Arqit Quantum Inc. (NASDAQ:ARQQ) Q4 2022 Earnings Call Transcript

Arqit Quantum Inc. (NASDAQ:ARQQ) Q4 2022 Earnings Call Transcript December 14, 2022

Operator: Good day and welcome to Arqit’s 2022 Fiscal Year Earnings Conference Call. On today’s call, we will be referring to the 20-F and press release filed this morning that details the company’s full fiscal year-end 2022 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 analyst. 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 identifies 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: Hello and welcome to Arqit’s fiscal year 2022 results conference call. Before discussing Arqit’s performance, I would like to reflect for a moment on the recent passing of our Co-Founder, colleague and friend, Andrew Yeomans. Andrew was responsible for early foundational patents of Arqit. He was amount of great intelligence, ethics and warmth and his daily missed. We will honor his life and achievements by seeking to fulfill the promise which he saw in Arqit. Promise is an appropriate word for Arqit’s first full fiscal year of commercial operation. For the period ending September 30, 2022 we generated $20 million in revenue and other operating income, compared to $48,000 for the prior fiscal year. However, revenue generation alone does not pay the appropriate picture of the promise, which we see for the business.

Arqit has made great strides in our technology, business model and go-to-market strategy, announcing this week three hyperscale channel partners which validate our technology and give us access to large global customer bases. As a result, we believe we have now built a pathway to success. In May of this year, the White House urged all organizations to prepare transitioned to post quantum cryptography. Also in May, the National Security Agency stated that symmetric keys are the recommended solution. We believe the Arqit is the only company in the world that can deliver zero trust cloud fulfilled symmetric key agreement at scale. Customers can now buy our product through three hyperscale channel; AWS, Dell, and Fortinet and other trusted partners.

We’re ready to deliver the requirements of the White House and others. I stated on Arqit’s 2022 half year earnings call, that Arqit was improving its understanding of how customers want to consume the product. I also said, that it’s often the ease of implementation that is a major purchasing decision factor. We’ve learned that end customers largely want to consume our product through products and services that are already part of our technology architecture and therefore easy to implement. Arqit’s go-to-market strategy was in the short-term to be focused on direct enterprise license sales to be followed by the launch of a cloud-based platform-as-a-service. And in the fullness of time we expected that we would generate channel strategies and market access through leading global technology partners.

The assurance of our security proof by the GCHQ accredited University of Surrey in May, accelerated the interest in our products by those leading technology vendors. As a result, we reoriented most of our finite sales and marketing resources during the year towards developing those relationships. Whilst the shifting resources with to the detriment of realizing potential short-term enterprise license opportunities, we are delighted with the outcome. The integration of our symmetric key agreement software with the products of AWS, Dell, and Fortinet gives access to very significant global sales and marketing resources into very large existing customer bases. Today’s announcement of the integration with the Fortinet Fortigate series of firewalls, enables unbreakable quantum safe encrypted connectivity between customer locations, keeping safe both data in transit and at rest.

Fortinet has launched the integrated product for all global customers and the joint proposition is to be found on both company’s websites. Fortinet has consistently shipped more security appliances than any other vendor for nine consecutive years and as reported to have a greater than 35% market share. For end users, particularly the large existing Fortigate customer base, it makes the Arqit purchasing decision and the implementation of our software easy and seamless. For Fortinet, the integration of our product is a potential sales differentiator, which we hope will help them to further drive unit growth and customer retention. For Arqit, the partnership provides us access to Fortinet’s massive installed base and potential new customers. Leverage is Fortinet’s global sales organization and is expected to result in annual recurring revenue.

Similarly, Arqit and Amazon Web Services announced the integration of QuantumCloud with Amazon S3 a cloud-based object storage service. The integration of QuantumCloud with AWS S3 will allow AWS customers to protect their data against the attacks today and against the future quantum threat. AWS is the largest global cloud service provider with reportedly a market share greater than 30%, that’s of an $83 billion global market. The integration of QuantumCloud with S3, presents our products to a very large global customer base, as an easy to purchase and implement upgrade. For us it greatly accelerates potential customer reach and joint marketing initiatives with AWS are beginning. We also this week announced a partnering agreement and a joint sales mission with Dell Technologies to integrate Arqit’s product into a range of products available to their U.S. Defense Department and other customers.

This solution will be available through the Dell order fulfillment system and made available initially via Dell’s federal and technical teams. We’re very excited about the immediate opportunity which this partnership presents within the Defense Department and other Federal Department market. We see additional broader opportunities with Dell across its business activities globally. We believe that the prioritization and consummation of these channel partner relationships is potentially transformational for Arqit. We believe that these relationships and others which we are pursuing, represents a significant acceleration of our go-to-market strategy, bringing forward the date by several years the moment where we expect it to be doing business with such fantastic hyperscale companies.

Two additional important initiatives gain traction for us in 2022. We recently announced that Arqit has signed a contract with TraxPay, a leader in supply chain financing solutions to deliver quantum safe digital finance instruments enabling supply chain access to conduct business more efficiently and securely. Financial institutions such as Deutsche Bank, DZ Bank, Nord LB, trust TraxPay financing solution and maintain strategic partnerships with that company. Deployed directly into TraxPay’s supply chain finance platform which has processed over €65 billion of supply chain finance to date. Arqit’s trade secure service users distributed ledger technology, made secure by QuantumCloud to provide customers with referenceable digital promissory notes in digital bills of exchange, which are easier to manage than paper-based alternatives, unique transferable and in variable.

What is driving the adoption of digital assets in this market, is the U.K. government’s upcoming electronic trade documents bill, which will legalize electronic transferable documents. Other leading trade jurisdictions around the world have also passed or will pass legislation enabling such advancements. This opens up the potential $17 trillion global market, the supply chain finance for digital assets. We believe that Arqit is the only company in the world to comply with the requirements of this legislation, namely that the digital asset must be tamper proof. Only Arqit has published a security proof demonstrating that it is provably secure. Without such proof, no digital asset can be described as tamper proof. We believe that digital transformation in the financial services market is likely to accelerate at scale now, but bank is experimenting with private ledger technology should take note of the importance of quantum security.

We’re very excited about the opportunity for digital transformation more broadly beyond trade finance. Finally Arqit Software has been selected by prime contractors as part of the potential technology solution for two U.S. government programs of record. The contracts were expected to be signed and built in the fiscal year 2022, but billing slipped into the current fiscal year. There are headwinds in the U.S. government contracting market, as a result of continuing budget resolution and also international operational requirements. But despite those headwinds, we are delighted that months of effort by our commercial and technical teams has been rewarded by these important contracts. Participation in these programs of record is important validation of our technology and represents what we believe to be just the beginnings of the opportunity within the United States and other government defense departments.

These contracts in our Dell channel partnership set us up for potential future success in this very important marketplace. In addition to the acceleration of our go-to-market strategy, innovation in our technology is resulting in changes to the financial profile of the company. We announced today under a separate press release that, as a result of additional innovation, Arqit no longer requires satellite delivery of replicated randomness to datacenters as part of the symmetric key agreement process at endpoints. Arqit sometime ago developed a terrestrial method of delivering this replicated randomness to datacenters. The security of encryption keys created on the endpoint using our lightweight software agent is as strong with the terrestrial method as with the satellite method.

The security proof work that we published earlier in the year satisfied us of this. Therefore, we concluded that we do not require satellites and associated ground systems in the background of our technology stack. The implications of this are as follows. We’ve commenced conversations to sell a partial or complete interest in our satellite system under construction with multiple parties. Some government customers for very specific reasons are interested in sovereign on-premises control of key agreement which comes with a concept called eavesdropper detection. We will continue to fund the construction of this asset until the sale is agreed. If the sale becomes unlikely, we would discontinue construction. Arqit will build no further satellite infrastructure beyond this and intends to license its quantum satellite IP to subsequent customers with similar requirements.

This will enable those customers to build their own domestic sovereign systems and we are seeing demand for this offering. We expect these changes to our technology strategy, will result in a positive effect on future results with a portion of capitalized satellite costs recouped through the planned sale of the satellite currently under construction. Additional revenues through the licensing of our quantum satellite IP and the elimination of future capital and operating expenditures associated with use of satellites as part of our core product offering. Arqit intends to continue to perform under its satellite construction contract with the European Space Agency and recognize these related projects incomes generated there under. We’ve recently completed a new security proof, demonstrating that the satellite technology has its own validated security, which has been shared with these new customers under NDA.

These are significant changes in our technology infrastructure. We believe that the changes simplify our business model by focusing on selling our symmetric key agreement software platform-as-a-service. The benefits of stepping away from hardware infrastructure, a potentially significant from a financial perspective. The most important takeaway is that, these benefits are achieved with no negative impact on the security of the keys created endpoints by our software. And of course, removes CapEx. It’s beyond doubt, now that the world wants and needs stronger and simpler encryption. We believe and leading cryptographic experts and validated that Arqit’s symmetric key agreement software delivers just that. The partnerships which we have announced a further validation of our technology.

However, our promise is not fulfilled by merely having great technology and people. Our promises fulfilled by getting our product into the hands of customers to secure their data. The acceleration of our go-to-market strategy offers Arqit a faster pathway to focused on fulfilling and maximizing the opportunities which these partnerships represent. With that let me turn the call over to Nick Pointon, our CFO for a few remarks on our financials. Nick?

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Nick Pointon: Thank you, David. We only commenced commercialization and began generating revenues late in the second half of our fiscal year 2021. Therefore, the comparison of our fiscal year 2022 results with the comparable period in fiscal year 2021 may not be meaningful across all financial metrics. For the 12 month period ended September 30, 2022, we generated $20 million in revenue and other operating income from new QuantumCloud contracts and other activities. Our QuantumCloud revenue totaled $7.2 million for the period generated by five contracts. The bulk of the QuantumCloud revenue was generated by contracts with Virgin Orbit and AUCloud. As David noted, the reorientation of much of our sales and marketing effort to realize our announced channel partner relationships, impacted our direct enterprise license sales activity in the second half of our fiscal year.

Other operating income for the fiscal year of $12.8 million resulted from Arqit’s ongoing project contract with the European Space Agency. Despite the announced shift in technology strategy, we expect to continue to perform going forward under our contract with ESA, realizing future other operating income. Our administrative expenses equates to operating costs for those more familiar with U.S. GAAP. For the period our administrative expenses was $72.2 million versus $14.6 million for fiscal year 2021. The material increase in expenses reflect significant post NASDAQ listing growth in our operating infrastructure costs and personnel. Additionally, $22.9 million of the increase reflects non-cash charge for share-based compensation. Our employee base grew to 145 from 73 at the beginning of the period.

Since the end of the fiscal year, we have undertaken a review of budgeted fiscal 2023 headcount and operating cost growth to align it with revenue and focus on our key partner initiatives. As a result, we have provisionally kept fiscal year of 2023 headcount at no more than 195 employees. And have reduced non-employee budgeted cost by 8%. In total, we have reduced budgeted costs for fiscal year 2023 by 18%. In addition, we will accrue benefits from the reallocation of certain employees to support our key partner initiatives and the deferral reduction or elimination of costs from activities, which are not deemed high priority at this time. Operating loss for the fiscal year was $52.1 million versus a loss of $172.6 million for fiscal year 2021.

As a reminder, the operating loss for fiscal year 2021 included a $155.5 million reverse acquisition expense associated with our transaction with Centricus. We generated a profit before tax of $65.1 million. However, we’ve generated an adjusted loss before tax of $52.3 million which in managements’ view reflects the underlying business performance once non-cash charge in warrant value is deducted from operating profit before tax — sorry from profit before tax. During the period, 1,852,736 warrants were exercised with cash proceeds to Arqit of $21.3 million. We ended the period with cash balance of $49 million versus a cash balance of $87 million as of fiscal year-end 2021. Please note that we have filed today a universal shelf registration statement and an ATM prospectus supplement.

The filings represent sound fiscal — sorry financial housekeeping providing the company flexibility in corporate finance matters in the future. With that, I’ll turn the call back to David.

David Williams: Thanks, Nick. The pioneering activities of our incredible team of engineers, innovators and commercial offices in fiscal year 2022 has created a pathway to success. We have assurance that our product delivers as advertised. We better understand how customers want to consume our products. And now we have hyperscale channels through which to reach end user customers. Securing this knowledge, we must now focus on the hard yards of execution in 2023. We’re pleased with all that we have achieved in the fiscal year and are optimistic for our future. So I now hand the call back over to the operator for Q&A.

Q&A Session

Operator: Our first question comes from the line of Scott Buck with H.C. Wainwright. Your line is now open.

Scott Buck: Hi, good morning guys. Thank you for taking my questions. David, the first one, how should we think about these channel partnerships converting to revenue?

David Williams: Hi, Scott. So the Fortinet project is perhaps the most easy to understand. They are making available our software to the entire global customer base as an upgrade that will cost each individual customer base single digit percentage increases in the unit cost. So it becomes very simple to module price times volume against the penetration of Fortinet’s existing and future customer base. And we will be walking you through that in a Capital Markets Day, which we’re hoping to host in the near future. AWS is very similar. They have commenced joint marketing with a specific cohort of the larger customers, and again we can start to build a picture of likely penetration rates of those customer bases and the price times volume metrics are quite straightforward.

We have, in fact, published our pricing on a British government cloud website. So for trade users of that portal, the Arqit pricing is now out there. So price times volume is becoming much easier to calculate. These organizations have got enormous reach globally and the penetration is likely to be in the 20% to 30% range, in our opinion over the medium to long-term, and this represents a potential to greatly fulfill our business plan without an enormous increase in Arqit direct sales and marketing costs. With customers like Dell, we’re focused more on a smaller number of government and defense projects, but each of those projects come with pretty significant tickets. I’ve already said that, there are two programs of record that we’re now working on and those will we hope come with some very significant current year billings.

But once the product is certified and accredited by government users one expect to see fairly rapid take up. So those defense customers will continue to have an enterprise license orientation, whereas the things like AWS and Fortinet will have an annual recurring revenue startup business. We are working hard on signing a couple of other hyperscale channel partners to that style of business.

Scott Buck: Great. That’s very helpful. I’m curious, what is the level of product education you’ve already provided the partners? And how should we think about, how that those sales channels begin to scale?

David Williams: Well, you can see the joint proposition is now on Fortinet’s website and it’s in their partner portal. We’ve already been working in the last couple of months in a number of jurisdictions around the world with Fortinet’s salespeople directly and there is already a list of customers that we’re targeting jointly Similarly, the Dell and AWS teams in various departments have been educated on the product, know what it does, know how to sell it and there are representations of this integration currently being very actively proposed into those customer bases. So there is still more work to do to educate sales teams and distribution channels. But that work has slightly begun in earnest and we’re starting to see the prospects coming through the pipeline.

Scott Buck: That’s great. And is there any exclusivity arrangements in any of these partnership contracts that would meaningfully restrict your ability to sign additional channel partners?

David Williams: No, we’ve engaged in no exclusive partner conditions whatsoever.

Scott Buck: Okay. Great. And then I wanted to ask a little bit about the work you’re doing on the trade finance side and obviously, that’s a large market. I’m curious, how far out are we from that becoming a meaningful revenue contributor?