hardware and software has also resulted in increased pricing pressure, which may cause the company to reduce its pricing in order to remain competitive, negatively impacting its gross margins and operating results.

Conclusion

Applied Digital Corporation is a dynamic and innovative company operating at the forefront of the high-performance computing industry. Despite the challenges faced in the latest quarter, the company has demonstrated impressive growth, with annual revenue reaching $55,392,000 and annual operating cash flow of $58,735,000.

The company's three reportable segments - Datacenter hosting, Cloud services, and HPC hosting - each offer unique growth opportunities, and the company is taking steps to strengthen its balance sheet and secure asset-level financing to support its continued expansion.

While the company faces risks and challenges, including regulatory uncertainty and customer concentration, the robust demand for its products and services, coupled with its differentiated asset base and the attractive valuation of its peers, suggest a promising future for Applied Digital Corporation.