Earnings Call Transcript - APLD Q2 2023

Operator, Operator

Good afternoon, and welcome to Applied Blockchain's Second Fiscal Quarter 2023 Conference Call. My name is Doug and I will be your operator today. Before this call, Applied Blockchain issued its financial results for the second quarter of fiscal 2023 ended November 30, 2022 in a press release, a copy of which will be furnished in a report on Form 8-K filed with the SEC and will be available in the Investor Relations section of the company's website. Joining us on today's call are Applied Blockchain's Chairman and CEO, Wes Cummins; and CFO, David Rench. Following their remarks, we will open the call for questions. Before we begin, Jeff Grampp from Gateway Group will make a brief introductory statement. Mr. Grampp, please proceed.

Jeff Grampp, Gateway Group

Thank you. Good afternoon, everyone, and welcome to Applied Digital’s fiscal second quarter 2023 conference call. Before management begins their formal remarks, we would like to remind everyone that some statements we're making today may be considered forward-looking statements under securities law and involve a number of risks and uncertainties. As a result, we caution you that there are a number of factors many of which are beyond our control, which could cause actual results and events to differ materially from those described in the forward-looking statements. For more detailed risks, uncertainties and assumptions relating to our forward-looking statements please see the disclosures in our earnings release and public filings made with the Securities and Exchange Commission. We disclaim any obligation or undertaking to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made, except as required by law. We will also discuss non-GAAP financial metrics and encourage you to read our disclosures and reconciliation tables to applicable GAAP measures in our earnings release carefully as you consider these metrics. We refer you to our filings with the Securities and Exchange Commission for detailed disclosures and descriptions of our business, as well as uncertainties and other variable circumstances, including but not limited to risks and uncertainties identified under the caption 'Risk Factors' and our annual report on Form 10-K. You may get Applied Digital’s Securities and Exchange Commission filings for free by visiting the SEC website at www.sec.gov. I would like to remind everyone that this call is being recorded and will be made available for replay via a link available in the Investor Relations section of Applied Digital's website. Now, I would like to turn the call over to Applied Digital's Chairman and CEO, Wes Cummins. Wes?

Wes Cummins, CEO

Thanks, Jeff, and good afternoon everyone. Thank you for joining us for our fiscal second quarter 2023 conference call. Our topline results exceeded expectations with revenue of $12.3 million in the quarter, above the $12 million we discussed on last quarter’s call. That represents the steady-state capabilities of our 100-megawatt Jamestown facility, which continues to perform as expected. When we couple that strong performance of our Jamestown facility with our Ellendale and Garden City facilities that are expected to be energized in the near term, we are confident in our ability to deliver long-term, high-margin sustainable cash flow for our company. So now let me update you on the progress of our two upcoming facilities: our 200-megawatt facility in Garden City, Texas, and our 180-megawatt facility in Ellendale, North Dakota. In Garden City, construction of the facility is complete, and we're actively installing miners. We've received regulatory approval and are working through final technical details with the utility and our wind partner. We expect to energize by the end of our current fiscal quarter. Our Ellendale facility has made great strides on construction in spite of the harsh winter weather of North Dakota. All concrete has been poured, which was the key gating item determining the construction timeline, and the buildings are being actively constructed. We expect Ellendale to be energized towards the end of the current fiscal quarter as well. Recall, Ellendale is fully contracted by Marathon for five years. In addition to the build-out of our next-generation data centers, we have made an important branding update, changing the name of our company from Applied Blockchain to Applied Digital. The name change more accurately reflects our mission, services, and broad business offerings to serve customers who require low-cost power for their high-performance computing needs. Ultimately, our core assets are low-cost and reliable power contracts and our next-generation data centers, which have wide-ranging use cases beyond cryptocurrency, including applications in machine learning, artificial intelligence, image processing, graphics rendering, and various Web 3 applications. We will remain a premier provider of digital infrastructure for cryptocurrency miners, but it's important for us as a company to distinguish that our next-generation data centers support many other HPC applications as we look to capitalize on the rapidly growing high-performance computing market, which is set to reach $65 billion globally by 2030. To be clear, we continue to see robust demand from cryptocurrency miners that exceed our capacity, irrespective of the macro dynamics in the sector, as low-cost hosting capacity remains the bottleneck in the system. However, we believe it is in the best interest of our shareholders to diversify our customer base and grow our exposure to other high-growth segments of the HPC market. We're beginning to capitalize on this broader HPC market opportunity. We announced last month we broke ground on a 5-megawatt standalone facility adjacent to our Jamestown site that will host several hundred graphics processing units for machine learning applications with a new customer. Concurrently, we retrofitted a small portion of our existing facility in Jamestown to support a Web 3 application with another non-crypto customer, which demonstrates our ability to modify existing locations to accommodate various HPC customer needs. We’re optimistic about our growth opportunities in the HPC market, where our next-generation data centers offer a more purpose-built solution than traditional data centers that are generally higher cost and more focused on delivering low latency than high compute power. Before I turn the call over to David, I want to address a few line items in our financials. First, our stock-based compensation expense was extremely high in the quarter. This is a result of almost two years of stock-based compensation being recognized in a single quarter, which was triggered by our resale registration statement becoming effective in October. In addition to the multi-quarter recognition in a single quarter, the value of the RSUs in many cases was significantly higher than any price our stock has traded at since our NASDAQ listing. This was due to the RSUs having been granted when the stock was thinly traded on the OTC. Second, our gross margin was lower in Q2, partially due to billing adjustments that happened in September from the partial outage of the Jamestown site that occurred in the first fiscal quarter. Gross margins are expected to be significantly higher in our current fiscal quarter, as you will see in David's guidance. This is a more normalized level. I will now turn the call over to our CFO, David Rench, to walk you through our financials before providing my closing remarks. David?

David Rench, CFO

Thanks, Wes, and good afternoon, everyone. Before I begin my remarks, I would like to note that like last quarter's call since we did not have operations in a year-ago comparable period, we will not be providing any year-over-year comparisons. Revenues in the fiscal second quarter were $12.3 million, which were entirely attributable to our hosting operations in Jamestown, North Dakota. The Jamestown site operated at full capacity throughout the quarter. Cost of revenues in the fiscal second quarter were $11.8 million, consisting of $10.3 million of energy costs to generate our hosting revenues, $900,000 of depreciation and amortization expense, and $700,000 of personnel expenses for employees directly working at our Jamestown hosting facility. Note that while our energy services agreement for Jamestown has largely fixed costs, there can be quarter-to-quarter variability based on seasonal power prices, which were higher in our second quarter than in other recent periods. This may also impact our revenues in our fiscal third quarter, but this is expected seasonality that normalizes itself over full-year periods. Adjusted gross profit, a non-GAAP measure that excludes depreciation embedded in costs of revenue and one-time electricity charges, was $1.5 million, or 12% of revenue for the fiscal second quarter of 2023. Operating expenses for the fiscal second quarter of 2023 were $27.2 million, which included $21.8 million of stock-based compensation, $4.7 million of other selling, general and administrative costs, and $700,000 of depreciation and amortization expenses. The elevated stock-based compensation during the quarter is anomalous as accounting rules dictated that we have a catch-up of recording these expenses as we had our registration statement declared effective related to the potential resale of previously awarded restricted stock and restricted stock units. We do not expect such events to occur going forward based on our currently outstanding awards. And it's important to note that stock-based compensation is, of course, a non-cash expense. Adjusted net loss from continuing operations for the fiscal second quarter of 2023 was a loss of $3.8 million, or a loss of $0.04 per basic and diluted share based on the weighted average share count during the quarter of approximately $93.4 million. Net loss attributable to Applied Digital for the fiscal second quarter of 2023 was a loss of $26.6 million, or a loss of $0.29 per basic and diluted share based on a weighted average share count during the quarter of approximately $93.4 million. Adjusted EBITDA, a non-GAAP measure for the fiscal second quarter of 2023, was a loss of $2.1 million. Lastly, on our balance sheet, we ended the fiscal second quarter of 2023 with $18.1 million in cash and cash equivalents and $20.5 million in debt. During the second fiscal quarter of 2023, we received $10.6 million in net customer deposits and $10.2 million in net deferred revenue, which collectively amounted to $20.8 million in net cash inflow, due to the structure of our commercial arrangements with customers that incorporate upfront deposits and prepayments. In certain contracts, the prepayments are amortized back to the customers over the first year of their contract with no impact on revenue recognition, but the timing of the cash flow with the upfront cash to us is a major benefit to the company as it helps with our CapEx funding needs. Now, turning to guidance, similar to last quarter, we will not be providing explicit guidance for the forward quarter, given the revenue materiality of our Garden City and Ellendale facilities that we expect both to come online in the current quarter. With regard to our Jamestown site, we expect our revenue generated to be slightly sequentially. With regard to our Jamestown site, we expect our revenue generated to be up slightly sequentially from fiscal Q2. We expect gross margin and non-GAAP numbers to be 25% of revenue or higher. That completes my financial summary. Now I'll turn the call over to Wes for closing remarks.

Wes Cummins, CEO

Thank you, David. Before we get to Q&A, I'd like to quickly go over some goals and initiatives for our company as we look to the future of Applied Digital. To start, we remain focused on the execution of our day-to-day business, and that includes operating Jamestown with high uptime and reliable performance and energizing our Garden City and Ellendale facilities in the near term. We continue to expect that once online, this hosting capacity should put us at an annualized adjusted EBITDA run rate of close to $100 million. To execute on this growth trajectory, we have also focused on remaining in a strong financial position. As David stated, we ended the quarter with $18 million of cash and cash equivalents and have over $7 million of undrawn capacity on our loan agreement for our Garden City facility. Also, our Ellendale facility is currently unleveraged, providing us optionality for additional non-dilutive sources of liquidity to fund future build-out. Lastly, another strategic focus for us is to continue building out our non-crypto use cases to demonstrate the broad capabilities of our next-generation data center assets. We are eager to initiate our pilot operations that I previously discussed and are actively in discussions with additional prospective customers for other HPC applications. We see significant potential in this part of our businesses as traditional data centers are a higher cost and less efficient solution than we can provide. With our proven ability to construct and operate low-cost next-generation data centers, we remain confident that Applied Digital will continue to be a leader in the digital infrastructure industry and capitalize on this market opportunity that is set to hit approximately $65 billion by 2030. To close, while this is a difficult time for the crypto industry, we are extremely confident that we're in a position to come out of these turbulent times stronger than ever. This is an incredibly exciting time to be part of Applied Digital as we continue to build out our facilities to accommodate the strong demand we have secured from both crypto and non-crypto customers for our services. I remain optimistic about our future and want to thank all of our team members for their dedication and service to Applied Digital. We're now happy to take questions. Operator?

David Rench, CFO

Hi, everyone, this is CFO David Rench. I want to quickly clarify that I misspoke on one metric during the remarks. I referenced adjusted net loss from continuing operations of $3.7 million. It was actually a $3.8 million loss, which is reflected in today's earnings release. Thank you, operator, we can now take questions.

Operator, Operator

Thank you. Our first question comes from Lucas Pipes with B. Riley. Please go ahead with your question.

Lucas Pipes, Analyst

Thank you very much, operator. And good afternoon, everyone. Happy New Year, everyone. And congratulations on the progress on the HPC side. Thank you for taking my questions. My first question is in regards to Ellendale and Garden City. I wondered if for both sites, you can walk us through in more detail on the kind of the current status. If we were at the site today, what would we see? And then more specifically to Garden City, what exactly is preventing the facility from being energized today? Thank you very much for your color on this.

Wes Cummins, CEO

Sure. Thanks, Lucas, for the comments and the question. So at Garden City what you would see is, as you can see in pictures, I think, up on our social media feed, basically, a fully constructed facility. There are some, I think six of the buildings have miners racked in them. And so we're continuing to do that. We very recently, last week, received the approvals that we need. The last pieces of the puzzle here are mostly technical around metering and instrumentation transformers. And so we're finalizing that. And then so we expect to finalize that, obviously, on the timeline that we said and energize before the end of February. So the way that energization looks is like we've talked; you really light up the buildings that are available. But we expect that facility to be fully online by the May, June timeframe. Recall for our largest customer there, which is 90 megawatts, we expect to bring that online sooner than that timeframe.

Lucas Pipes, Analyst

That's very helpful. Thank you.

Wes Cummins, CEO

Let me follow up. No, I missed the Ellendale piece. There, you'll see 4 to 6 buildings standing. We're putting racks in the buildings. The timeline there is we sat in front of the PSC in late December. I think we'll get the finalized approvals there. I feel very confident about that process. There's some work to be done by the utility on the substation for interconnection. That's kind of the primary gating item but also our buildings aren't ready to turn on yet there either. But we expect that again by the end of February.

Lucas Pipes, Analyst

Thank you, Wes. My second question is on Jamestown. Your customer, in a press release last week noted installing additional miners there. What allows that to take place given that this facility was already fully contracted? That’s it, thank you for your color on this.

Wes Cummins, CEO

That's a good question. So we're getting additional power, a little bit of additional power in Jamestown. So there's two pieces; it's optimizing Jamestown to have some additional power. And with Marathon, we've installed six immersion containers on site. It will be a trial for us for immersion. I think they've already been through that pretty in-depth and know how it works. So those are there; we're waiting for final sign-off, they're actually connected and mostly ready to turn on. So hopefully those turn on in the next few weeks for us and for Marathon. And then we have some additional space in the air cool. And we were shuffling one of our customers down to Garden City and not, I guess, again, it's not any of the 90 megawatts that we've contracted with Marathon. We're moving some of their capacity or some of their miners to Garden City, and we're putting Marathon in place in Jamestown, and that will happen this month mostly.

Lucas Pipes, Analyst

Very helpful. Thank you. Thank you, Wes. I'll do one last one, before turning it over. On the HPC side, you mentioned you're in discussions for additional commercial relationships. Can you give us a sense of the order of magnitude in terms of the discussions you have currently? Thank you very much for your color on this.

Wes Cummins, CEO

Sure. That’s a great question, Lucas. So I think you should think about HPC; the way I think about it is, we're putting this facility up. We already have some GPUs running and we have some customers working and trialing on those GPUs in a couple of locations. The site that has been built in Jamestown; it's going to happen in phases. So it really happens in three phases. The first phase goes up and there will be 300 GPUs that run; we have two customers for those GPUs. And that's really kind of proving out how this works. And then we'll expand it from there by a little over two megawatts. And then there's a third expansion by another little over two megawatts that would happen later in the year. So it's kind of staged a couple of months apart on each one. But the way I look at this is, we're seeing a significant amount of demand. And if we get these customers up and running successfully over the next few months, we'll sign additional customers; I have no doubt that we'll do that. But my view is signing a few, there's a potential to sign a few very large customers once this is proven out. But we've had some initial discussions with those customers, but we're not going down the track with them initially; we'd rather make sure that the facilities are tuned to where I think they should be and where the team thinks they should be before we do that. But the strategy is to add a few small customers and then maybe add what I would call an anchor tenant, similar to what we did with the Bitcoin mining later this year.

Lucas Pipes, Analyst

Thank you very much, Wes to you and your team. Continued best of luck.

Wes Cummins, CEO

Thanks.

Operator, Operator

Our next question comes from the line of John Todaro with Needham and Company. Please proceed with your question.

John Todaro, Analyst

Great, thanks for taking my question. Congrats on another quarter down here. First question, just as we do think about gross margin, so 25% of revenue for Jamestown, with the Texas and Ellendale sites when they're up and running, should we expect kind of a similar gross margin profile there as well?

Wes Cummins, CEO

I think we expect those sites to be a little bit more profitable than Jamestown. I mean, the target we're shooting for John is around 30% gross margin, once we have everything up and optimized. It will need the site to be running for a couple of quarters to get there. Now that can be a moving target a little bit, because generally our business focuses on a spread between electricity and what we charge our customers. But where that's dialed in right now, I think looking towards 30% optimized gross margin is where we're trying to get to, where I think we can get to.

John Todaro, Analyst

Okay. Got it. Great. And just one other question for me on HPC. So just remind us and sorry if I missed this, kind of a timeline for the pilot program? And what is being determined in that? Is there some optimization you guys would look to do? Or is this really just kind of testing the waters before building more demand?

Wes Cummins, CEO

Yes, it's both of those, actually. So it's putting the facility up; we've designed the facility, putting it up, and then making sure it works correctly for the application. So we have a software partner on this that we're working with as well, and working through how that software works on site, specifically for machine learning. And so we're putting that up, making sure it works on this location in Jamestown, making sure the design looks good. And then we can expand from there, but it's truly both of those. You should expect the 300 GPUs to be running in March. And then we'll expand from there. But right now, I fully expect the full 5 megawatts to be running by the end of 2023. But if things are running well there, we should already be on to the next facility and expanding that.

John Todaro, Analyst

Got it. Great. Thank you. Appreciate it.

Wes Cummins, CEO

Thanks, John.

Operator, Operator

Our next question comes from the line of Rob Brown with Lake Street. Please proceed with your question.

Rob Brown, Analyst

Good afternoon. Congratulations as well. Just wondered how much CapEx do you project for completing Ellendale and Garden City?

Wes Cummins, CEO

I’ll let David take that.

David Rench, CFO

I think we have $15 million to $20 million more in CapEx to complete both of those. And we have that in cash and potential loans lined up. So we're in good shape there.

Wes Cummins, CEO

And we have additional prepayments. Rob, I think the important part about it is we think we're fully funded to finalize Garden City, Ellendale, and the 5-megawatt HPC center as well.

Rob Brown, Analyst

Okay, great. And then on the HPC business, maybe longer-term or midterm, how do you see that mix of your business playing out in say three years out?

Wes Cummins, CEO

Yes. So that's a good question. The goal for us right now is at least 10% of our revenue coming from HPC besides Bitcoin by the end of this current calendar year. And three years from now, we're shooting for a 50-50 split by 2025.

Rob Brown, Analyst

Great, thank you. I'll turn it over.

Wes Cummins, CEO

Thanks.

Operator, Operator

Our next question comes from the line of Chris Brendler with D. A. Davidson. Please proceed with your question.

Chris Brendler, Analyst

Hi, thanks and good afternoon. Thanks for taking my questions. I may have missed this, but the gross margin came under pressure. And there's a note in the press release about some charges or some follow-up from last quarter's shutdown; could you give a little cover there? And with a normalized, what does non-GAAP gross margin look like?

Wes Cummins, CEO

Yes, Chris, there were adjustments from specifically really the month of August. We had shutdowns in the way we build; the customers got credits for that in September. And so you'll see that hit the gross margin. So in September, we actually had a slightly negative gross margin for the month because of those adjustments. So that impacted the full quarter. And then as I've made in the comments, in David's guidance, you expect gross margin to be above 25% for the current quarter. So significant move back up, and I think you should expect that to be more of a normalized gross margin for us right in that. And then to answer the earlier question that John had, I think the goal for us here is that 30% gross margin over time.

Chris Brendler, Analyst

Great. Is it fair to take that normalized margin and sort of estimate the one-time charge from last quarter or was also a comment on power costs being a little higher this quarter?

Wes Cummins, CEO

In Jamestown and you'll have this in Ellendale as well, both in North Dakota. The power cost changes somewhat through the year but it will average out to the cost we expected to roughly plus or minus call it 10% for the year. We actually have a mechanism in our contracts that allow us to adjust for that which we do, but it's a little bit lagging. So in North Dakota, you are going to see some quarters where we're below that level on gross margin and some quarters were above that level on gross margin where we, call it over-earn and under-earn. Excess will be more stable than the prices; it doesn't have a lot of seasonality to it; it's more fixed because of how we structured that.

Chris Brendler, Analyst

Okay. Great. That's helpful. Separate area of questions: obviously, a lot of stress in the crypto mining sector and it seems getting worse rather than better. If you can give us an update on your customer base and how you feel outside of Marathon which we kind of have a lot more information to this public; but your private customer base, is there any situation that deserves we're monitoring? Or is it still really good about the customers you've?

Wes Cummins, CEO

We haven't seen anything yet. So we've Disney; we have GMR; we've got two pools we talked about in the previous call; the other fairly large customers that are hosted in our facilities, and I think those remain, as far as those types of miners go, kind of the best of the best financially. So we haven't had any issues. Obviously, you can see Marathon; I think I talked about that last time where I think from a balance sheet and liquidity position they're best-in-class. I think they've made their liquidity position even better in December. So I think we have as good of a customer base as we can possibly have in the industry, call it the best houses in a bad neighborhood. But I don't know that there's any more color I can give you. We've had no issue with payments or defaults or anything of that nature.

Chris Brendler, Analyst

I guess, you benefit from being a relatively recent installation. So I imagine a lot of your customers have S-19s or better so they're more profitable than some of the older operating machines out there.

Wes Cummins, CEO

It's all S-19 pros, and I believe a lot of the Marathon equipment will be XPs as well. Ultimately, our customers have some of the most efficient miners available in the market. We operate efficiently and charge a very reasonable price, which makes our customers highly competitive in the market.

Chris Brendler, Analyst

Excellent. One last question is just the $100 million fund that you're participating in or helping set up. Is that going to require any capital on your side, or is that independent from the way you're contributing to that?

Wes Cummins, CEO

It’s independent from us. We have the ability to host for those who are not professional miners and want to engage in a challenging industry. This provides a way for them to do so. We are involved, but not through any financial commitment.

Chris Brendler, Analyst

Awesome. Thanks, Wes, and congrats on the progress.

Wes Cummins, CEO

Thanks.

Operator, Operator

We have a follow-up question from the line of Lukas Pipes. Please proceed with your question.

Lukas Pipes, Analyst

Thank you very much, operator. Great discussion this afternoon. I thought I squeezed one in. You mentioned some of the names you're talking to on the HPC side would be recognized by most on the call, and I was wondering if you could maybe elaborate on that a little bit and provide us a flavor with the sort of counterparties you're engaging with? Thank you.

Wes Cummins, CEO

The short answer, Lukas, is I'm not yet ready to elaborate on that. And I'm not trying to hide anything or bat. I just don't have permission to use any names.

Lukas Pipes, Analyst

Well understood. I thought I'd give it a shot. Appreciate the follow-up. And again, best of luck.

Wes Cummins, CEO

Thanks, Lucas.

Operator, Operator

There are no further questions in the queue. I'd like to hand the call back to Mr. Cummins for closing remarks.

Wes Cummins, CEO

Thanks, everyone. I want to take the opportunity again to thank all of our employees. We've grown quickly, and really appreciate everyone's hard work here, especially in the rough weather we've had in North Dakota for the month of December and everyone on the construction side as well making it through that. So thanks, everyone, for joining us and talk to you next quarter.

Operator, Operator

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.