archTIS Limited (AR9) Earnings Call Transcript

All right. Well, good morning, everybody. Welcome to our friends in Australia, and good evening to our international attendees. Welcome to the archTIS Q2 FY '24 investor update for the period ending December 2023. I'm Kurt Mueffelmann, Global COO and U.S. President. And as always, I'm joined by my sidekick, Mr. Daniel Lai, the Managing Director and CEO of archTIS. Dan, why don't we kick things off? We'll go through the obligatory disclaimers. But why don't you kick us off about pretty exciting quarter for last quarter.

Yes. Thanks, Kurt, and welcome, everybody. And again, thanks for your support. Look, it's been a very positive, hard-working quarter, and I think there's some very positive results there. Cash position is strong with $5.7 million at the end of the quarter. We had a significant and very strategic wins with some customers, which we'll go into some detail with BAE Systems Australia, Naval -- Australian Naval Infrastructure branch. Revenue was good. It's up 144% from the prior comparative period. Licensing revenue is up 40%, and we've had an outstanding services growth as well. Positive operating cash inflow for the first half of the year. Operating expenses are down. So we're well on track to hit cash flow positive by the end of the year, which is one of our primary commitments. So we are seeing growth in revenue and sales licensing, but we're also decreasing cost, which is extremely fine-tuned and well-balanced machine that we've been operating. And again, repetitive results from previous quarters. So we're on a trajectory, which I'm very proud of. Just get into the detail, I'll hand over to Kurt and he can take through the numbers, we told the investors are keen to see.

Not only was the quarter strong, but as we closed out the first half of the year, we've had some record numbers there. We'll wind up reporting our first audit reports at the end of February. But during Q2, total revenue was $2.6 million, an increase of 144% from the prior comparative period. The revenue is split across licensing of $1.2 million, which grew 40% and services and key strategic accounts of $1.5 million, which as Dan just mentioned, expanded up by over 500%. Our annual recurring revenue, or ARR, was $3.6 million, a 6% increase from the prior quarter. So that continues to ship along nicely. We'd always like to see that go up faster and harder, but it's continuing to be some steady growth. The nice thing that we did experience as the company did not experience any customer churn during the quarter. So our product remains very sticky with our existing customer base. The gross margin percentage decreased from 44% from 57% over the prior comparative period and was slightly lower than the prior quarter. However, when you look at that, though, in total gross dollars our value was up 89% from the prior comparative period. So although the margins have dropped, the total dollar went up significantly. The lower gross margin percentages were always associated with our increased services, including those of third-party resources to deliver key accounts across the various Australian Department of Defense contracts. And these strategic services continue to drive more mature pipeline in future licensing sales at increased margins, which Dan will take you through a couple of different examples as we go through the presentation. Operating costs for the quarter were $1.2 million. The significant decrease in the costs reflect a reduction of 40% from $2 million from the prior comparative period. The drop in operating expenses reflects our continued cost effective reductions in our management's commitment to become cash flow positive during the current fiscal year. We ended the quarter with $3.7 million of cash in the bank and $2 million from an unused lending facility. The company's net operating cash inflow for the quarter was $700,000 and an improvement of 385% versus the prior quarter and up 165% from the prior comparative period. So nice to see the positive cash coming in that quarter. Cash components were comprised of customer receipts of $3.1 million which I believe is a record and R&D and tax incentives and grant receipts from the ATO an honest trade respectively of $2.2 million. So again, pretty strong. And we continued during the first half of the year to really experience, as I said, record growth. When you look at revenue up in the first half of the year on an unaudited basis, it was up 142% from the first half of FY '23. Our operating expenses remained in that 40% reduction. So again, pretty strong numbers there. EBITDA was up 90% and customer cash receipts were up 89%. So overall, a pretty strong quarter from a financial perspective. We continue to see licensing increase quarter-over-quarter. You'll note that there's a small drop from revenue from Q1 of this year. That was mainly delivered to some of the services from one of the large PoCs that we did earlier in the year. So again, really driving in those right directions as we take it forward. But I think the big thing, Dan, that we really want to talk about is continuing to drive that broad adoption across defense and defense industry, and there were some nice wins this quarter that maybe you can take us through.

Yes. Thanks, Kurt. So while we're seeing a continued expansion of Kojensi and that's really being driven by the AUKUS arrangements. We're seeing supply chain and reaching out to us in a much more higher activity rate. We've said, now we've got 156 organizations using the Kojensi platform and 1,020 users on that platform. And we're starting to see the real evidence of network growth effect in that Kojensi platform. NC Protect still seems to be the policy enforcement product of choice for Microsoft. We've had a number of inroads in there with U.S.-based global insurer. But the big ones that I've been getting quite excited about is what's been happening in the Australian Department of Defense and around that defense industrial base and BAE was one of those strategic wins. Recently, we did in 6 weeks what BAE has been attempting to do after a 3-year investment, a demonstration about how they can integrate and apply policy enforcement to their data across the supply chain, and that is leading into significant opportunities with them. For those investors that don't know BAE is the largest Australian defense prime in this market and is contributing to nearly every ship building program of work in the Australian Department of Defense and has a significant supply chain, including with other primes. So a very good opportunity for us there. And that has resulted in them reaching out to the BAE in the U.K. and doing introductions, we're probably heading off the next week across to the U.S. and the U.K. to run some demonstrations with the BAE teams about what we have achieved here in Australia with most recently in December. Australian Naval Infrastructure, branch is again and you're starting to see the dots here, they're rebuilding the Osborne shipbuilding yards for classified information and security purposes to support the submarines and also the frigates and destroyers that are being built there. And again, integrate and have dependencies in the whole of the supply chain for capability development with a number of different primes integrated into that. They recently adopted Kojensi to share that information across those suppliers. And again, we're seeing a network growth effect out of that. So that's just one element where you're seeing a couple of strategic wins which are forcing network growth across our products and introducing them to other customers that have now made inquiries or licensing those products. So very exciting good strategic wins, which is high value.

Dan, maybe you can explain how someone like BAE found us.

Well, this is interesting, isn't it? And this is what I think is very exciting is that the market is starting to really mature very rapidly because of the things that have happened. Now we've talked about the geopolitical situations. We talked about the alliances. We've talked about particularly the need for August to have high levels of security through the supply chains. Well, we first approached them 3 years ago when they started the Hunter class build for the Australian Department of Defense. And they decided that they wanted to go it alone. We came across them at DSEI in Japan. They called us out and took us to launch and said, we need you to help us solve a problem. We haven't been able to solve it ourselves. They invited us in to do a review of what they had built. And then they engaged us to build it ourselves. And we delivered that in 6 weeks, which they have been spending 3 years trying to achieve themselves. And now it's being demonstrated to the customer being Australian Department of Defense. So that's the sort of acknowledgment that we've been getting from industry for our specialized product and platforms, and most importantly, our expertise. So it's a real win and a paradigm shift in the industry and seeing what we can do and how we can help solve those problems.

I guess the other one that keeps popping up all the time is KPMG from the defense One DD program. Can you talk a little bit about how that's moving forward.

Absolutely. And they've been in the news a little bit, too. So that's been interesting as well. But we're part of that consortium and what we are really delivering is the architectural for data-centric security. So they're building data capabilities. So how do they integrate data across multiple areas, get insights a visual and analytic insights into that data? And how do they do that security meeting the compliance requirements? We've been working with all of those services that we've been able to book are about teaching them how to do that and bringing along the Australian Department Defense in an educational process and getting architectural approval to do that. And that's now pulling through opportunities for licensing because they have to build these platforms. They're building 2 platforms, one at the protected level and one at the secret level. And certainly, they're going to need an Attribute-based access control and policy enforcement to be able to achieve that level of integration. It's mandatory. And so we're very excited about those opportunities as well. And it's very important as part of that education process to get opportunities for demonstrating the value of our products to build into enterprise licenses for the Australian Department of Defense in multiple areas.

Yes, I think a couple of the other nice wins that we saw, which kind of lend our kind of global expansion towards archTIS. We continue to see the alliance of archTIS really push hard. And so we're seeing a lot more inbound communications with U.S. and U.K. defense organizations. In the U.S., as we've talked about before, we're seeing some regulatory requirements around CMMC which is one of the big governance requirements around defense firms from a compliance standpoint as well as ITAR. So we had a number of victories in that area, which is nice and the pipeline has really continued to grow strong in that area, particularly as we get closer to when CMMC and some of the other U.S. compliance requirements will be going into effect. We also closed a deal with an Austrian company, not Australian, but Austrian, right? And so they jumped on with Kojensi SaaS because, as Dan talked about, and we'll talk a little bit more, it's that network effect they heard and referred to us by one of their suppliers. They like what they heard and that they need to communicate with some of their suppliers over in Australia, so they decided to select Kojensi SaaS. We also had expansions of our licensing with a Korean defense firm as well as SAP. So again, not only are we getting in keeping customers but expanding them into it as well. And then lastly, I think what's really need is we still have 2 more European resellers come on board, one in Sweden and one in the Czech Republic. They chose NC Protect and NC Encrypt for that independent encryption key management for the Microsoft M365 applications. We were introduced to both partners through the Microsoft co-sell opportunities with Microsoft field reps. So we're really happy to see that continuing to push and really driving more opportunity forward. And we really provide that value add and helping Microsoft get into non-U.S. entities by providing that third or that different independent key encryption management, which ties outside -- nicely and ties into both our products. So some really good space as we head into that. So I guess, Dan, maybe it's kind of the results of the quarter that we wanted to share with everybody, but talk a little bit about kind of where we're heading from a vision standpoint. We put this a version of the slide up last time talking about kind of where we see new opportunities for re-rates and new opportunities and driving the share price forward. And then we can talk a little bit more about the underlying strategy behind it.

Yes, absolutely. Obviously, the foresee results that we've just presented are all about achieving positive cash flow. There's been a lot of hard work built into that space, and we're continuing to demonstrate strategic execution to get there. And that's really pleasing. But what's also exciting in that we expect that we'll get recognized for that in the marketplace being cash flow positive and moving the business in that direction. But I think really excitingly for us as well is that we have set the company a target to get a large Australian defense licensing deal. We've had in the last 12, 18 months, large revenue deals are based around services, but it's about demonstrating and validating that that's going to get that license pull through into that market and particularly that customer. And so we'll be highly focused on that, and I'll talk a little bit about that later on how we're progressing. But we also want to prove that we've got a global market and global reach, and that's about delivering a significant international defense deal with either a DoD or a defense department overseas. We wouldn't put these things up, we weren't actively working on that. So it's really now about executing those things and making sure that we pull them in. But they are all very real opportunities that put us in a very strong position to prove to the market that we are going to deliver what we said we would deliver and reach our potential. So from that perspective, I just wanted to give the shareholders a quick update on how we are traveling. And one of those -- there's a lot of work going on in the company, but this will just give you a quick little example of when we talk about we are executing what we said strategically and we're winning in this fight, here's a quick diagram of the complexity of the Australian Department of Defense. Now we are at now in 6 out of 10 of key divisions. And you might ask what areas aren't too active in. But we -- that's not saying we're not active. It's just saying we haven't penetrated that yet to be active in those deals. But CASG, for example, which builds all the Air Force and Army capabilities and space capabilities, we have 2 live opportunities in there right now. JOC we had to successfully delivered NC Protect in there, and it's being utilized as a control and access control for Joint Command. We won the VCDF area with where our top secret platform is in, and we've been doing work on that, and it's about to go a new version, but that's about to go live shortly and that gives us growth potentials in there. We've got the next-generation information management or record management PoC, which is currently active and about to be -- should be wrapped up fairly soon in the next couple of months. And -- but we have also got a product in there in terms of that KPMG One Data Defense and services ability to influence product selection in that space as well. And finally, we've got new programs of work after the settling of the defense strategic review where people have been moved into the right positions and are now settled, and we're seeing that spending activity increase. And there's a number of programs, which we've been looked at and have committed ourselves to those opportunities. NSSG, which is the Navy Sustainment and Support Group, that's where that BAE PoC has been demonstrating the ability to share data across the supply chain security and into defense. And we're seeing growth opportunities there as well. That's led straight into new opportunities, which we are driving through the business. But also that Australian Naval Infrastructure. Now that opens up opportunities overseas as well. So for example, they referred to what we did to the U.S. Navy, and we have the Commander of Information Warfare visiting Australia next -- this -- well, next month. and they're going to visit our offices here to see what all the hopes about. So that's the sort of opportunity that it opens up internationally. In Navy, we've got -- we completed a proof of concept, which is one of those proof of concepts we talked about. And now we're just trying to close a deal in there as well. So there's lots of opportunities going on. Strategic -- the Definite Strategic Review has pointed to the need to solve this problem. People are now in the right places, and we're seeing the activity in terms of procurement of this. But what we're really driving towards is critical mass. And what we hope to be able to do there is to move from point of proof of concepts or point solutions into an enterprise license. Now I just want to talk quickly about the difference between an Enterprise License and the whole of government license -- a Whole of Defense License. An Enterprise License could be any one of those areas. So there are multiple Enterprise Licenses to be done in the Australian Department of Defense, not just one. And when you get critical mass with that, then you move into the Whole of Defense License. Now we're not talking tens of thousands of dollars for any Enterprise License. We are talking the vicinity of above 6 figures and possibly, but the potential for multimillion dollar deals of any one of those areas, which gives you a potential scope for what a Whole of Defense License could look like in the next 18 months to 2 years. And that's just in the Australian Department of Defense. Our other key objective there was to be the preferred platform of sharing of information across defense. We've led that with Kojensi NC and a lot of our clients have procured both Kojensi and NC Protect. But to give you an idea of how successful that's going. Again, if you have a quick look at the number of primes, and the primes lead this subject matter experts. And this is where we're seeing that substantial growth in the number of organizations that are utilizing the products and we're seeing that network growth -- evidence of that network growth effect come through, particularly in the last 4 months. So that's very exciting for us. And it's cost research institutions as well that are doing defense research. What's trying that -- once again, stronger penalties are being implemented for AUKUS and there's a clear need to update the level of cybersecurity across the supply chain.

Yes. I think what's interesting too is, again, you've seen some of the alliance stuff really pushing that hard across the industry as well as some of the regulatory compliance and with the number of PoCs that we've talked about, some are in process, what have you. I think what's interesting is when you take a look at across the sales journey, how we look to monetize that. And I think that's a big area. When we look -- talk about the PoCs, we talk about the initial sales process. And again, we're dealing with Fortune 100 companies that are in the defense sector as well as within defense agencies. So these are not short-term deals that are just going to close overnight, but they've been going on for a while. Again, we're early stages with some and very mature with others. But the way we really see that, and you can kind of see that in the way that our margins have gone is that our margins are really decreased down into the lower levels as our services revenue has gone up. And when you look at the PoC and services engagements, as we talked about, whether it's through KPMG or BAE or a couple of the others that we're doing, right? That really gives us the ability to show and demonstrate our domain expertise and knowledge and really come to these opportunities with the way -- how is it being done in the market, how are we bringing that expertise around data-centric security about Attribute-Based Access Controls. It's a little bit of a teaching process that we get paid to do. And so when you see those engagements come through, they have very low licensing, very high services. And obviously, with services being driven, it's going to drive a lower margin on a percentage basis. But now when we get into that next stage, when we get approved through the PoC, the proof of concept, we get into that licensing sale and deployment, year 1, we generally see the margins start to go up. Why? Because we're driving a higher level of licensing. We've already done a lot of the upfront work to get it to a stage where the customer is ready to go, they're ready for deployment. The product has already been configured, any customization or development need to be done was generally done in the proof of concept. And so you'll see licensing come up. But where we really meet the traction of really driving that high growth is in the repeatability. And as I said earlier, during our financial sector that we had 0 churn last quarter. That's amazing for a company with the number of customers that we have out there today to do that. Again, it's very steep products that when you get involved with security, yes, it's difficult to share names and things, but that's a stickiness that most organizations are really driving towards. And you can start to see that in year 2 and then year 3 and year 4, right, those margins go up higher because there's very little services that needs to be done. The customer is self-sufficient, support becomes very low for products that we carry. And so you start to drive those higher margins. And so we really start to see, once we start getting these PoCs closed, getting them on to the new opportunities, driving that increased margin in the out years, which becomes really exciting from an investor standpoint as we go forward. So we just wanted to kind of share where our thinking is, not only from a strategic positioning of industry as well as across the Aus defense. But as Dan comes over to the U.S. next week, we're going to be in San Francisco meeting with some people from the investment community and looking at a couple of other things that are out there that are exciting for the business. And then we're going to spend a couple of days in Washington, D.C. We have a number of partner meetings that are going on, a number of meetings with different U.S. defense and U.S. intelligence agencies as well as meetings with Microsoft and a couple of the other large primes. So it should be a good, interesting and exciting trip as we go forward. So I guess, Dan, any thoughts on closing before we jump into questions.

No, look, I think we're taking responsibility for the business as a whole. We're executing a strategy. And I think that what we are learning is that those services and solution for the PoC to demonstrate the value is necessary. And it's a really good indicator that the market is maturing and coming to us. And I think that's been the paradigm shift over the last 6 months. We're seeing the market come to us. We're not just driving product -- trying to drive product into the market. And that's good for us because the value sell means higher gross margins. And I think the last thing that I would say is the other exciting part that we probably haven't spoken about is the international engagement that we're starting to get some traction on from some of the primes in the U.S. and the U.K. and Japan. And again, they're all signs that, that AUKUS and quad alliances are actually starting to take traction and money starting to really flow about solving these critical problems which we have a niche solution in.

Great. There's been a couple of questions. Let's jump into them. Some of them are investment based. And I know when we go over to the U.S., when you come over next week, we're going to meet with a couple of institutional investors as well as large family offices. But any comment on the volume and share price activity and how we're struggling to get new eyes involved and new people involved into the business itself?

Look, we certainly obviously think about this consistently. That's why we started to talk about the 3 market opportunities that we have put on the table and set targets for ourselves to achieve to make sure that we can drive that shareholder value. And no one looks at you until you land something that everybody looks at, and then everybody looks at you. And I think what we've also seen is that small margins are trading significantly changed the share price. And so for us, it's about pulling one of those deals that's going to actually really give the market pause and we'll open up that visibility of why we're being successful. Yes, there's also a research to be done in terms of market research, finding the right partners, new institutional -- attracting new institutional investors. But in the end, it really is about execution. And our numbers are heading in the right direction. And I think that as we continue to execute and hit that inflection point.