Arqit Quantum Inc. (NASDAQ:ARQQ) Q4 2023 Earnings Call Transcript

Arqit Quantum Inc. (NASDAQ:ARQQ) Q4 2023 Earnings Call Transcript November 21, 2023

Operator: On today’s call, we will be referring to the press release issued this morning that details the company’s fiscal year-end 2023 results, which can be downloaded from the company’s website at arqit.uk. [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 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 and 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 fiscal year 2023 earnings call. The year was one of evolution, growth and challenges for Arqit. Our reported revenues were modest but that said, much progress has been made in deepening and broadening the foundation for future success, particularly in the expansion of our channel partnerships and specialized applications. Since our strategic pivot in December 2022 to focus on an exclusively-software product sold through sales channel partners, there has been encouraging commercial progress in building OEM integrations and distribution partnerships. It takes considerable time for these partnerships to become productive, and so revenue growth from these channels is at an early stage. We hope to see an inflection point in fiscal 2024 as those channel partners’ sales initiatives begin to mature.

During 2023, we worked hard on the execution of that new strategy through integrations of our software with OEMs and the creation of distributor and reseller channel partnerships. This was a pivotal way from a focus previously on direct enterprise sales of a previous product, which involved hardware. Changing our go-to-market strategy, combined with the pace of activating our new sales channels results in limited revenues from our products. However, progress in establishing those OEM integrations and channels convinces us that the strategy is correct. Beyond the headline revenue result, there is evidence of material progress in broadening and deepening our business foundations, specifically the growth in our channel partnerships, the development of the suite of specialized applications of our core symmetric key agreement product, and the green shoots of revenue contract activity.

There is evidence, for example, in the White House National Security Memorandum of May 4, 2022 and the activity that followed, that government and commercial organizations are moving forward with the switch to new forms of encryption. We also believe that our product is compliant with relevant standards laid down by the NSA in the U.S.A. for National Security Agency Commercial Solutions for Classified Symmetric Key Management, which has relevance in most markets. When we announced our new go-to-market strategy in December 2022, we named 5 partners at that time. As of today, we have 15 channel partners, including leading technology OEMs, distributors and resellers. These channel partners provide Arqit with access to different industry verticals such as security and financial services and telecoms, and in many cases, our partners offer global market reach.

Each new channel partner relationship is further validation by leading market participants of the efficacy of our Arqit’s symmetric key agreement platform. Each of these relationships offers distribution leverage to Arqit, which creates sales opportunities and reduces Arqit need for a significant direct sales force. In turn, Arqit provides its general partners with a differentiated encryption service to offer to their customers that addresses issues with today’s encryption architecture and also those presented by the advent of quantum computing. Our differentiated product offering represents incremental sales opportunities for our partners. We now focus on translating these partnerships into meaningful revenue growth. Each of our channel partnerships are at different stages of activation.

Some are advanced, such as Juniper Networks, where an integrated Juniper Arqit solution has been released for general availability. Others are earlier stage with additional channel education occurring. In the fiscal year, we generated revenue through 6 of our channel partners. Whilst the revenue is modest, the increase from sales through 2 channels in the first half of 2023 to sales through 6 different channels for the full year is positive momentum. Arqit’s foundational product offering included QuantumCloud, a Platform-as-a-Service for those customers who prefer a multi-tenanted solution; and the QuantumCloud Private Instance for those customers who require private control of their own tech stack. To encourage ease of adoption and to address specific industry verticals, Arqit then undertook the productization of some specialized applications of the QuantumCloud symmetric key agreement platform.

Specifically, we created and announced in fiscal 2023, Arqit NetworkSecure to address network security via firewalls, routers and other networking devices; also Arqit TradeSecure, which addresses digital trade finance; and Arqit WalletSecure to address financial transaction compliance and security. We’re pleased to say that we now have strong partners for each of these specialized applications. Arqit NetworkSecure is embedded into certain firewall offerings of Juniper Networks and Fortinet with integration work with other similar companies underway. We’re pleased to say that first sales of NetworkSecure-enabled firewalls of both channel partners have been executed. We believe this is a significant market opportunity for the company in both the commercial and government markets.

As distributors and resellers of Juniper and Fortinet firewalls who are our partners, such as Carahsoft and Exclusive Networks become fully activated, we expect commercialization of Arqit NetworkSecure to gain more traction. The TradeSecure product has benefited from regulatory progress this year. The Electronic Trade Documents Act came into force in the United Kingdom in September 2023 and permits the use of legally recognized digital trade documentation. Digital trade documentation offers benefits to importers of lower administrative costs, faster payment for exports and lower capital allocation for banks. The supply chain finance market is a large and growing market, and digital transformation is accelerating now as a result of legal clarity.

Arqit believes that TradeSecure is the only digital trade documentation product, which is fully compliant with EDTA and provides the added benefits of symmetric key agreements encryption. Arqit’s first channel partner to bring TradeSecure to market is Traxpay. Currently, the first trade finance transactions under the Electronic Trade Documents Act, using TradeSecure are progressing. We expect to announce them shortly. Arqit has identified and is in discussion with additional potential supply chain finance and banking channel partners to bring TradeSecure to market. WalletSecure, which provides compliance analytics and digital asset security, is our newest specialized application and is targeted towards the financial services industry. WalletSecure will be offered as part of an existing product offering of a major global financial services company.

We expect to announce that arrangement in the near term and have this product offering come online in fiscal 2024. For fiscal 2023, we generated revenue from all of our product offerings that were available to the market, being QuantumCloud, PaaS, QuantumCloud Private Instance, NetworkSecure and TradeSecure. In the case of QuantumCloud Private Instance and NetworkSecure, we have made multiple sales of these products. Again, while the number of revenue transactions is modest, sales across all of our available products is encouraging. To provide Arqit with additional runway to progress the commercialization of its products, we took significant actions in 2023 to improve our capital position and lower our operating costs. The company undertook 2 offerings of common stock and also placed stock through an at-the-market placement program.

We raised $47.7 million in gross proceeds from those offerings during the period. Our cash balance at the end of fiscal year 2023 was $44.5 million. We announced with our first half results and successfully executed a cost reduction action and benefits which became evident, started in July. Nick will discuss more about this in a moment. Taking cost actions, which included reducing headcount are difficult decisions. However, for the stability of the business, they were the correct decisions and give Arqit the best chance to realize the value we see in our groundbreaking symmetric key agreement platform. We believe that the opportunity in which our product addresses merits additional patients as we work to further activate our channel partnerships and sign new such relationships.

Our product develops stronger, simpler encryption in a manner that Arqit believes meets the requirements of the White House’s National Security Memorandum 10, which calls for the adoption of enhanced encryption and advocates for symmetric key solutions. Significant technology companies share our view and have become partners. Furthermore, we believe we are unique in having such a solution available today that is compatible with existing protocols and standards and is easy to implement. We believe that we made meaningful progress with the business in 2023, and we’re optimistic that our channel partnerships will deliver further improvement in 2024. With that, let me turn the call over to Nick Pointon, our CFO, for his remarks on our financials.

Nick?

Nick Pointon: Thank you, David. We announced early in the fiscal year that was exploring transactions to sell or otherwise monetize its satellite under construction. The satellite was part of our original technology. As we previously stated, through innovation, our technology stack no longer requires a satellite component, and it is now entirely software-based using terrestrial classic computing technology. We have reclassified intangible assets and project development costs related to the satellite and have presented them as discontinued operations according to IFRS 5. Our fiscal 2023 results and 2022 comparisons reflect this new classification. For the 12-month period ended 30th September 2023, we generated $5.6 million in revenue and other operating income from discontinued operations.

For the comparable period in 2022, we generated $20.0 million. Revenue from our QuantumCloud product for the period totaled $639,968 generated by 7 contracts, representing revenue through 6 different channel partners. As David noted earlier, we generated revenue from all 4 products currently available for sale, including multiple sales of QuantumCloud Private Instance and NetworkSecure. The balance of the fiscal year 2023 revenue was from other operating income from discontinued operations, specifically from our contract with the European Space Agency associated with the satellite development. Future other operating income from our ESA contract is uncertain. For fiscal year 2022, revenue and other operating income from discontinued operations was $20.0 million, of which $7.2 million was revenue from our QuantumCloud product and $12.8 million from our contract with the European Space Agency.

Revenue from our symmetric key agreement products for the period was highly concentrated as $4.7 million of $7.2 million or 65% was from the direct sale of one enterprise license contract with Virgin Orbit. The direct sale of enterprise licenses is no longer our primary focus as a result of our pivot in our go-to-market strategy. The year-over-year decline in revenue from our QuantumCloud product reflects the refocusing of our sales effort through OEMs, distributors and resellers. It was a step back to move forward. The 2023 versus 2022 decline in operating income from our ESA contract reflects slower development of the satellite as we contemplated selling or otherwise monetizing the asset. Discussions regarding possible transactions associated with the assets are ongoing, but there can be no assurance that the transaction is consummated.

Our administrative expenses equate to operating costs for those more familiar with U.S. GAAP. For fiscal year 2023, our administrative expenses were $55.2 million versus $71.0 million for fiscal year 2022. Lower share-based compensation and foreign exchange loss were the largest drivers of the variance between periods. We announced a cost-saving initiative in May, along with our H1 results. A significant component of the cost actions was a reduction in headcount. Our headcount at the end of H1 was 170 employees. As of September 30, it was 147. We began to realize the benefits of our cost-saving initiative in July. We have continued to review all areas and functions in pursuit of increased operational and cost efficiency. Administrative expenses for the fiscal year 2023 includes a $14.1 million noncash charge for share-based compensation versus $21.7 million charge for fiscal year 2022.

Operating loss for the fiscal year was $84.4 million versus a loss of $63.8 million for fiscal year 2022. The variance in operating loss between periods primarily reflects lower revenue and the reclassification of other operating income as profit from discontinued operations, combined with a $12.3 million impairment on trade receivables and contract assets associated with the Virgin Orbit bankruptcy and $17.6 million impairment associated with satellite project development costs. We generated a loss before tax from continuing operations of $73.9 million. However, we generated an adjusted loss before tax of $84.7 million, which in management’s view, reflects the underlying business performance once noncash change in warrant value is deducted from loss before tax.

For fiscal year 2022, we generated a profit before tax from continuing operations of $53.4 million and an adjusted loss before tax of $64.0 million. We raised $47.7 million in gross proceeds from the sale of common stock during fiscal year 2023. We issued shares in 2 registered direct offerings, one in February and one in September. We also placed shares directly into the market through an at-the-market issuance program. As a result, we ended the period with a cash balance of $44.5 million versus a cash balance of $48.9 million as of fiscal year-end September 30, 2022. With that, I’ll turn the call back to David.

David Williams: Thank you, Nick. As I noted at the opening, our top line performance was modest. Activating go-to-market channel partnerships with large OEMs, distributor and reseller partners does take some time. There is most certainly, in our view, a market for our products, and it has strong efficacy. We must now get our channels to a tipping point, and we do see reasons for optimism in sales across our product offering, sales across channel partners and momentum across geographies. We’re working hard with our partners to perfect sales strategies, which will benefit all parties. We hope investors can appreciate the uniqueness of our technology and market opportunity and demonstrate patience with Arqit as we strive to deliver success. I now hand the call back over to the operator for Q&A.

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Q&A Session

Operator: [Operator Instructions] Our first question today is coming from Scott Buck of H.C. Wainwright.

Scott Buck: David, I’m curious, how are you thinking about the anticipated ramp in revenue in ’24 as these relationships mature versus your current cash balance? I mean do you have enough runway to get you at least meaningfully closer towards the operating breakeven?

David Williams: We have confidence that the scale of our channel partnerships and the increasing maturity of those partnerships does offer us the ability to get towards cash flow breakeven within a relatively modest time period. We’re, therefore, reasonably confident that the amount of runway that we currently have gives us a degree of comfort that we’re satisfied with.

Scott Buck: Great. That’s helpful. And then I wanted to ask, you have a good base of channel partners in place now. Are you still having meaningful discussions with other potential partners? Could we see announcements over the next few months on that end?

David Williams: Yes. We are working hard with several very large technology companies who are similar OEMs with detailed software integration work in progress and go-to-market strategies under discussion. I’m hopeful that these partnerships will quite soon come to fruition and that they would be announceable in the short term.

Scott Buck: Great. That’s helpful. And then last one for me. On the satellite business, are there other potential strategic opportunities besides just an outright sale that could help you at least partially monetize those assets?

David Williams: We are working and have been for quite some time with a number of potential partners who have expressed an interest in cooperating with us to monetize that satellite technology. It can’t be certain that deals will come to fruition, but we are working very hard with a group of organizations that offers some potential for us to generate an elegant outcome for that project.

Operator: [Operator Instructions] At this time, I’m not seeing any further questions. I’ll turn the call back over to David Williams for closing remarks. Please go ahead.

David Williams: Thank you, operator, and thank you, everyone, for joining the call. We look forward to speaking with our investors and analysts again following the close of our next fiscal half year results. And we are anticipating bringing forward some new investor events in the near term to share deeper information about our progress. Thank you all very much.

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