Arqit Quantum Inc. Q4 FY2024 Earnings Call

Good day, and thanks for being with us. Today’s call will reference the press release issued this morning detailing the Company’s Fiscal 2024 Results, available for download on the company’s website at arqit.uk. After the prepared remarks, there will be a question-and-answer session. Additionally, a recording of the call will be accessible in the Investors section of the company's website later today. Please note that this webcast includes forward-looking statements. These statements reflect the company's beliefs and expectations and include terms like may, will, could, believe, expect, and similar expressions. They are based on assumptions and beliefs as of today. The company encourages you to review the Safe Harbor statements, risk factors, and other disclaimers in today’s press release, along with the company's filings with the Securities and Exchange Commission, which identify specific risk factors that could cause actual results or events to differ significantly from those described in our forward-looking statements. The company does not commit to publicly updating or revising any forward-looking statements after this webcast. It is important to note that this call may also discuss non-IFRS financial information, provided 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 included in today’s earnings release. Now I will hand the call over to Andy Leaver, the company’s Chief Executive Officer. Andy?

Thank you, and thank you for joining our fiscal year 2024 earnings call. I'm pleased to discuss Arqit's financial year results. Let me start by saying that I stepped into the CEO role at an exciting time for the company. The market for better, simpler encryption, which addresses cybersecurity issues today and those posed by quantum computers is moving towards us. Previously, it had been major governmental entities such as the White House and the NSA evangelizing solution providers such as Arqit driving the discussion about the need for enhanced cryptography. What we saw during 2024 was the marketplace pick up the microphone and start leading the dialogue. That is a fundamental and positive development. Before discussing the market for our products and our fiscal results, let me take a moment to introduce myself and comment on stepping into the role of CEO at Arqit. I most recently have been an operating partner at Notion Capital. Notion is a leading European technology venture capital fund. It has been a long-time investor in Arqit. Prior to joining Notion, I was a senior executive at leading software companies such as Ariba, Bazaarvoice, Hortonworks, SuccessFactors, and Workday. I held positions including international VP, CRO, and COO. In addition, I have advised several successful private software scale-ups. Understanding of and working with software companies at Arqit's stage of development is squarely in my expertise and experience. I was asked by the Board of Arqit early in 2024 to do a deep review of the Company, its product, and the market opportunity. My survey covered all aspects of the business. After a several-month review, I concluded the following: Number one, Arqit's symmetric key agreement software product is unique and built for purpose. Number two, there is a significant market opportunity, which is only beginning to be addressed. Number three, Arqit's engagement with OEMs, network operators, governments, and end-users is accelerating. And number four, the company needed to focus its operations and resources in line with this opportunity set and stage of development. In summary, I concluded that Arqit has a compelling product offering and significant market opportunity. That was the message I conveyed to the Board. The Board of Directors approached me in mid-summer regarding stepping into the Chief Executive role. Given the conclusions from my review of the company and my executive skill set, I believe that I could help the company focus these efforts and scale revenues. Obviously, I accepted the position. I'm excited by the opportunities in front of the company. My primary objectives are; number one, focusing the sales efforts on markets and prospects which represent meaningful near-term revenue. We are also building our technology roadmap for future verticals and opportunities. That said, we do not lack for near-term sales opportunities. Number two, appropriately allocate on our personnel and expenditures in support of our sales initiatives and customer fulfillment. Sales without excellent customer fulfillment and support is not a recipe for success. Number three, ensuring the stability of the business, that means making sure Arqit is appropriately capitalized and on firm footing from a legal and regulatory perspective. The Board is supportive of my objectives and shares my positive assessment of Arqit's prospects. Members of the Board demonstrated their support for the company by investing additional capital in the company this autumn. Support from several leading stakeholders was greatly appreciated and gives the company confidence in moving forward with purpose. Circling back to my earlier comments about the market moving toward Arqit, 2024 was the year of all things AI. It dominated headlines and was a big catalyst for the stock market. Is 2025 going to be the year of all things quantum? Difficult to say for sure, but we've seen an increase and acceleration in the dialogue around quantum computing and encryption in 2024 which should continue into 2025. Importantly, as I mentioned, the dialogue is coming from the marketplace and media; previously, it had been governmental agencies and companies such as Arqit driving the narrative. For instance, in October, Gartner named Quantum Computing and encryption as one of the major technology trends for 2025. In November, Amazon Web Services launched Quantum Embark, an advisory program that aims to prepare its customers for society's shift towards quantum computing, and mainstream media ran hard with the story regarding the possible cracking of RSA encryption by a quantum computer. While the merits of the story remain in doubt, it demonstrates the spotlight that is beginning to shine on all things quantum. The spotlight has shone on Arqit as well. International Data Corp, or IDC named Arqit a 2024 IDC innovator for post-quantum cryptography. Arqit is one of only five vendors recognized by IDC as providing transformative solutions, which enterprises can use to protect classical data and infrastructure with a long shelf value from the risk of a potential quantum cyberattack. Three factors have come together to drive increased customer engagement for Arqit: the market's heightened awareness of the quantum threat, Arqit's compliance with the NSA commercial solutions for classified symmetric key management requirements, and industry recognition for our technology by organizations such as the global mobile awards. As a result, Arqit engaged with eight leading telecom network providers during the fiscal year with the pace of engagements increasing over the period. To be clear, these engagements have been focused on technical and integration matters. However, these engagements represent opportunities for conversion into annual recurring licenses associated with sell-through to the network operator's customers or a license for our symmetric key agreement software for use by their network operator within its own estate. Our engagement with Sparkle serves as a blueprint for success with other network operators. Sparkle is rolling out its Quantum-Safe network-as-a-service product offering secured by Arqit. It serves 33 countries with a network of over 600,000 kilometers of terrestrial and subsea fiber. We will generate license revenue as Sparkle signs up customers for its service. We are excited about this partnership opportunity and see additional opportunities with our partners. Our relationship with Sparkle developed quickly. While we'd like all our engagements with other network operators to move as quickly, we must be mindful that these are large counterparties with sophisticated technological requirements. It takes time and significant interaction to reach commercial acceptance given the critical nature of our security offering. The feedback we receive is positive as we move through the process with each prospective network operator. We are confident that future contractual revenue can be realized from this key target market for Arqit. Another key market target for the company is the government and military markets. The company announced in May that it had been awarded a seven-figure multi-year contract which was subject to final documentation. While finalization of documentation took longer than we expected, we are pleased to say that the contract was executed prior to the close of the fiscal year. The contract is through our Middle East distribution partner for a significant governmental agency in the region. We expect to commence booking revenue under the contract in the current fiscal year. The contract is significant in and of itself as it represents meaningful contractual annual recurring revenue. In addition, the contract provides our target with a marquee reference customer, which should result in further opportunities with other governmental agencies and significant in-country commercial enterprises. We are currently in dialogue with several parties. While we see land and expand potential in this particular country, we expect this win to have broader positive implications across all our government and military activities. Arqit executed under two contracts for two defense contractors during the fiscal year, both for our Symmetric Key Agreement Platform as a Service. We believe that the government and military markets represent significant opportunities for Arqit. Identified prospective customers have increased. The level of dialogue is up, and we are beginning to see contract wins and revenue. These are tough markets to break into, but we have a foot in the door. If we can step through the door, these markets are vast. Our revenue for the fiscal year was $293,000, down from $640,000 in the previous year, that's in U.S. dollars. Neither result is compelling, nor are they reflective of the market opportunity and underlying progress which the company has made. Nick will discuss the movement in revenue in a few minutes. I want to make sure not to lose sight of the progress we have made in fiscal year 2024. We executed on 13 contracts in 2024 versus seven in 2023. We delivered for 13 customers in 2024 versus six the prior year. Arqit engaged in significant technical discussions with 11 entities, including eight telecom network operators. These represent near-term opportunities for conversion into material revenue contracts. We engaged in 19 technical demonstrations across a range of end-markets, including VPN service providers, edge computing, government, defense organizations, and network performance monitoring, and executed a significant ARR contract with a leading government organization, which should have a material knock-on benefit. It is the growing market awareness of the need for Arqit's product and the tangible evidence of progress by the company that excited me to take on the role of CEO. Yes, a lot of work is in front of us to drive revenue to scale. I have successfully done that in the past with companies at Arqit's stage of development. Importantly, the pieces are in place to build towards success. We've taken critical steps since I joined the company to focus our efforts and ensure stability in our business. We have undertaken additional cost-cutting initiatives which build upon those taken earlier in the year. Budgeted monthly operating costs for fiscal 2025 have been reduced to $2.15 million per month. Thus far in fiscal year 2025, our cost savings initiatives are ahead of budget. Headcount has been reduced to 82 employees at fiscal year-end from 147 the prior year. As part of the headcount reduction process, we have reshaped our workforce to prioritize sales, engineering, and customer fulfillment. It is not about doing more with less. It is about allocating resources to the most mission-critical tasks at our stage of development. It is also about driving decision-making down in the organization so we can be responsive. It is about focusing on the most important opportunities. In the current fiscal year, we'll be focused particularly on the telecom network, government, and military markets. We are also investigating financial services and IP-rich industries. Conversion of our current engagement with prospective customers to operating licenses is our top priority. Adding additional opportunities to our sales funnel is important, but not at the expense of converting prospective customers with whom we are deep in discussion. Refining our internal processes to ensure the highest quality customer fulfillment and support is imperative; we have made significant progress in this regard. While I cannot opine as to whether 2025 is the year of quantum, I do know it brings the world a year closer to a quantum computer at commercial scale. And that means the need for post-quantum encryption grows. Arqit's symmetric key agreement software addresses that need. We are focused on the hard work necessary to build upon 2024's progress and take large steps forward in 2025. With that, let me turn the call over to Nick Pointon, our CFO, for a few remarks on our financials.

Thank you, Andy. For the fiscal year, Arqit generated $293,000 in revenue as compared to $640,000 in revenue for the comparable period in 2023. The decrease was due to no significant perpetual enterprise licenses being sold in fiscal year 2024. In fiscal year 2023, the company sold 2 such licenses with high upfront revenue, which represented a significant portion of revenue during that period. Arqit has intentionally moved from perpetual licenses towards operational licenses with prospective annual recurring revenue. The transition results in lower upfront revenue associated with a perpetual license. While generating upfront revenue, operational licenses are expected to result in growing annual recurring revenue as consumption of our symmetric key agreement software increases. Arqit SKA platform contract revenue totaled $293,000, of which $102,000 was professional services in support of contract activity. Most contracts were limited licenses for demonstration and integration testing of Arqit's symmetric key agreement software. Arqit's SKA platform revenue for fiscal year 2024 was generated from contracts with 13 customers. Arqit SKA platform revenue for fiscal year 2023 was $640,000 from seven contracts, the bulk of which was from two perpetual licenses. Our administrative expenses equate to operating costs for those more familiar with US GAAP. Administrative expenses for the period were $23.5 million versus $55.2 million for fiscal year 2023. Lower share-based compensation, employee expenses, and legal and professional fees were the largest drivers of the variance between periods. Arqit's head count as of fiscal year-end was 85 compared with 147 for the fiscal year end 2023. Administrative expenses for the period include a negative $1.6 million non-cash charge for share-based compensation versus a $14.1 million charge for the comparable period in 2023. The operating loss for the period was $24.6 million versus a loss of $54.5 million for fiscal year 2023. The variance in operating loss between periods primarily reflects lower administrative expenses for fiscal year 2024. The loss before tax from continuing operations for the period was $23.9 million. Adjusted loss before tax for the period was $23.9 million, which in management's view reflects the underlying business performance once the non-cash change in warrant value is deducted from the operating loss before tax. For fiscal year 2023, the loss before tax from continuing operations was $44.1 million and adjusted loss before tax was $54.7 million. The variance between periods is primarily due to lower administrative expenses, impairment losses on trade receivables, impairment losses on intangible assets, and the change in fair value of warrants. Arqit ended fiscal year 2024 with cash and cash equivalents of $18.7 million versus a cash balance of $44.5 million as of Arqit's 2023 fiscal year end. With that, I turn the call back to Andy.

Thank you, Nick. I want to thank you for joining us today. If I leave you with one message today, it is that the market for enhanced encryption is moving towards Arqit. We have the right product. The challenge is on for us to capture the market opportunities that are most realizable. We do not lack for opportunities. We must stay focused and execute. It is my job to ensure that we do. I hand the call back over to the operator for Q&A.

Thank you. We will now begin the question-and-answer session. Our first question comes from Scott Buck with H.C. Wainwright. Your line is open.

Hi, good afternoon guys. Thank you for taking my question. Andy, first, I want to ask on the seven-figure Middle East deal that commences this period, can you discuss the revenue cadence? Does that ramp over time? Or should we see kind of a steady revenue flow through the period?

Yes, hi, good question. So the deal is – it doesn't ramp; it's steady. It's taken ratably. And you should see that deal start being led in during this reporting period, and you'll see that appearing in our results. So you'll see that start layering in.

Perfect. I appreciate that. And then kind of as a follow-up, the release mentioned, I think you mentioned in your prepared remarks, some additional government and enterprise contract opportunities in the region that this deal could be a potential catalyst for. Can you provide a bit more color on what kind of deals you're looking at there and maybe what the potential revenue opportunity is?

Yes. And again, good question. So there's kind of two angles I'll give you on that: first of all, it's governmental, and we're seeing some of the larger enterprises there take a strong interest. And behind that, as people who watch this space may see, locally to the Middle East, some of the governments have been very proactive and actually trying to enact legislation or guidance about taking post-quantum encryption earlier rather than later. And that's playing through into the governmental bodies in that region who are now engaging us in conversation. Now that we have a strong partner down there and the ability to deliver and have the connections down there, it puts us in a really good spot to have those conversations and follow through on delivering on those conversations. So very active and we have a lot of people in that region regularly to pick up on those conversations. So I feel good about that. Just to add one small little side note as well, I'm actually talking to you now from our U.S. office here in the Washington, D.C. area. And again, we see a large opportunity here with governmental entities as well, with similar challenges and similar problems, and we are working hard to replicate that story here as well.

Great. I appreciate that color. And then I'm curious how AI is playing a part in the Quantum-Safe story? Does that impact the use of your technology?

Yes. Again, good question. So we are never resting in terms of our technology roadmap. One of the most immediate things that we're looking at is how can AI play a role in our roadmap. One of the things we're looking strongly at right now is the remediation story. So if you think people look at the vulnerabilities in their network and their operations, think about how quantum could play a part in that. And we use – we are thinking of using AI now as the remediation agent to allow that dialogue to happen to suggest kind of conversationally how you may fix those issues you have and how our technology may be applied because I think I kind of call it putting technology in the hands of mere mortals, actually having the ability to go through the remediation process in a guided, intelligent way rather than having to have deep technical experts for every step of the process. So we are looking strongly at that now, and that's looking very promising.

Great. That's really helpful, Andy. I appreciate that. And then two quick modeling questions. You guys have done a really nice job bringing costs in. I'm curious as revenue starts to ramp here in 2025 and 2026, how quickly do you need to add back in some of those kind of infrastructure costs? Just trying to get a sense of what operating leverage could look like going forward?

I'll jump in for that. Scott, currently, we're on track for fiscal year 2025, so the current fiscal year. Our model suggests that we can deliver all our expected revenue in the current fiscal year with the current cost base. So very little leverage is expected in the current fiscal year.

Great. That's helpful. And then lastly, just on the cash balance. The raise that you did at the end of the quarter, is that included in the filed number? Or was that subsequent?

To the extent that cash had been received prior to year-end, it was included. A portion of the cash came in early October, so it has not been recognized. $1.8 million came in very early October but missed the cutoff for recognition in this financial period for FY '24.

Thank you. This concludes our question-and-answer session. Now I'll turn the call back over to Andy Leaver for closing remarks. Andy?

Thank you. And again, thank you all for joining us today. We look forward to speaking with you again following the close of our first half fiscal 2025 results. That said, we will find additional forums in which we engage with you in the coming year in an effort to be more timely in providing updates to investors. We appreciate your interest in the company. Thank you for joining us.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect. Speakers, please stand by for your debrief.