Hello and welcome to the D-Wave Q1 2023 Earnings Call and Webcast. [Operator Instructions] A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Kevin Hunt, Investor Relations. Please go ahead.

Thank you, and good morning. With me today are Alan Baratz, our Chief Executive Officer; and John Markovich, our Chief Financial Officer. Before we begin, I'd like to remind everyone that this call may contain forward-looking statements and should be considered in conjunction with cautionary statements contained in our earnings release, and the company's most recent periodic SEC report. During today's call, management will provide certain information that will constitute non-GAAP financial measures under SEC rules; such as non-GAAP operating expenses and adjusted EBITDA. Reconciliations to GAAP measures and certain additional information are also included in today's earnings release, which is available in the Investor Relations section of our company website at www.dwavesys.com. I'll now hand over the call to Alan.

Thanks, Kevin, and good morning, everyone. Well, it feels like we were just here talking about Q4 and FY ‘23. But it really is a pleasure to connect again so quickly and keep you apprised of D-Wave’s business momentum. As a reminder to those investors following D-Wave and the overall quantum computing category, we are in a unique market position as the only company in the world offering quantum annealing technology. And unlike other types of quantum computing modalities, quantum annealing is in the market with commercial customers today. That gives us a first mover advantage in accelerating the commercial adoption of quantum, while others in the industry focus on research and development. Quantum annealing is a valuable technology for solving complex optimization problems and awareness of its value to the enterprise is quickly growing. In fact, earlier this month, global information technology market intelligence firm IDC recognized quantum annealing as a core quantum computing system in its annual taxonomy report on the sector. Companies are increasingly turning to the technology to find solutions to their most computationally complex optimization problems. These are problems that are fundamental to nearly every business and industry, things like employee scheduling, factory process automation, fraud detection, advertising optimization and many more. The fact is that quantum computing is here today and already emerging as a key strategy for solving the seemingly unsolvable by finding new and better ways to build businesses, navigate disruption and accelerate transformation. Customer interest in D-Wave continues to grow and our commercial customer portfolio remains robust. We've seen a steady increase in the growth of revenue producing commercial customers. Over the last four quarters, revenue derived from our commercial customers has increased by 30%, when compared to the immediately preceding four quarters. This quarter, we welcomed a number of new…

Thank you, Alan, and thank you to everybody taking time to participate in our call today. Revenue in the first quarter of fiscal 2023 was $1.6 million, a decrease of $129,000 or 7.5% for the first quarter of 2022. Given the nature of our professional services engagements, the timing of our professional services revenue recognition may vary causing some revenue lumpiness on a quarter-to-quarter basis. With respect to D-Wave's revenue recognition in general, the revenue recognition associated with the QCaaS component of our revenue is quite straightforward and predictable given that QCaaS revenues typically recognize ratably over the term of the underlying contract. However, revenue recognition associated with our professional services contracts is more complex given that there are a number of variables involved, including many engagements with multiple phases, specific starts, updates for each phase and specifically defined deliverables. However, we are generally paid in advance of the completion of the professional services and the corresponding revenue recognition timeframe. With respect to the first quarter revenue mix, QCaaS or our quantum computing as a service subscription based revenue total $1.2 million in the quarter representing 74% of total quarterly revenue. This compares to the year earlier QCaaS revenue of $1.4 million that represented 81% of total quarterly revenue. I will be providing bookings, non-GAAP, gross profit, gross margins, operating expenses, and adjusted EBITDA as we believe these metrics improve investor's ability to evaluate our underlying operating performance. These measures are defined in the tables at the bottom of today's first quarter earnings press release and for the most part, adjust for non-cash and non-recurring expenses. Due to the timing associated with our professional services revenue, we believe that our bookings performance may at times be a better indicator of our business momentum than quarterly revenue. We define bookings as…

Actually, I think we're going to hand it over to questions.

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Our first question is coming from David Williams from Benchmark Company. Your line is now live.

Hey, good morning and thanks for letting me ask a couple of questions here. I guess first, so you haven't previously given the bookings number, really talked much about that, but it's very helpful and appreciate the clarity around the demand trends. I guess on the revenue recognition side and understanding the lumpiness of the pro services revenue, what are the drivers there? And as we kind of think about that trending through the year. Are there any things I guess that have changed in that pro services that have you changed the way that you're recognizing the revenue or changed the milestones? Is there anything that’s, kind of, different that we should be thinking about?

John, do you want to take that?

Sure. So the essence of each agreement, David, the nature of the milestones can be a little bit different. But it's not been -- there's not been any fundamental changes from what we've experienced historically in terms of how these agreements are structured. The issue is that there's a lot of complexity associated with optimizing a lot of variables and in some cases, we’re -- that timeline is dependent upon feedback and our work with the client and sometimes that can get delayed in the process.

And David, maybe I'll just add one other thing. And that is previously we had, kind of, had a clean separation between QCaaS agreements and professional services agreements. And the QCaaS agreements are quite straightforward as John said when it comes to revenue recognition, it’s just ratably over the duration of the QCaaS agreement, whereas revenue recognition on the professional services agreements tend to be more lumpy, due to all the various factors associated with the agreement, the nature of the work to be done, start dates, stop dates, deliverables and so on. However, more recently, customers have been interested in combined agreements where it is both QCaaS and some professional services. Now this is really good for us, because we move -- we help customers move much faster when they're working with our professional services organization than when they're trying to do development themselves. So we're actually encouraged by this and feel like it's a good direction for the company to be moving in. But as we start putting those different elements into a single agreement, it starts impacting the way the revenue recognition across higher agreement is done. And so that's, sort of, another element that has started to impact exactly how we do revenue recognition.

Okay. Fantastic. I appreciate the color there. And then I want to ask too on the generative AI and things we talked about with the machine learning and artificial intelligence. But it seems like the hallucinations within the AI's have been really a big issue. And it seems like quantum is an area that could really especially on the mid-optimization side, it really fix a lot of those issues that we're seeing particularly in the hallucinations. Can you talk about what you're seeing in terms of, of that demand trends from customers in developing and working towards an AI or ML solution?

Okay. So let me, kind of, separate that into two different questions. One is can the work that we are doing in the AI machine learning space help to mitigate hallucination? And while I can't give you definitive proof that the answer to this is yes. I can tell you that what we do in the area of feature selection is to help identify the elements of the data that are most representative of what you're trying to model of what you're trying to learn and filter out the, if you like, superfluous data. Condensing the dataset in that way makes it much easier and faster to train the model and also gives you higher accuracy relative to what it is that you're actually trying to learn. And so you would think that by removing some of the superfluous data, you might help to mitigate hallucination or some of the hallucinations. But this is just a perspective, not a kind of specific proof or evidence, that's possible. Second, you were, kind of, interested in understanding how that AI work is progressing. And what I will tell you is that we worked on this problem initially with one customer in the financial services arena, and then following that, we had two more customers that were interested in the same solution. Another one in financial services and one actually in drug development. And so that caused us to define a feature selection offering, which currently is a professional services offering. So you can either buy a generic proof-of-concept where we'll help you to actually develop a proof-of-concept and application of interest to you or if you're specifically interested in feature selection you can buy a services engagement where we will help you specifically with feature selection. And we have a lot of interest in that particular professional services offering. So much, so that we are actually exploring making that a software-as-a-service on our lead cloud service. But I caution you, we're exploring the possibility of doing that. I have nothing specific to report on that.

Color. Okay, that’s excellent color. Thank you. And maybe lastly just John, can you talk maybe a little about the milestones or the hurdles for the second tranche in the term loan?

Yes, we'd be happy to, David. So there are three principal deliverables: One is, and by the way, this is all set forth in the agreement that has been filed, we've got to provide the Board with an updated multiyear financial plan. We have to reviewed the findings of our financial advisor and we've had to complete an independent intellectual property valuation of our IP portfolio.

Okay, great. And do you feel like all of those things are achievable or are in place to get to that 15 -- to get to that hurdle?

Yes, we do.

Thanks so much.

Thank you. [Operator Instructions] Our next question is coming from Harsh Kumar from Piper Sandler. Your line is now live.

Yes. Hey, guys. I had a quick question, I noticed that the deal size is up very, very nicely sequentially and then year-over-year even very impressively, I'm just curious if you could tell us what your customers are saying. Obviously, they're putting dollars down and they like what they're seeing. So generally, I was curious about the color that Alan, you might be picking up as you talk to the customers and where can this number go to as you look out?

So relative to where the number can go to as we look to the future, it's hard for me to predict how large the average deal size could become. But a comment that I made previously does provide some, kind of, insight into why the deal size is growing. And that is as I said, as customers are increasingly recognizing that not only can annealing quantum computing help them to solve their hard computational problems, it's best to work with us to understand how to use the system to solve those problems. And so we're starting to see deals that are not just QCaaS, not just a proof-of-concept, but rather a deal that incorporates QCaaS plus maybe even multiple proofs-of-concepts to try to move more aggressively down the path of understanding more broadly how annealing quantum computing can help them improve their businesses.

And I have one for John and I'll get back in line. The falloff in revenues I think you mentioned was accounting shenanigans associated with the recognition of revenue with professional services. I just want to like ask you again, was that all there was or did you actually see like dollars and revenues peel off in any manner that is fundamental?

Well, first, Harsh, I wouldn't characterize this as a shenanigan. So there's a very, very complex set of rev rec rules that you may be familiar with called ASC 606. And as we outlined previously, the composition of some of our professional services agreements have a fair number of moving pieces to them. So I think the bookings is best indicative of where we're headed here, because we have increased the bookings in professional services pretty significantly particularly on a year-over-year basis. So from our perspective, this is principally a timing issue with respect to when we will recognize the PS or professional services portion of those bookings.

Understood. Thank you so much.

Thank you. Next question today is coming from Richard Shannon from Craig-Hallum. Your line is now live.

Hi guys. Thanks for taking my questions as well. I might follow quickly on the deal size question from earlier here. I just want to get a sense of whether the timeframe or length of the contracts are still the same here. So deal size per time period is increasing or is there a lengthening of the deal size period as well?

Yes. Oh, sorry, go ahead, John.

Yes. Richard, we are seeing a increase, a gradual increase in the average term of our deals on a sequential basis as well.

Okay. Helpful to hear. Thank you for that. Maybe, kind of, a two-part question here on the guidance for the year both on sales and getting down to the EBIT line here. So I guess my question here on the sales element here is thinking about the linearity. You just talked about sequential growth into the second quarter. If you could characterize what that level of growth is versus -- is it something that's accelerating greatly into the back half of the year? And then obviously looking at the gross margin here that's a little bit low and understanding the dynamics within rev rec here on the services elements here, how do we think about the gross margins throughout the year that helped us get to that EBITDA guidance that you've reiterated for the year as well? Thank you.

Sure. So with respect to the revenue growth as we outlined earlier, we haven't changed the guidance on the year. We entered the year with some pretty decent backlog, our level of renewal rates have exceeded 90% plus with the influx of the bookings in Q1. That all gives us confidence in achieving those numbers. I will also add, like we mentioned this in the last call that on a year-over-year basis, we've seen a pretty dramatic shift in the magnitude inbound inquiries for our services. And we've also expanded the size and qualifications of our sales organization. So given all that, that gives us a lot of confidence with respect to achieving these numbers on the year. And you can expect from where we started the year, obviously there's going to be a fairly significant increase on a quarter-to-quarter basis to exit the year with those numbers. The gross margin is going to be -- the expansion of the gross margin is going to be a function of the top line revenue, as well as the mix as we've outlined earlier QCaaS carries a higher margin to the professional services. But with the general trend being towards a higher component of QCaaS we expect that will have a positive impact on the gross margins.

Okay. Perfect, guys. Thank you very much. I'll jump on the line.

Thank you. Next question is coming from Kevin Garrigan from WestPark Capital. Your line is now live.

Yes, good morning, guys. Thanks for taking my question. Hey, are you guys seeing any companies that you initially started talking to that are still waiting on their sidelines, because of either a tough macro environment or quantum is on their priority list?

So I think, what I would say is that our sales cycles are variable. There are deals that close in a short number of months and there are deals that take 12-months or 16-months to close. And that's been true since we started selling commercially a little over a year ago. I do think that the sales cycle is starting to shorten. So whereas a year ago, we might have started taking to a customer that we're still working with to try to get closed. Now when we engage customers, a lot of times it's inbounds. We have many more inbounds now as John pointed out than we used to have. And those deals tend to close faster, because they're kind of already -- they've done some research, they understand the value, they're contacting us, because they want to start working with us and those sales tend to close faster. But even when we reach out to customers, there does seem to be a greater awareness of what at least D-Wave approach to quantum can do. And this is in part, because we've been able to do a good job of getting the message out through a lot of different vehicles whether it's PR or with a technical analyst like the report that IDC just put out, which for the first time actually puts us was -- as one of the prime modalities for quantum computing. And that just generally helps to raise awareness. And then as we get more referenceable customers that helps to raise awareness. So that cycle -- that sales cycle is starting to shorten. Relative to whether the economic environment is impacting the sales cycle or not, I'm not seeing that. It's not that customers are, you know, putting discussions on hold or dragging their feet or walking away for economic reasons. I'm really not seeing that. For us, it really ends up being the fact that we must continue to raise awareness of the fact that commercial quantum computing is available today and can benefit your business today, because we're the only ones in the world that are able to deliver on that. Everybody else in the quantum industry is still saying not yet ready for commercial, just start experimenting with the system, start building a small workforce to understand it. And that's fine for everybody else. But for us, it's time to move today or be left behind.

Okay. Yeah. No, that makes a ton of sense. Thank you for that. And then just as a quick [Technical Difficulty] remind us of your retention rate for your customers?

Our renewals on our QCaaS business Kevin has historically been consistently in excess of 90%.

Perfect. Thanks, guys.

Thank you. Next question is coming from Suji Desilva from Roth [Capital Partners] (ph). Your line is now live.

Hi, John. Congrats on the progress here. Just real quick on the cash just to clarify with the $15 million that came in after the end of the quarter, so I would take the $9 million and $15 million, $24 million, that’s a rough way of thinking about your current cash run way, is that correct?

That's correct, Suji. So we closed the first tranche of the $50 million loan commitment, it was funded on the 14th of April.

Great. Just want to make sure there's no other elements. And then lead generation, I was curious when you had your January, you had a lot partners -- channel partners presenting there. What percent of your lead generation now is coming direct versus from your channel partners trying to get a sense of how that's working out the channel program?

Yes. I think that we've got some really great channel partners. We've talked about NEC in the Asia Pacific region and now looking to grow with us in Europe. We've got Deloitte as a partner, that actually presented at qubit. We've got some regional partners like Sigma-i in Japan or Multiverse in Europe. All that having been said, I would say that still the majority of our business is direct. I'd say that John, I don't know the exact number. The exact percentage maybe you have it, but the vast majority of our business is still direct as we are now, kind of, working with those partners to, kind of, help them understand how to be successful in the market and add new channel partners. So it's still early with respect to building out the channel.

Got it. That's a good opportunity there. And then last question real quick, Alan, you mentioned something about competitors and how you'll be kind of the lowest funded, kind of, business to grow. Can you just walk us through the two or three reasons why you're more efficient from a funding capital perspective versus competitors?

Yes, actually it was John that made that comment.

Sorry.

But look, I'll share some thoughts and then John may want to weigh in on it. The thing to keep in mind is that our quantum computers are commercial today. It's not like we have years of R&D ahead of us before we become commercial and drive that business. We're commercial today, so the money that was invested in D-Wave over the last 15-years that has allowed us to get to this point where we have systems that are today capable of supporting business applications in production, driving a positive ROI for our customers and build the business means that as we look to the future, we need to invest less in the product R&D piece as we, kind of, drive the top line number for the business, and that's what -- that's unlike everybody else where it's a very heavy R&D investment for many years to come. In fact, I think I said this in the past, there's no evidence at all that a gate model system, which is what everybody else in the industry is pursuing, will ever be able to deliver commercial value without error correction. There's just no evidence of that despite what people working in that space would like you to believe. And error correction is very difficult, very challenging technology where many years away and there's a heavy R&D list that's going to be associated to get there. So, you know, that's kind of, the perspective that we have on our ability to uniquely drive the business and drive to profitability. And John, I don't know if there's anything you'd like to add.

No, I think you've captured it, Alan.

Great. Sorry for the wrong attribution there. Thanks, guys.

Thank you. Next question is coming from Quinn Bolton from Needham & Company. Your line is now live.

Hey guys, let me -- thank for taking my question. Just I just wanted to follow-up on sort of the deal size versus number of customers, sort of, question, deal size obviously seen a very strong increase over the last several quarters, but the number of customers only increased modestly to 65 in the latest 12 months versus 63 in the prior 12 month period. And so wondering if you could comment on the trends in the number of customers with whom you're engaged in generating revenue? Are you sort of limiting the number of customers just so that you can provide adequate support? Do you think it's a lack of interest in Quantum just any thoughts you have on the number of customers? Thanks.

Yes. Let me take a pass at that and then maybe John wants to weigh in. So first of all, yes, we are really focused right now on helping to get customers to production. In other words, our focus is on working with customers to evaluate their applications, to develop the proofs-of-concept and then to start moving that into production. Because at the end of the day, that's really what fuels the quantum compute as a service component of the business. And what really allows us to, kind of, build that backlog and very predictable revenue growth, because the simplicity in revenue recognition in QCaaS as both John and I have mentioned in the past. So we do have a very heavy emphasis on that right now, which includes upselling to our current customers. And so I think I've talked about this in the past, but Mastercard that also presented at our Qubit’s Conference is a great example of that. Steve Flinter from Mastercard talked about customer loyalty rewards optimization, which we're moving well down the path on. And then he mentioned several other applications, and so we do have a heavy focus right now on working with customers to move them to production and then upselling those customers. And the sales team is very -- they're very focused on helping to drive that upsell. So that is absolutely a component of, kind of, what's going on relative to increase in the number of customers.

Thanks, Alan for that perspective. And then I guess one -- just quickly for John, if I annualize the first quarter EBITDA loss, it looks like you're tracking more to about a $68 million EBITDA loss. Obviously, your guidance for the year is $62 million or lower. Is it a sort of function of just revenue ramping, gross margins increasing that sort of brings EBITDA loss down or do you expect to limit discretionary spending anything on the expense side that may also be factored into reducing EBITDA loss down to that $62 million target as we come through the year? Thanks.

Sure. So we have some costs incurred in the first quarter, Quinn, that are not recurring in nature. For example, the cost of the audit, we also have some obligations that are trailing off over the course of the year. So that's essentially from the expense side of it -- on the top side of it, we do expect that the growth in our gross profit over the course of the year will help offset that as well.

Got it. Thank you.

Thank you. [Operator Instructions] We reached the end of our question-and-answer session. I'd like to turn the floor back over for any further or closing comments.

Okay. Well first of all, thank you all for taking the time to be here with us today. I think the biggest takeaway from today's call is that we're seeing positive momentum and traction with the commercial adoption of our quantum annealing technology as evidenced by a number of commercial customers, sequential quarter-over-quarter growth in bookings and increased size of quantum computer-as-a-service and professional services engagements. Companies are recognizing that they should start exploring and incorporating quantum technology into their compute infrastructures now or be left behind and they're engaging with D-Wave and our commercial ready practical quantum computing solutions to get started with their quantum journey today. So with that, again, I thank you all for your time and we'll look forward to talking with you at the end of next quarter.

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.