Arqit Quantum Inc. (NASDAQ:ARQQ) Q2 2024 Earnings Call Transcript

Arqit Quantum Inc. (NASDAQ:ARQQ) Q2 2024 Earnings Call Transcript May 20, 2024

Operator: Good day, and thank you for standing by. On today’s call, we will be referring to the press release issued this morning that details the company’s first half of fiscal year 2024 results, which can be downloaded from the company’s website at arqit.uk. At the end of the company’s prepared remarks, there will be a question-and-answer period for selected equity research analysts. [Operator Instructions] Finally, a recording of the call will be available on the Investors section of the company’s website later today. Please note that this webcast includes forward-looking statements, statements about the company’s beliefs and expectations containing words such as may, will, could, believe, expect, anticipate, and similar expressions are forward-looking statements and are based on assumptions and beliefs as of today.

The company encourages you to review the Safe Harbor statements, risk factors, and other disclaimers contained in today’s press release, as well as in the company’s filings with the Securities and Exchange Commission, which identify specific risk factors that may cause actual results or events to differ materially from those described in our forward-looking statements. The company does not undertake to publicly update or revise any forward-looking statements after this webcast. The company also notes that on this call it may be discussing non IFRS financial information. The company is providing that information as a supplement to information prepared in accordance with International Financial Reporting Standards, or IFRS. You can find a reconciliation of these metrics to the company’s reported IFRS results in the reconciliation tables provided in today’s earnings release.

And now, I’ll turn the call over to David Williams, the company’s Founder, Chairman, and Chief Executive Officer. David?

David Williams: Thank you for joining our first half of fiscal year 2024 earnings call. Arqit reported revenue for the period of $0.1 million. It is a modest result. However, our conviction in the trajectory of the business has never been higher and is supported by clear evidence that our market is finally maturing. As we said in our earnings release published this morning, our revenue generation for the first half is not reflective of the depth and breadth of engagements which Arqit has with numerous customers. Our conviction in the trajectory of the business stems from these engagements, which we’re starting to see come to fruition with contracts announced post year-end. We said on our fiscal year end 2023 earnings call in December that it takes considerable time for channel partnerships to become productive and we hoped to see an inflection point in fiscal year 2024.

We’re standing at that inflection point today. There were a number of projects across our product lineup that we expected to land an invoice in the period, but did not. None of the opportunities were lost. They all nearly slipped into the second half of the fiscal year. We had observed in the last three months that sales cycles are getting much shorter. Customer contract renewals and contract expansions were solid during the first half. We experienced a 100% renewal rate of expiring contracts, which will show up in the current half-year results. These contracts were for Arqit’s symmetric key agreement platform, our network secure firewall products with our partners Fortinet and Juniper, as well as professional services. During the period, three additional major telcos agreed to launch or launched initial test installations of Arqit’s SKA products.

We now have six major telcos engaging with our product, and we hope and expect that we will see conversion from early installations to broad adoption during the current year. The period was marked by the establishment of additional reseller or partnership arrangements bolstering our business development efforts in government, defense and enterprise markets. We also enhanced our business development in trade finance, digital negotiable instruments with additional supply chain platform and finance partners. It was a notable achievement in the period that we assisted Intel Corporation to quickly appreciate the product merits, to integrate it, and launch the software into their Xeon-based servers, and also to go to market with details, technical white papers and marketing activities.

During the six month period, we received additional external validation of our technology. The GSMA published a paper describing the need of the suitability of Arqit’s symmetric key agreement platform for the mobile telecom market. GSMA’s view of our product was echoed by the mobile industry CTOs who attended the Mobile World Congress in February, voting Arqit the top honor of the CTO Choice Award for outstanding mobile technology. And finally during this period we were able to announce that Arqit’s SKA platform product meets the National Security Agency Commercial Solutions for Classified Symmetric Key Management requirements Annex and uses an NSA approved Key Generation Solution to generate and manage pre-shared keys. The SKAP product has been integrated into NIAP validated CSfC components, which deliver a significant competitive advantage for National Security Systems.

As a result, there is growing interest from partners and customers for incorporation of this technology into government contracts and we’re now seeing our technology actively bid into requests for proposals emanating from defense organizations. All of the referenced highlights are important building blocks of medium and long-term success. What was less visible to the market during the period was the additional work of our technical teams resulting in recent important developments for our business. Let me start with a development which investors are most keen to see, which is revenue. You will note in our earnings release that we announced that as part of a consortium offering a solution in response to a request for proposal by a government organisation, Arqit has been awarded this past week, its first seven-figure multi-year contract in the region.

Documentation remains to be finalised, but we expect to be under contract in early summer. This contract award is important in several dimensions. Firstly, the opportunity was driven by one of our previously announced distribution partners. This demonstrates the effectiveness of that go-to-market strategy. It also demonstrates what I stated at the open, it does take some time for channel partners to become productive and in this case, patience has paid off. The contract award is important also in that it validates our belief that governments represent a significant market opportunity and one of scale. Our decision to prioritize the government market is beginning to be rewarded with fully commercial and scaled contracts. Finally, this contract award opens the door to other opportunities within that specific organization and also the broader government institutions in this and similar countries.

We’re already engaged in discussions regarding several additional commercial opportunities. Our ability to meet the requirements of the NSA commercial solutions for classified and components is important in the decision-making resulting in such contract awards. Will this contract be noticed by other governments considering the use of our product? We do expect so. Each of these developments builds upon each other. Another important recent development, which is a direct result of efforts during the period, is the announcement last week by Telecom Italia Sparkle, the fourth largest global Tier 1 telecoms network that has completed the initial installation to secure a connection between Italy and Germany using Arqit’s SKA platform. I encourage you to read Sparkle’s press release and media comments announcing the intention to fully roll out Arqit’s SKA platform during the current calendar year.

The release is a great endorsement of our product, and the successful completion of the first phase of the project is described by the customer as preliminary to a large-scale commercial launch. It should be noted that Sparkle operates the fiber infrastructure across 33 countries, including the United States, with more than 600,000 kilometers of network. Sparkle intends to expand Arqit’s SKA solution to additional parts of its network by the end of June and full network rollout by the end of 2024. This echoes what we’ve heard recently from many telcos. Whereas last year telcos were considering post quantum cryptography, this year telecoms companies are increasingly telling us that they have made decisions to deploy quantum safe protections on their commercial networks during the current calendar year.

The timing of the launch and the financial implications are to be determined, but the important takeaways from the announcement are as follows. Further confirmation of our established view that telecom network operators represent an important market for our products. We’re now in various stages of engagement with about a dozen large-scale telecoms operators. Additional validation by a significant and sophisticated technology vendor of the efficacy of our product and the ease and flexibility of its use. The suggestion that lead network operator sees market demand for quantum-safe IPsec network connectivity by its end customers and a differentiator in the marketplace. And of course, clear line of sight to revenue for Arqit. The final development to highlight, which is not captured in first half results, is the announcement of our integration with Intel.

In late April, we announced our collaboration with Intel for the integration of our platform running on Intel Xeon Scalable processors. Arqit believes that it represents the world’s first quantum safe 1.9 terabyte IPsec solution. The product is currently available to sale and joint commercial efforts are underway. Intel is a $55 billion revenue company with a market capitalization of approximately $136 billion and is a global leader in processor technologies. Arqit is a young company with modest revenues and a small market capitalization. Our initial conversations with Intel only occurred in February and the public announcement of the integration occurred in April less than three months later. Already since the announcement, we’ve begun significant joint marketing efforts.

White papers have been released, and a significant impact was noted in recent cybersecurity conferences. The scope and scale of the opportunity with Intel is evolving rapidly, but I’m convinced that this is a very large scale route to market for Arqit. The collaboration opens a new sales vector for Arqit, and we’re working at pace to develop and implement the sales motion. This is an exciting development and one that consumed time and resources during the fiscal period, which did detract from possibly more immediate, but ultimately less significant in period opportunities for revenue. With finite resources, this is a strategic trade-off which we made, and we believe that the median term, prospects for Intel, is compelling and worth the trade-off.

Again, the Intel collaboration was built upon our security proof, meeting NSA Commercial Solutions for Classified requirements, as well as our earlier integrations with our partners Fortinet and Juniper. Going back to my opening statement, coming out of the first half of our fiscal year, our conviction has never been higher. The depth and breadth of OEM and customer engagements which we had during the period resulted in one large EMEA contract award, the successful launch of business with Telecom Italia Sparkle, and network rollouts and collaboration with Intel. All of these major events provide clear line of sight to revenue from or through major institutions and organizations, all providing large building blocks upon which to grow further the business.

There are several other observations of note from the first half of the fiscal year and our successes announced post year end. Firstly, we are seeing compression in sales cycles in 2024, as evidenced by the speed of our collaboration with Intel, our engagement with Telecom Italia Sparkle, and the engagement with as yet unnamed mobile network operators and government customers. Additional conversation to engagement is now often three to four months. This suggests to us that the appreciation of the need to harden networks through stronger, simpler encryption to get ahead of the quantum threat is becoming mainstream. That is most definitely observable amongst telcos and governments, and we expect this picture to evolve in the enterprise market during calendar 2024.

Telcos are leading the way in terms of exploring solutions to address the quantum risk. We are engaged with about a dozen telcos now, and each announcement brings in new inquiries. But we’re actively engaged now with also numerous defense prime contractors who are submitting routinely our product into ordinary course of business requests for proposals worth six or seven figure contracts to Arqit and we are expecting to win several of these during the current half year. The enterprise market has not developed at the same pace. However, recent leading market research surveys published in April, suggest that 40% of respondents are either actively implementing today or are planning to start implementing post-quantum cryptographic solutions during the next 12 month period.

This is encouraging and we believe that our relationships with telcos are a strong avenue to address ultimately the enterprise market. Looking forward to the balance of the fiscal year, we will be focused on revenue generation from or through our newest government contracts, live telco business, and RFPs involving our OEM partners. Arqit’s SKA Private Instance product involves the sale typically of an initial one-off integration license which allows customers to set up the platform. The full commercial use of that platform results in new revenues from the sale of endpoint license bundles, which are then expected to become recurring after the initial integration license period. Whilst we sold two such licenses in the fiscal period ending September 2023, we expected to generate new integration license sales during the period ending 31st of March 2024, but these sales opportunities slipped into the second half of the fiscal year, one of which has already completed.

We had a number of additional opportunities through our regional distribution partners that we’ve landed in the EMEA region, which we’re expecting to expand. As for the defense end market, we are progressing contract opportunities with multiple prime contractors, which should come to a conclusion during the current period. We also expect to announce soon the first transaction for our trade secure and wallet secure products. The depth and breadth of our customer opportunities is increasing. As a result of our efforts, technical and commercial, evidenced by the significant announcements we’ve discussed today, it feels as though the company is at the inflection point that we expected last November may come true in the current calendar year. It’s for that reason that our conviction has never been higher, that significant revenue will now flow, enabling us to begin a more advanced form of reporting soon.

With that, let me turn the call over to Nick Pointon, our CFO, for a few remarks on our financials. Nick?

Nick Pointon: Thank you, David. For the six-month period ended 31 March 2024, we generated $119,000 in revenue. For the comparable period in 2023, we generated $19,000. Revenue was generated from the sale of Arqit’s Symmetric Key platform as a service, the sale of Arqit’s network secure firewall product and of professional services. We executed under nine customer contracts. No contracts expired or were terminated during the period. In fact, we experienced a 100% renewal rate of any contracts due to mature in the first half. The year-over-year growth in revenue reflects growth in the number of contracts for Arqit’s Symmetric Key platform. In prior periods, we generated other operating income related to our satellite division’s activities.

The division had been held as a discontinued operation as we pursued a sale of the division. After an exhaustive effort, we determined that the satellite assets were fully impaired. As a result, we did not generate other operating income for the six-month period ended 31 March 2024. Our administrative expenses equates to operating costs for those more familiar with US GAAP. For the six-month period, our administrative expenses were $16.8 million versus $25.4 million for the comparable period in 2023. Administrative expenses for the period includes a $293,000 non-cash credit for share-based compensation versus an $8.3 million non-cash charge for the comparable period in 2023. Lower employee costs resulting from headcount reductions and attrition were the primary drivers of the variance in administrative expenses between the periods.

At 31 March 2024, we had 125 employees as compared to 170 employees at 31 March 2023. And now today we announced further cost saving initiatives including headcount reductions and rationalization of our real estate under lease. Pro forma for the commenced headcount reduction initiatives, headcount will be 81 employees. These cost reduction initiatives are expected to result in a 40% decrease in monthly budgeted operating costs to approximately $1.8 million commencing July from previously budgeted monthly operating costs of approximately $3.0 million. Operating loss for the period was $16.6 million versus a loss of $25.4 million for the first half of fiscal year 2023. The variance in operating loss between periods primarily reflects low administrative costs resulting from cost attritions — cost actions.

Loss before tax was $16.1 million — adjusted loss before tax was $16.1 million, which in management’s view reflects the underlying business performance once non-cash change in warrant value is deducted from loss before tax. For the comparable period in fiscal year 2023, profit before tax was $12.6 million and adjusted loss before tax was $34.7 million. The variance between periods is primarily due to the change in fair value of warrants and cost actions. Arqit did not issue any shares during the period through a registered public offering, private placement, or Arqit’s established at the market issuance program. As a result, we ended the period with a cash balance of $21.3 million versus a cash balance of $44.5 million as of fiscal year end 30 September 2023.

Shortly after the close of the fiscal period, we issued 1.2 million shares, raising $0.9 million in gross proceeds via an equity subscription directly with D2BW Limited, an entity controlled by Arqit’s founders. The issuance was at the market pricing and no warrants were issued satiated with the subscription. I would like to clarify what appears to be a misconception by pockets of the investor community. Periodically, Arqit delivers to our employees, officers, and directors shares which vest under our equity compensation program. The delivery of shares is deemed income to the recipient from a tax perspective, and taxes are owed by the recipient. Our employees, officers, and directors can elect to fulfill the obligation either by personally making a cash payment to the relevant tax authorities or can have a sufficient portion of the shares they receive sold and the generated cash withheld to cover the tax obligation.

This is called a sale to cover transaction. This is all standard practice for public companies. SEC regulations implemented last year require all Form-144 filings to be made electronically and are therefore now more readily visible, including those made in connection with sale-to-cover transactions made by offices and directors of the company. The misconception by some investors is that sale-to-cover represents discretionary sales by those offices and directors of long positions in the company’s shares, reducing their holding of shares. This is incorrect. In fact, net of the sale-to-cover, the offices and directors ownership in Arqit shares increases as a result of the delivery of vested shares. The misconception occurs because Form-144 does not distinguish between the sale-to-cover versus a discretionary sale.

Commencing with Form-144 filings in April 2024, Fidelity Stock Plan Services, which administers Arqit’s employee share plan, began denoting sale to cover transactions in relevant Form 144 filings for great transparency. I encourage our current and prospective investors to read Arqit’s Form 144 filings closely to understand the nature of any reported share sales. With that, I turn the call back to David.

David Williams: Thanks, Nick. As I’ve said, our conviction in the business is incredibly high. That conviction is based on the progress we’ve made on multiple fronts, most importantly, the announcement of awards of contracts which are expected to generate meaningful revenues in the current year. That said, we’re acutely aware of the needs to convert these opportunities to cash, and we remain very focused on the conversion of revenue opportunities which we’ve discussed today and additional opportunities that we have identified and are pursuing vigorously. It feels as though this is the inflection point where revenue, which is material, will begin to flow during 2024. We’ll keep working hard to deliver strong results for the full year on the back of that momentum that we’ve been experiencing. I’ll now hand the call back over to the operator for Q&A.

Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Scott Buck with H.C. Wainwright & Company. Your line is now open.

Scott Buck: Hi. Good afternoon, guys. Thanks for taking my questions. David, on the award you announced today in the Middle East, I was hoping you’d give us a little more color on timing from here through the end of fiscal 2024. Could you actually see revenue this fiscal year from that contract? And then second, what do you see as the immediate opportunity in that region?

David Williams: Thanks, Scott. Yes, the EMEA region contract that we’ve announced is a multi-year seven-figure contract and it’s anticipated that the first revenues will arise during the current half year, a number of other contracts have also arisen which are likely to result in revenues in a similar timeframe. And we’re also expecting some of the initial tests that we’ve done with telecoms companies to turn into scale rollouts during the current financial year. Finally, as I’ve said, there are a number of RFPs that have been responded to by defense prime contractors that incorporate Arqit’s technology, and we are hopeful of landing some of those. I do think that the business development that we’ve done in EMEA is going to yield results in several countries, but equally the work that we’ve announced with Intel has a global reach to it, and so there’s now a strong possibility of generating revenues through that channel partnership much faster and at global scale.

Scott Buck: I appreciate that. And then you indicated in the release that all the contracts that were up for renewal were renewed or extended in the first half. Can you talk a little bit about the qualitative feedback you’re getting from your partners and what — I guess what you’re hearing as they start to sell on your behalf?

David Williams: Yes. The feedback that we get on the product is that it’s incredibly easy to use, quick to deploy and very stable. We tend not to experience any network outages. On the recent contracts that we’ve talked about, we’ve experienced 100% success rate in uptime. It’s a very stable platform. The ease of use is its most interesting factor in many ways. Not only is it fully secure against the future of quantum attack, Not only does it harden existing networks through rotating authentication, but through its existing integration with partners like Intel, Fortinet, and Juniper, it’s very, very easy to use and deploy, requiring minimal technical input from the customer, and it uses existing standards-based methods to ingest.

These are all very significant elements of our success. The Intel white paper that was published quite recently also noted that this implies no burden on performance. There is no change in performance in IPsec tunnels when Arqit’s encryption product is used, whereas other methods that are attempting to compete with Arqit suffer from extreme performance lags. In some cases, things like TLS connections simply fail to get established. So we feel that we have very strong competitive advantage in performance and reliability. And that’s the feedback that we’ve been getting quite universally from our customers.

Scott Buck: Great. That’s helpful. And then last one for me. You guys have been very proactive on the cost controls front. I’m curious, as revenues start to scale, hopefully here in the second half of this year, how quickly you may need to add back to some of that cost infrastructure to support that growth?

Nick Pointon: Yes, the cost cuts have happened in two areas. Firstly, we exited the satellite business and whilst there remains the potential for upside from licensing of the IP. And some of those discussions are in live conversations right now. There’s no particular cost burden that goes along with that. On the software side, we substantially completed the build out of our core software platforms and so we’re now down to routine maintenance of the software as well as the support of the software through integrations with customers and that gives us the opportunity to scale back our investment in software. As the contracts ramp up with customers, we feel during the remaining part of the year that we’ve got adequate resources in pre and post sales engineering to cope.

The only additions that I can see happening probably into the next financial year would be in customer support and service and they would be relatively modest and low cost resources. So right now we’re happy that the cost base can remain stable with the scale of contracts that we’re expecting turning to revenue in the current half year period. That’s great. It sounds like investors should start to see some operating leverage then as business scales. Appreciate it, guys. Thanks for the time.

David Williams: Thank you, Scott.

Operator: Thank you. We have no further questions at this time. Now I’ll turn the call back over to David Williams for closing remarks. David?

David Williams: Thank you very much. That concludes the conference today and thank you everyone for your attention.

Operator: Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect.