Earnings Call Transcript - ARQQ Q1 2025

Operator, Operator

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 fiscal year 2025 results, which can be downloaded from the company's website. At the end of the company’s prepared remarks, there will be a question-and-answer period for selected equity research analysts. 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. And now I'll turn the call over to Andy Leaver, the company's Chief Executive Officer. Andy?

Andy Leaver, CEO

Thank you, and thank you for joining our first half of fiscal year 2025 earnings call. I'm pleased by Arqit's performance for the first half of fiscal year 2025 and by recently announced developments in the business. If one looks at our results solely through the lens of first-half revenue, my comment may leave you slightly confused, but please bear with me for a moment. Arqit has developed a transformational technology for addressing significant weaknesses in today's encryption technology, weaknesses which will be magnified by the arrival of quantum computing. We believe that our symmetric key agreement encryption software is the most secure, standards-compliant, and implementation-flexible solution to meet the threat to data and communications. We are building a company to deliver our technology to sophisticated large enterprises and government customers. This is an ambitious objective, one with significant obstacles to overcome and timelines, which often seem elastic. However, I am pleased that we are making significant progress towards realizing our objective. Circling back to our first half performance and recent announcements, I'm delighted because Arqit has made significant progress in product development, penetration of key identified markets, sales pipeline growth, shift in business model, and cost of business process discipline. Tangible progress along all of these vectors are additional courses of brick, which build towards long-term success. Before I discuss Arqit's performance for the first half, let me briefly outline the market environment for our symmetric key agreement encryption software. The current weaknesses of today's public key cryptography, which safeguards much of the world's data, remain largely unmitigated. The pace of investment in and the development of quantum computers which pose an existential threat to current encryption is accelerating. Google, Amazon, and Microsoft all announced quantum computing chips during the last six months. Last week, Quantinuum, which is majority owned by Honeywell, signed a $1 billion deal with Qatar, which further develops its quantum computing technology. And this week, D-Wave announced its 4,400 cubic sixth-generation quantum computer, a major forward capability, which surprised the financial markets. There is little doubt that quantum computing at scale, known as Q-Day, is coming. When Q-Day arrives is uncertain, but I would predict it will be sooner than most expect given the players developing the technology and the vast sums being invested. And when it does, data that has not been safeguarded with quantum-safe encryption is at risk as quantum computers will render existing public key cryptography obsolete. Awareness of the need to upgrade to post-quantum cryptography is growing, and the call to action is increasingly urgent. Last week, Japan's Financial Services Agency instructed Japanese banks to take immediate action to begin shifting to post-quantum cryptography. This is just the latest example of influential government bodies, including the White House and the NSA, sounding the alarm. Arqit was early in identifying the risk to current cryptography and early in identifying a market opportunity for a solution. We have developed symmetric key cryptography software, which is quantum-safe and easily adopted as it is compliant with many of the most widely used communication standards. Put simply, we as a company have heavily invested in the right products for the current quantum threat at the right time. We feel uniquely positioned to take on the coming threats in the commercial, federal, and defense sectors. The market for our product keeps moving towards us. We're beginning to feel the market bear wave pushing us forward, and it is evident in our recent developments and prospective customer interactions. We talked much about our collaboration with a leading Tier 1 telecom network operator during our fiscal year 2024 results. Our partner integrated our Arqit NetworkSecure encryption products into its network as a service and announced that in 2024 it will be rolling the product out to market. Importantly, shortly before the close of our first half to enable commercial rollout, the network operator signed a three-year contract licensing NetworkSecure for resale to its end customers as part of its network as a service offering. Arqit NetworkSecure enhances and differentiates its offering. It sees a market need which we can address. The signing was a culmination of a 14-month journey from testing to business care development to go-to-market strategizing. The contract highlights a number of important points. One, our focused targeting of large value vertical markets, particularly telecom networks and government defense, was the right decision. Two, our shift to a go-to-market strategy through leading hardware and technology vendors and network operators is the correct approach, integrating with and enhancing products and services, which end users already consume is an easier sale, and our partners are a field sales force multiplier. Three, our shift to a subscription licensing model properly aligns our interest with those of our customers. Our arrangement with a network operator is a B2B2B model. The initial license is for a defined amount of capacity of our products and can grow as end customer demand increases. This file of contract encourages the initial commitment to our product by our customer with a pay-as-you-grow approach as end customers take up the offering. Our customers succeed, and we succeed. Our interests are aligned. Four, and most importantly, there is end-user demand. The network operator who is already engaged with three significant end-user customers for its network as a service, secured by Arqit NetworkSecure. I expect that book of business will continue to grow, and we will be scaling up the contract to meet demand. And a final thought on this contract, it was a 14-month journey from a standing start to a signed contract. It's a blueprint, which we are replicating with a significant number of other large brand-name network operators with whom we are engaged. We expect cycle times to compress for these opportunities. In addition to the telecom network vertical market, the defense sector is another key market on which we are focused. Cybersecurity is a critical focus for defense and intelligence organizations. The battlefield from the warfighter to drones and finally command and control is increasingly being digitalized. The digital battlefield requires the highest levels of data security. We have spent significant time and resources in our effort to penetrate the defense market. Shortly before the close of our first half, we signed a contract, which has Arqit's symmetric key agreement software embedded into a solution sold to the US Department of Defense for a funded program of record. This is our first win with the DoD. The solution is in partnership with perhaps the largest IT vendor for the DoD and was sold through one of our established government sales channels. More details will be forthcoming. The importance of this contract win cannot be underestimated. It is a significant break in building the future success of the company. The contract confirms our technology is compliant with the National Security Agency's commercial solution for classified programs. Compliance with the program is critical to being considered for such contracts. Being able to reference these contracts in the DoD program of record makes the pursuit of additional DoD opportunities easier as well as proving our bona fides to other military organizations around the world. We have our foot now in the door of the large DoD market. It has taken longer than we expected to get to this point we have arrived, and we'll push to capitalize on the success with additional defense contract wins. An additional area of tangible success has been the continued development of further applications and use cases for our symmetric key agreement encryption software. Currently, our sales and contracting activity is focused largely on our Arqit NetworkSecure product, which enables quantum secure VPN connectivity, effectively securing data in transit. Ultimately, we want to develop applications of our core technology for securing data in transit, data in process, and data at rest. Perhaps the most exciting application development has been in securing data in process, otherwise known as confidential computing. Confidential computing protects data by encrypting it while it is being processed by a computer, which is particularly important when processing sensitive data on shared infrastructure like a public cloud. For instance, confidential computing would allow AI to train and run on sensitive data without exposing the data to cloud providers, systems administrators, or data center hosts. We announced in collaboration with Intel the integration of Arqit NetworkSecure running inside the Trusted Domain enclave created by Intel TDX. What this means is that together with Intel, Arqit can protect both data on the cloud server and while it's moving between cloud services in a way that makes it completely hidden from any would-be hackers as well as the hosting provider themselves. It provides data sovereignty across domains as information is processed, moves through data centers, and is sent to or from cloud repositories. Confidential computing is a focus for large enterprises and is a significant addressable market with use cases that include AI training and inference, processing regulated data, and the enforcement of Zero Trust. Our collaboration with Intel delivers a highly secure differentiated solution to the market. The collaboration takes Arqit a significant step closer to having additional applications for data in transit, process, and at rest. This is our third collaboration with Intel. We now have joint efforts across secure mobile communications, confidential computing, and server technology. Arqit is working jointly with Intel on further developments of these integrated technologies and go-to-market strategies. We are excited about where our efforts with Intel may lead. We stated on our fiscal year 2024 earnings call that focus was an important watchword for fiscal year 2025. One area of focus has been cost control, be it headcount, infrastructure, real estate, or travel. Nick Pointon, our CFO, will touch on these shortly. We've been disciplined in doing more with less and yet making substantial progress. Our performance compared to budgeted costs has been strong. I'm pleased by the discipline we have exercised, and we'll continue to do so going forward. Despite positive momentum in the market's understanding of our proposition and product adoption, some revenues were slower to be recognized than expected. We previously announced a multiyear contract with seven-figure total contract value for a customer in the Middle East. Revenue under the contract was expected to commence in early 2025. Due to unforeseen delays on the part of the end customer, revenue did not commence until very late in March, just before the close of the financial period. As our contract base is still modest and not able to readily absorb changes in timing, any unforeseen delays in contracts closing or revenue recognition can have an adverse effect on our results. Fortunately, the full terms of our Middle East contract remain in effect, and we expect to be recognizing revenue during the second half. I'm pleased with the progress we've made since the beginning of the first half of fiscal year 2025, with contractual wins in our two key vertical markets, telecom networking and defense, with additional visible opportunities to come. We are paying customers in the US, Europe, and the Middle East. We have exciting developments regarding additional applications in mobile communications and confidential computing plus others that I have not yet discussed. We remain disciplined in our cost control and internal processes. For the balance of this fiscal year, the key focus points for the company will be the conversion of concluded test and evaluation engagements into licenses. I see near-term opportunities, particularly in the telecom network space. Also, the commencement and hopefully completion of an end-to-end test and evaluation collaboration, which brings together a leading data center operator, a leading telecom network operator, an AI company, and leading network and server technology vendors. Finally, cost control will remain a priority. We have laid many additional courses of brick to support our success going forward. Our progress is being recognized in the marketplace, and brand and product awareness is driving sales inquiries. The level of foot traffic at our stand at the recent RSA Cybersecurity Conference and the sales leads generated were substantial, higher than we've experienced at prior conferences. The positive inquiries generated from leading IT vendors and network operators resulting from our tech and contracted partnership announcements were exciting. The sales leads generated create grounds for continued and increased optimism for the company's prospects. I believe revenue will ramp. Our encryption software is proven and unique. The market is moving towards us. We are well positioned to meet the rapidly growing quantum threat and address the resulting market opportunity. Thank you. Before I turn over the floor to Nick to discuss the financials, a quick housekeeping note. As of May 20, Nick has stepped down from the Board of Directors. I have joined the Board in his stead. I and the Board want to thank Nick for his service on the Board during this formative years of the company. He will continue in his role as our Chief Financial Officer. With that, now over to you, Nick.

Nick Pointon, CFO

Thank you, Andy. For the first half of fiscal year 2025, Arqit generated $67,000 in revenue as compared to $119,000 in revenue for the comparable period in 2024. As discussed earlier, revenue for the first half of the fiscal period was adversely affected due to end customer delays in commencing activity under a previously announced multiyear contract in the EMEA region. The variance between periods was also due to less revenue being recognized under customer contracts as Arqit continues to transition from primarily enterprise sales for which revenue is recognized upfront to sales through channel partners for which revenue is recognized over time as services are provided under the contract. Going forward, we expect less further impact from the transition from enterprise sales to SaaS sales, as the shift is now largely complete. Revenue from the Arqit SKA-Platform as a service and Arqit NetworkSecure products totaled $52,400. Professional services and maintenance revenue in support of contract activity was $14,500 for the period. For the comparable period in fiscal year 2024, Arqit SKA-Platform as a service and Arqit NetworkSecure contract revenue totaled $65,000, and professional services and maintenance in support of contract activity was $54,000. Arqit SKA-Platform revenue for the period was generated from contracts with six customers. For the six months ended March 31, 2024, the revenue was generated from contracts with nine customers. Four contracts represent a license for SKA-Platform as a service. Two such contracts represent multiyear recurring revenue contracts, specifically our contract in EMEA and our contract with a Tier 1 telecom network operator. We began recognizing revenue under both contracts immediately before the close of the first half period. Two of our six revenue-generating contracts were for Arqit NetworkSecure licenses. Two contracts for Arqit SKA-Platform as a service are professional services and maintenance contracts attached to them. It is our expectation that future SKA-Platform as a service contracts will similarly have professional services and maintenance contracts attached. Our administrative expenses equate to operating costs for those more familiar with US GAAP. Administrative expenses for the first half of fiscal year 2025 were $18 million versus $16.8 million for the comparable period in fiscal year 2024. The variance between periods was due to a lower headcount resulting in lower staff expenses and share-based compensation, and a reduction in property costs as a result of the termination of Arqit's previous office lease arrangements being more than offset by unfavorable changes in foreign exchange. Arqit's headcount as of March 31, 2025, was 72 employees, as compared to 125 as of March 31, 2024. Administrative expenses for the period include a $1.3 million credit for a noncash charge associated with share-based compensation versus the $293,000 credit for the comparable period in 2024. The operating loss for the period was $17.8 million versus a loss of $16.6 million for the first half of fiscal year 2024. The variance in operating loss between the periods primarily reflects lower revenue and an increase in administrative expenses for the period. For the period, the loss before tax from continuing operations was $17.2 million. For the first half of fiscal year 2024, the loss before tax from continuing operations was $16.1 million. The variance between periods is primarily due to lower revenue, increased administrative expenses, lower finance income offset by lower finance costs. As of March 31, 2025, the company had cash and cash equivalents of $24.8 million. And with that, I turn the call back to Andy.

Andy Leaver, CEO

Thank you, Nick. I want to thank you for joining us today. My final comment is that we believe momentum is building for Arqit. Market awareness of the need for quantum-safe encryption is growing. Awareness of our product is growing as well. Partners are selling Arqit-enabled solutions to their customers, and leading technology players are actively integrating our encryption software into applications to address market needs. The breadth and depth of discussions with additional potential partners is significant. All indicators are pointing in a positive direction for the company. Thank you again. And with that, I hand the call back over to the operator for Q&A.

Operator, Operator

Our first question comes from Scott Buck with H.C. Wainwright. Your line is open.

Scott Buck, Analyst

Hi, good morning, guys. Thanks for taking my questions. Andy, there's a lot to digest there. The deals that closed at or near the end of the fiscal period, are they currently generating revenue today? And are these under multiyear contracts for the most part or shorter periods?

Andy Leaver, CEO

Hey, Scott, I appreciate the question. Thank you. Let me tackle that. So as we mentioned in the earnings release, the contract with the Tier 1 network operator is for three years. The initial size of the contract minimizes its risk. We expect the contract will grow materially as it signs up end users. We noted that it's already engaged with three significant end users, as I mentioned, and we expect to revisit the contract relatively soon. As for the DoD contract, it's a one-year contract. A successful completion of the contract could lead to additional significant opportunities.

Scott Buck, Analyst

Great. And then I'm curious on the sales team. It sounds like you guys have been doing some hiring there. What type of folks are you hiring? What industries are they coming from? And generally, how long does it take to get a new sales hire up to speed?

Nick Pointon, CFO

This is Nick Pointon. I feared Andy may have lost reception. Just bear with us, please, Scott.

Scott Buck, Analyst

Of course, Nick. Thank you.

Nick Pointon, CFO

I see he's trying to get back in. Andy, are you there now?

Andy Leaver, CEO

I am. I'm not even sure where I cut off. Apologies, my line dropped.

Nick Pointon, CFO

It dropped at the end of my answer to your first question. So Scott, could you please repeat the second question regarding the salespeople?

Scott Buck, Analyst

Yeah, of course. Andy, it sounds like you guys have been active in hiring on the sales side. I'm curious what types of people have you been hiring? What industries are they coming from? And generally, how long does it take to get a new hire up to speed?

Andy Leaver, CEO

Yeah. Great question, Scott. So if you think to what I just talked to in the release, there are early salespeople who have really proved out a lot of these use cases. As I said, the telco operator was a 14-month cycle from start to end. So these people have really had to roll their sleeves up and get to work in figuring a lot of things out. Now that the majority of that is done, we can hire more commercially available salespeople because we have a blueprint in the sales book for that. So the first type of operators for each space in each region and each vertical they, of course, need to figure out the use cases and everything around compliance, how it fits in the infrastructure, et cetera. Behind that then, we're starting to hire people that know that vertical very well, so they can talk the language of the customer. For instance, in the US now, we're looking at filling roles around telco, and we'll be looking to fill roles more around defense. So these are people that are well-versed and deep operators in those sectors. But we have a number of open roles which we're actively recruiting for within our operating plan to start capitalizing on all the inbound that we saw at the RSA show recently in San Francisco. Hopefully, that helps.

Scott Buck, Analyst

Yeah, absolutely. So as you guys start stacking these contract wins, it sounds like the sales cycle is starting to compress a little bit. How much of that do you attribute to your ability to sell versus kind of broader market interest and maybe even a little bit of fear of missing out by some of the folks that are not as quick to move?

Andy Leaver, CEO

I believe we've previously discussed a pay-as-you-grow model that creates alignment between us and our customers. This model also helps them align with their end customers, especially in the telecommunications sector. We've focused on streamlining the sales process to facilitate incremental contracts, particularly concerning our service consumption. This includes aspects like endpoints and the number of keys generated, making it easier for customers to sign up for and absorb additional capacity under existing contracts. For renewals and expansions, we also strive to simplify the process as much as possible. Once we establish relationships with existing customers, we can broaden our presence more easily, given our technical familiarity with their infrastructure, allowing implementation to follow a set blueprint. It's important to highlight that we are a software company rather than a professional services firm, so we aim to make implementation as straightforward as possible. We believe we excel in integrating our technology into more complex customer environments. New customers can reference existing ones, which makes initial sales easier than before. For our new salespeople, this should lead to significantly shorter sales cycles, especially in telecommunications, which traditionally took around 14 months. That said, any new customer will still want reassurance that new technology is properly tested before being integrated into their critical infrastructure. Overall, we anticipate shorter sales cycles in the future, leading to faster technology adoption and revenue recognition. I view subscription revenue recognition as a layering process akin to building with bricks, particularly with multiyear agreements that contribute to deferred revenue. This new approach contrasts with the older model of large one-off perpetual licenses, which often involved significant commercial friction and slowed market adoption. We believe this new model ultimately benefits both us and our customers.

Scott Buck, Analyst

No, that makes a lot of sense. And your Intel partnership on confidential computing, how should investors think about how that can be monetized?

Andy Leaver, CEO

We are exploring various use cases, some of which I mentioned earlier in the call. For large enterprises, including those in federal defense, there are significant investments in both cloud infrastructure and AI. We see a common approach that allows them to leverage these existing investments while also safeguarding against the emerging quantum threat. Intel is an excellent partner, and I am very positive about our collaboration. We have established a great working relationship and share a similar vision for the developing confidential computing sector. Both of us believe this will be a major enhancement for our businesses. The ability to embrace new public cloud infrastructures, multi-cloud environments, AI, and LLMs without the fear of quantum threats significantly eases their concerns. We strive to make our solutions as user-friendly as possible, and operating on Intel's TDX enclave in the latest devices ensures we're positioned effectively. Our technology footprint is compact yet powerful enough to address all the challenges mentioned. We are very excited about our partnership with Intel.

Scott Buck, Analyst

That's perfect. And then last one, if I can squeeze in. Nick, given the momentum in the business on the sales side, do you expect any increase in OpEx to support some of these new contracts you signed towards the end of the period? Just want to understand what the operating leverage could look like here as the business scales.

Nick Pointon, CFO

Okay. So, I think the main thing is to mention is that our headcount is down materially from a year ago, and we kind of repositioned our employee base to increase the focus on customer fulfillment as we have been winning customer contracts and expect more to come. We are currently sufficiently staffed for the near term. We do have a handful of budgeted open positions, as Andy mentioned earlier, that we are looking to fill, but we have no plans for meaningful growth in headcount at this time. In terms of other operating costs, we do not see significant growth over the near term. Our trailing monthly cash burn has been around sort of $2.2 million or $2.4 million-ish, and we expect that to stay around that level for the meaningful amount of time. Does that give you what you need?

Scott Buck, Analyst

Yeah, it's very helpful. I appreciate the added color, guys. Thank you very much and congrats on all the momentum in the business.

Andy Leaver, CEO

Thank you, Scott. Appreciate the questions.

Operator, Operator

Thank you. We have no further questions at this time. Now I'll turn the call back over to Andy Leaver for closing remarks. Andy?

Andy Leaver, CEO

Thank you. Again, thank you 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 forms in which to 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 again.

Operator, Operator

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