Arqit Quantum Inc. (ARQQ) on Q1 2022 Results - Earnings Call Transcript
Operator: Good day and thank you for standing by. Welcome to the Arqit Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. On today's call, we will be referring to the press release filed this morning that details the company's first half of fiscal year and 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 maybe 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, Carmen. Hello. I'm David Williams and I'm joined by our Chief Financial Officer, Nick Pointon. Welcome everyone to Arqit’s Half Year Results Conference Call. While this is not our debut earnings call, it is an important milestone as it represents our first full period of commercial operations since our NASDAQ listing in September of 2021. We're pleased with our results for the six months ended March, 2022, compared with a nominal prior year revenue, we've generated $12.3 million in revenue and other operating income for the first six months of our fiscal year 2022. While we're pleased with the financial results, we are perhaps more excited about what the period suggests for our future prospects. As a young company, we are on a journey. We are growing in our development of our technology. We're growing in our understanding of the application and use of our product. We're growing in our understanding of how to sell our product. And we're growing as an organization to meet the market opportunity, which we see in front of us today. There is one thing about which we are absolutely certain, the needs today for stronger, simpler encryption to address current security threats and the threats of tomorrow. Whether it is in conversation with enterprise customers, governments, or regulatory bodies, the awareness of the need for focus and action to proactively address the issue is becoming profound. Last week, the White House issued a national security memorandum in which it urged U.S. government departments to prepare for the quantum threat and noted that symmetric encryption is presently regarded as a suitable upgrade path. This is the very technology that Arqit uniquely has transformed. Arqit is positioned to benefit from the tailwind of the market imperative for improved security and does so with unique technology. Arqit sells a symmetric key agreement software platform. Quantum safe keys can be generated by endpoints using a lightweight software agent with zero trust in the instant needed in practically unlimited group sizes for secure data and communications channels. Symmetric encryption has always been the benchmark for cryptographic security. It’s drawback has been its distribution in efficiencies, Arqit solves that problem. This is crucial since the algorithms required to use symmetric keys are already standardized and widely understood. Thus Arqit's technology represents a reimagining and greatly more usable version of an existing standard, which means that customers do not need a costly replacement cycle to use QuantumCloud, as our products already fit into many existing standards and protocols. Last week, the national security memorandum on promoting United States leadership in quantum computing while mitigating risks to vulnerable cryptographic systems said that by December 2023 agencies maintaining national security systems shall implement symmetric key protections. Arqit fits that category and most competitors do not. To more easily demonstrate an evidence, the unique quantum safe capabilities of Arqit's technology to customers, we submitted Arqit security proof to the University of Surrey for review. The University of Surrey is widely recognized as an academic center for excellence in cybersecurity research by the UK government's national cybersecurity center. We announced the results of the review yesterday. The review concluded that Arqit's symmetric key agreement technology generates encryption keys, which are zero trust and computationally secure and declared that our technology represents a significant advance in secure communications. Arqit continues to innovate. Last week, we were informed that a fifth patent family was granted by the UK intellectual patent office. During the six month period ending March, Arqit submitted 145 additional claims in five new patent families bringing Arqit's total to 1,580 patent claims and 26 patent families filed or granted in the UK. We hope to be able to discuss some of the key innovations, which are under development in the near future. Innovations in the queue could potentially make our technologies more efficient, save costs and increase product features. Our success with customers in the first half and announced demonstration initiatives confirm that we have targeted the right industry segments. We continue to focus on defense, telecoms, financial services and the Internet of Things. We continue to develop potential use cases for our products and how to take them to market. For example, our partnership with Blue Mesh funded by the UK government Department for Culture, Media and Sport to demonstrate a quantum secure data communication service over a widely standardized protocol called MQTT for industrial IoT is a fine example. The applicability of the product is broad. We can take what we learn from the demonstration and seek to monetize it across a range of industrial IoT applications. We described another compelling use case through our social media channels this past Monday. A major cybersecurity vendor and Arqit jointly demonstrated the first quantum secure firewall at the Cyber UK Security event hosted by the UK National Cyber Security Centre. It is clear to us from this demonstration that a quantum safe firewall is a compelling and broadly applicable use case. And also that leading hardware and security vendors are increasingly forward thinking about meeting the quantum threat and are open to incorporating innovative third-party technologies. Over the past six months, we’ve grown in our understanding of our value proposition and how to position it with customers. From the perspective of the customer, it is often the ease of implementation there’s a major purchasing decision factor. Our QuantumCloud product can be integrated into existing security architectures to provide the benefits of symmetric key encryption without the need to rip and replace. Our product is compatible with the AES256 symmetric encryption algorithm, which is widely used today. QuantumCloud can wrap a client’s existing architecture, providing the benefits of symmetric key encryption, while permitting the client to evolve its underlying architectures over time. We believe emphasizing ease of implementation will be an important sales differentiator as we move forward. In terms of sales opportunities, we see significant potential client demand in both the enterprise and government markets. We’ve expanded our sales teams significantly since September with in-country coverage now for all of our major target markets internationally. Our focus is on the prioritization of the customer opportunities, best able to deliver significant near-term results. We must marsh our resources effectively to maximize results. We’re pleased with our announced first half results. We expect to build momentum from our first half performance, continued success in the commercial sector and meaningful announcements in specific industry verticals, such as telecoms and defense are anticipated in the second half of our fiscal year. With that, let me turn over the call to Nick Pointon, our CFO for a few remarks on our financials. Nick?
Nick Pointon: Thank you, David. As we only commenced commercialization and began generating revenue late in the second half of our fiscal year 2021, a comparison of our current half year results with a comparable period in the fiscal year 2021 may not be meaningful across all financial metrics. For the six month period ended March 31, 2022 we generated $12.3 million in revenue and other operating income from new QuantumCloud contracts and other activities. Our QuantumCloud revenue totaled $5.3 million for the period generated by four contracts. The bulk of the QuantumCloud revenue was generated by contracts with Virgin Orbit and AUCloud. It is our expectation that the scope of these contracts will expand in the future. Other operating income of $7 million resulted from Arqit’s ongoing project contract with the European Space Agency. Our administrative expenses equates to operating costs for those familiar with U.S. GAAP. For the period, our administrative expenses were $26.6 million versus $5.5 million for the comparable period in fiscal year 2021. The material increase in expenses reflect significant post listing growth in our operating infrastructure costs and personnel reflecting a 35% increase in head count to 109 employees during the period. Additionally, $10.1 million of the increase reflects a non-cash charge for share-based compensation. Operating loss for the period is $14.3 million versus a loss of $5.5 million for the comparable period in fiscal year 2021. We generated a profit before tax of $58 million. However, we generated an adjusted loss before tax of $14.4 million, which management’s view reflects the underlying business performance once non-cash change in warrant value is deducted from profit before tax. During the period, 1.85 million warrants were exercised with cash proceeds to market of $21.3 million. We ended the period with a cash balance of $82.3 million versus a cash balance of $87 million as of the end of fiscal year 2021. Market believes it has sufficient financial resources to meet its funding needs. As our revenue and contract base increases, providing us with a deeper data set from which to draw conclusions, we expect to provide KPIs to give constituents a better understanding of the business. With that, I’ll turn the call back to David.
David Williams: Thank you, Nick. As I said at the outset, this is a journey. On September 30, 2021, we were a company with 74 employees and revenue and operating income of just $48,000. Six months later, we had become an organization of 109 people and revenue and operating income of $12.3 million generated from our contracts with leading organizations. We’re learning and growing every day. Our conviction in our business, driven by our belief in our technology grows every day as well. The excitement and confidence in Arqit is shared by our investors. Today, we also announce that shareholders holding 105.9 million of the 108.6 million shares previously subject to lockup agreements that were due to expire in connection with this results announcement were approached to voluntarily extend their lockup agreements until September. All approached shareholders agreed to participate. We appreciate this strong statement of support. We hope you share our excitement as well. We thank you for joining us today. And now I’ll hand the call back over to the operator.
Operator: Thank you. And we have a question from the line of Scott Buck with H.C. Wainwright. Please go ahead.
Scott Buck: Hi. Good afternoon, guys. David, I was hoping you can give us a little bit more color on the major enterprise grade vendor reference in the press release. Is this something that we could expect monetization from near-term? Or how should we think about the size of the potential opportunity here?
David Williams: Thanks, Scott. There is a very deliberate strategy for us to work with significant vendors of both hardware and software products. It is a powerful sales channel tactic to embed our software into what vendors are doing, because it makes it easier for the sales channel partners like telcos to just sell our platform in scale. There are actually a number of major vendors with whom we’re currently engaged in projects that see our software being embedded. For example, this week we did undertake a demonstration with a firewall vendor at a cybersecurity conference showing how Arqit software can be integrated with a firewall. And that was very successful. I do believe that successful integrations with vendors should lead to the commencement of monetization within a reasonably short period of months or a couple of quarters.
Scott Buck: Great. That’s helpful. And this is probably a question for Nick, but where do I see the grant revenue flow through the P&L?
Nick Pointon: So pure government grants flow to the balance sheet, where you can see them under non-current liabilities, specifically the trade and other payables under non-current liabilities and grants will then amortize to the P&L as an offset to the costs in the future.
Scott Buck: Okay. So grants are completely excluded from the $12.3 million of revenue reported this half.
Nick Pointon: That is correct.
Scott Buck: Okay. And then another kind of accounting question here. I mean, why the difference in accounting between QuantumCloud revenue and ESA revenue?
Nick Pointon: So our primary line of business is the selling of symmetric key encrypt software platform. So, any revenue from our primary line of business is classified as revenue. Our work with the European Space Agency meets the five steps for revenue recognition to be recognized as revenue. However, since it is not part of our primary line of business, we disclose this as other operating income. It is a revenue distinction without any difference.
Scott Buck: Okay. Understood. Thank you. And then, how should we be thinking about operating expense growth from here? Obviously, a significant amount of hiring. At this point, do you guys think you have the infrastructure in place to support meaningful top line growth? Or should we expect a significant ramp in OpEx from here?
Nick Pointon: We’re not giving guidance. What we can say is, we expect costs as a percentage of revenue to moderate as revenue scale. We do not – we do have infrastructure in place to support meaningful growth. But have plans to expand engineering and customer fulfilment roles as we move through the years.
Scott Buck: Okay. That’s helpful, Nick. And then David, can you help walk us through sales cycle? And I guess, I’m curious, you announced the demonstration with Blue Mesh and you had the CRADA with the air force. I mean, how do we think about those announcements in terms of potential revenue opportunities down the road?
David Williams: So demonstrations like the Blue Mesh example, proved with a degree of government implementer, that project was funded by the British government that Arqit’s technology is widely interoperable with common open standards. In this case, we were referring to the open standard that governs much of the Internet of Things, technology being deployed globally. So demonstrating interoperability with standards is definitely important. And I’ve received a number of inbound calls from potential customers just in the last 24 hours on the back of that. So that demonstration is important in generating new business. And I expect the pace with which we’re able to capture new business from IoT companies to accelerate as a result of that demonstration. With respect to defense customers, you will very rarely see announcements from us. There are a small number of public facing announcements that are possible where we are engaged in broad programs like the CRADA that you’ve referenced. But you won't see announcements from us on other projects, which are covered by higher levels of secrecy. However, when we are able to announce a project like the CRADA or the multi-domain integration program with the United Kingdom, Ministry of Defense that we announced last month, it means that the company, its products have undergone a degree of diligence and onboarding that enable us to represent ourselves to those defense organizations as suppliers with a degree of accreditation. And that degree of accreditation grows over time, the more projects that we do. So that's definitely an important part of the journey to generate monetization in the defense market.
Scott Buck: Great. That's helpful color. Appreciate the time guys. Thank you.
Operator: Thank you. And this concludes our Q&A session. I will pass it back to David Williams for any closing remarks.
David Williams: Are you sure there are no other questions, operator? I believe that one or two of the other analysts might have some questions.
Operator: It’s Simon Strong with Cenkos. Please go ahead. Your line is open.
Simon Strong: Hi guys. Well done on a set of results, which I saw you put lots of effort into. I've got a question please on balance sheet. I did drop out for a couple of minutes. So I hope this question hasn't already been asked. Perhaps you can clarify the movements in the balance sheet. The PPE figure has been built up substantially in the first half for just under $8 million. Is that a fair interpretation that relates to the rollout of a private instance contract, which you would expect to see given your business model? And the other point on the balance sheet I wanted to try and understand is your working capital model, trade receivables have risen substantially and stand quite a high figure relative to revenues, but your trade payables were relatively flat. Can you just walk us through the working – talk us through the working capital cycle in a bit more detail so we can understand those movements please?
Nick Pointon: Sure, Simon. I'll take these. So I think with regards to your first question, the rise in PPE in the half year, the principle reason for the large jump is actually accounting consequences of accounting for what's called a right of use asset in connection with our London office. It is a non-cash item. Satellite costs are actually included within intangible assets. With regards to your second question on the increase in trade and other receivables, during the period, we have the receivables connected with the revenue as you point out. But in addition, in those items, we also have the receipts – the final trash of the cash from the warrant exercises that happen in the period. The cash is received one week in arrears from the accounting for the exercises. So that's together with the revenue account for the large increase that you'll see at the end of the half period.
Simon Strong: Okay. That makes perfect sense. Thanks very much. I do have one other question if I have time, please. Is it reasonable expectation that given the level of capitalized expenditure on intangible assets seen in the first half that could rise further in the second half? Or is that going to level off the sort of levels – I know if you're providing any specific guidance, but perhaps just an indication of where that figure might go to would be useful, please.
David Williams: We are providing guidance, but that line does reflect the investment in the satellite. And we will continue to invest in that line item.
Simon Strong: Okay. Brilliant. Thanks very much, guys. We're done on getting the results out.
David Williams: Thank you, Simon.
Operator: Okay. And with that, I will pass it back to management for any final comments.
David Williams: Thank you very much, everyone for attending the conference call today. If there are ongoing questions, please contact us directly or through the contact us email address on the website. And I look forward to talking to you again soon. Thank you.
Operator: And with that, we conclude today's conference. Thank you for participating. And you may now disconnect. Everyone, have a great day.
