Kneat.com Inc

TSX:KSI

Earnings Call Transcript 2023-Q1

[Operator]

Ladies and gentlemen, good morning. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Kneat First Quarter 2023 Earnings Conference Call.

[Operator Instructions]

And I will now turn the conference over to Katie Keita, you may begin.

[Katie Keita, executive]

Thank you, operator, and welcome, everyone, to Kneat's earnings conference call for the first quarter of 2023. Today's call will be hosted by Eddie Ryan, Kneat's CEO; and Hugh Kavanagh, Kneat's CFO. Before we begin, I would like to draw your attention to the safe harbor statement on Slide 2 and the forward-looking statements disclosure at the end of the earnings release.

Comments made on today's call may contain forward-looking information. This information is, by its nature, subject to risks and uncertainties, and as such, actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult the company's relevant filings which can be found on SEDAR and on the company's website at kneat.com/investors. Also during the call, we may refer to certain supplementary financial measures as key performance indicators.

Management uses both IFRS measures and supplementary financial measures as key performance indicators when planning, monitoring and evaluating the company's performance. Management believes that these non-IFRS measures provide additional insight into the company's financial results and certain investors may use this information to evaluate the company's performance from period to period. I will now pass the call to Eddie Ryan, CEO of Kneat..

[Edmund Ryan, executive]

Thank you, Katie. Good morning, everyone, and thank you for joining today's call. I will begin with some high-level remarks before passing the call to Hugh to provide a detailed financial update. At the end, we will open the call for questions. In short, 2023 has gotten off to a fantastic start for Kneat. We closed the first quarter with total revenue up 53%, SaaS license revenue up 94% and annual recurring revenue up 100% compared with the first quarter of last year.

The acceleration of all 3 of these revenue metrics for Kneat comes from a combination of things. First, as we continue to make strides in our core markets, the benefits of using the Kneat platform are becoming more well known. This should not be surprising given that our approach, which is revolutionary compared to current standard practice, enabling customers to derive significant value through greater efficiencies and a higher compliance standard. Second, our customers are increasingly discovering Kneat's value as a platform and they're applying this beyond what they had initially implemented it for, for more teams, more sites or more quality processes.

This means we are expanding within our customers' organizations, a major contributor to revenue growth and into the companies that are part of their supply chains as well. Finally, the investments we made last year to grow our team are paying off. With a larger R&D team, we can tackle more of what we have planned for the Kneat platform sooner. And with more sales resources, we can better and more broadly showcase what Kneat can do as the industry builds towards pharma 4.0.

We saw ample evidence of all these factors at work in the first quarter of 2023. The wins of 3 large new customers continue to build our market leadership momentum. In January of Fresenius Kabi, in February of the manufacturer with more than 80 sites worldwide and in March of the division of a top 20 pharma. Expansion within our existing footprint drove the majority of our SaaS revenue growth in the quarter. The ongoing expansion of Kneat licenses within long-standing customers supports the sustainability of revenue growth, particularly as Kneat continues to win new logos.

Finally, our sales team is now well over twice the size it was last year and are bringing in smaller new deals that don't get announced. We are excited to see what they achieved as they continue to ramp up. There was a lot of interest in the power of the Kneat platform at our user conference VALIDATE, which we hosted in Dublin last month for our European customers. I'd like to commend the Kneat team that kite is out as it got stellar reviews by users and sponsors alike.

Over 150 attendees got to see some of the creative ways our customers are putting the platform to work. Most of the top 15 global pharmaceutical companies were there with several sharing their digital validation journeys using Kneat's from selection through to successful global rollout. After experiencing how transformative Kneat has been for their own productivity across teams and processes, these customers were eager to contribute knowing that further adoption of digital validation will add velocity to their industry's mission.

After all, to fully realize the benefits of digitization, the influencers need the other players connected to the ecosystem to get onboard. Customers at VALIDATE also got a preview of Kneat 9.0, which is now launched. 9.0 is a fundamental step forward for Kneat Gx as we continue to innovate. Several years ago, we transitioned from on-prem to SaaS. Today, 9.0 further modernizes Kneat with next-gen software approaches like containerization and multi-tenancy as well as other architectural expenses. This foundational work enables me to go further in terms of efficiency, functionality and speed of delivery, valuable to ourselves and to our customers.

We are incredibly proud of our development teams, every single one of which contributed materially to this release. Definitely not easy, but of course, the work that is worth doing rarely is. In addition to customers promoting our product as they did at VALIDATE and the efforts of our expanded sales force, our growing partner community is also leaning in. All 3 together make a powerful formula for growth. These partners and service providers are taking on more services to support our customers and are bringing new customers onto the Kneat platform as well.

In fact, the large strategic customer that we announced in early April came to us through one of our partners, a large global consulting firm. Like our customers, they too are eager to help the industry shed the owner's legacy approach to compliance and instead turn it into a power tool with Kneat, one that removes friction and adds value. So whether you are a part of Kneat as a customer, a team member, a partner or a shareholder, right now is an excellent time to be onboard with us. We look forward to reporting our continued progress as 2023 unfolds.

I will now hand you over to Hugh for a review of the financial results.

[Hugh Kavanagh, executive]

Thanks, Eddie. As Eddie mentioned, we saw excellent topline growth in Q1, led by an acceleration of our SaaS license revenues. Revenues for the quarter ended March 31, 2023, was $8.0 million, up 53% from $5.2 million for the first quarter of 2022. SaaS license revenues, which is a key metric for Kneat was $6.4 million compared with $3.3 million for the same period in 2022. This is an increase of 94%. Our accelerated revenue growth in the quarter was driven by existing customers scaling their use of Kneat Gx while the purchase of license subscriptions by new customers also contributed.

Cost of revenues for the first quarter of 2023 was $2.6 million, which is actually down from last quarter and up $0.7 million from $1.9 million in Q1 2022. This increase was mainly due to an increase in payroll and cloud hosting costs. Gross profit for the 3 months ended March 31, 2023 was $5.4 million, 64% higher than $3.3 million in the same quarter in 2022. Gross margin percentage was 67% compared with 63% for the first quarter of 2022 and 63% for the fourth quarter of 2022. The increase in gross profit was driven by a significant increase in SaaS revenue, which carries a higher gross margin.

As we continue to scale our license revenues and as the proportion of license revenues to professional services revenues continues to increase, we expect the gross margin percentage to continue to trend upwards towards SaaS industry norms.

Moving on to operational expenses. Sales and marketing expense was $3 million for Q1 2023 compared to $1.3 million in Q1 2022, while R&D expense was -- for Q1 2023 was $3.9 million compared to $2.5 million in Q1 2022. We grew both teams substantially since Q1 of last year. So the incremental salaries and benefits associated with these investments is primarily behind the expense growth here. Annual recurring revenue, ARR, is a key performance metric for Kneat. ARR includes SaaS license fees and maintenance fees.

The proportion of our SaaS offering, which adds to our annual recurring revenue base is essential to our growth strategy. ARR doubled over last year from $13.4 million at March 31, 2022, to $26.9 million at March 31, 2023. ARR for SaaS alone grew by 113% from $12.4 million at March 31, 2022, to $26.3 million on March 31, 2023. ARR from maintenance fees decreased by 44% to $2.6 million from $1 million over the same period in 2022, reflecting the shift of legacy customers transitioning from on-prem to SaaS since the end of Q1 2022.

As we look ahead, we are optimistic for the remainder of the year. We have a high retention of a base of high-quality customers, and that base gets bigger every quarter. The revenue they generate is increasingly SaaS revenue. SaaS revenue carries much higher gross margins than service revenues, which we do not expect to grow as much into the foreseeable future as these services are increasingly directed towards our partners. And with the hiring we did through 2022, our teams can spend more of their time in 2023, developing great products and getting it out to the world. As a reminder, we have filed our unaudited condensed interim consolidated financial statements and MD&A on SEDAR and they are also available on our website.

I will now turn the call over to our operator for your questions.

[Operator]

[Operator Instructions]

We will take our first question with Christian Sgro with Eight Capital.

[Christian Sgro, analyst]

Congrats on the quarter and as well as momentum with the partner channel, which is growing quickly. My first question is there on the partner channel. Are you finding that you're building more of a template, I guess, structural way of adding partners? Or is there more investment to do there where you think you can get them online and up and running quicker? How those conversations have been going, maybe with the consulting firms, where it seems like you're seeing some traction?

[Edmund Ryan, executive]

Christian, Eddie here. Hopefully, you can hear me clearly. Yes. So definitely, as we go forward, we're able to repeat and a standard process that we build with our partner managers, we have a very strong partner management team for bringing partners up to speed and getting them enabled and getting them into projects with us or if they can go directly to the customers. So there's -- but I would say it's continuously improving. There's -- we're finding better ways to improve that. Like all our business, I guess, better ways to deliver our solution to the marketplace to go to market. And that's happening with -- through the partner channels and to software delivery as well.

[Christian Sgro, analyst]

Okay. Perfect. So I'll ask one more question before passing the line more on the market opportunity on your pipeline, if there's any verticals or geographies that are exciting. You just now -- if anything has changed since the last conference call? And are you seeing any momentum in your end markets as you talk to customers?

[Edmund Ryan, executive]

Yes. So regarding the geographies, there's no major change there. Europe and the U.S. is primarily our key areas. We do have some customers also in Asia, but they'd be customers that are there to our existing large global customers. We're not actually pushing out that direction at this point in time. So yes, so we continue to do that. And our customers that we have, we're very excited about how our customers are using our technology. We're going deeper and broader with our existing customers, and we're adding new customers and our customers are considering us for adjacencies within their organization.

And regarding other segments, I would say there's a lot of activity in the supply chain and on the distribution side of the manufacturing. So we are seeing a lot of activity from there as well. And of course, consumer product goods' companies continue to be something that's a very strong opportunity for us.

[Operator]

And we'll take our next question from Doug Taylor with Canaccord.

[Doug Taylor, analyst]

Yes. Thank you. Good morning, Eddie and Hugh, and the rest of the team, congrats as well on a good topline growth performance. You've obviously had a period here of an exciting period of new MSA announcements over the last couple of months. So a couple of questions on that. I mean, firstly, can you refresh us on the go-live timetable and the ramp-up schedules from these agreements? And are you on track to work through the implementation along the original timetable, which I think was Q2, Q3?

[Edmund Ryan, executive]

Doug, absolutely. One thing I'm really proud of across the Kneat organization is our delivery of our capital projects in the first deployment phase, and they're been 4 and 5 months approximately for those delivery times from the first go live with our customers. So everything is on target there for those. There might be some process that might be quicker than that, but generally longer than that. So I'm very proud of our delivery rate there. So everything is on target in that perspective.

[Doug Taylor, analyst]

Okay. And I understand that these MSAs sort of start small and expand over time. I think you've demonstrated that in spades. But I'm hoping I can get you that either qualitatively or quantitatively, if you can help us understand the relative significance of these recent signings in terms of potential ARR or any other way you want to frame it. Can you help us out there?

[Edmund Ryan, executive]

Yes. I'd have to default to a standard approach there because the standard approach continues to be the standard approach. So it really is starting out small. All our customers are -- they start usually small. And -- but as we mature in the marketplace, those earlier deals may become a bit larger and the ability to reach a fully scaled out with our customers in a certain area is getting a bit better as well. There are still some resistance within the companies in that different sites have different variations and stuff like that. But by and large, they're all being overcome.

So I think the line really, Doug, is that it could start out a couple of hundred thousand and they all become these customers' multimillion-dollar opportunities as they move forward. So -- and typically, if I was to say how long does it take to scale a customer for validation within these organizations, I think, anywhere between 3 and 5 years, depending on how quickly they go. And there's multiple processes within validation of the 8 processes in January.

[Doug Taylor, analyst]

Okay. Maybe one last question for me, and this one is probably for Hugh. Even if we exclude the perpetual license revenue, the onetime kind of upfront revenue in the quarter, gross margins would have been, I think, north of 65%, which is certainly a new high and pretty impressive. Is that a reasonable place to build from here, 65% as you bring on these new customers in the coming quarters and considering your scaling and the rest of the factors that go into that?

[Hugh Kavanagh, executive]

Yes, I suppose the way you look at it, there is the way I think it's probably the best way to look at it in terms of rolling forward, backing out the on-prem to get what the underlying gross margin is. And as you indicate, there's an excess of 65%, 65.5%, 66%, just over 65.5%, excluding the on-prem. And yes, no, I think that's not a bad basis to look to -- sort of as a basis to look forward and try and estimate for future gross margins will be, again, as I said, a lot of times before, that gross margin is a composite of the very low margins that we get on professional services, but they're very good margins that we get on SaaS revenues. And essentially, if you look back, you can sort of back into those relative margins and roll those forward to estimate where you think we will be in the future.

[Operator]

And we will take our next question from Rob Goff with Echelon.

[Robert Goff, analyst]

And let me also congratulate you on a very solid quarter and a great start to the year. Could you talk to the wins that you have recorded for the year-to-date and some of the competitive dynamics that may have been around those wins? What point you saw as your winning hand on those?

[Edmund Ryan, executive]

Absolutely, Rob. So they're all strong competitive competitions to win. This is a -- you can imagine this is a corporate decision that's been made deciding on a highly compliant rate to manage their mission-critical regulated processes in their organization. So they don't make decisions lightly around these. And what I would say is that some of them would have gone on for quite a while as some of the evaluations looking at alternatives in the marketplace. So very competitive, I would say, is the summary, Rob. And in some cases, they went on for quite a while. And in some cases, we're going in where maybe a competitor already is because of they're not fully happy with the competitor in the marketplace.

[Robert Goff, analyst]

And perhaps more of a macro question. Could you give your perspective on potentially expanding on your definition of the total addressable market and such, your thoughts there?

[Edmund Ryan, executive]

Absolutely. As we go along and look outside of validation, today, we assess the validation space alone within manufacturing for medical devices and pharmaceutical companies as around the USD 600 million mark. So when we look outside that into the supply chain and the distribution side, we see this being a multibillion -- several billion marketplace TAM for us. And that's before we look at adjacencies that also can come into play within our existing customers.

[Robert Goff, analyst]

And once again, back to the cadence of your wins, like are these wins perhaps encouraging you to up your investment in R&D product development to capture what's coming to you faster and faster?

[Edmund Ryan, executive]

Yes. So one other thing to say, Rob, that Hugh said earlier, right, is that why are we -- many of these deals are maturity, our product maturity and company maturity in the marketplace, the service that the customers are getting from our technology and the reputation we have with the largest companies in the world. And these are all strong -- very strong referencability situations, and our customers are sharing that information amongst each other.

So I think that's the key thing. Our technology is very solid. We're bringing on new technology, and we're also able to show new customers and existing customers, this new technology at this point in time. Our recent release is significant. It's a major release for Kneat, and there are some great features coming through there. And our customers are showing -- telling us back that these are great features that we're bringing through for them, and they're very happy. And it's all -- these features are all being built around their needs and close discussion with our customers are real intimate relationship.

[Operator]

And we will take our next question from Andy Nguyen with Raymond James.

[Andy Nguyen, analyst]

Congrats on the quarter, guys. Quick questions for me. What is -- I'm looking at the ARR for this quarter, and can you break it down like the growth from the existing customer and also the contribution from the new customers of that increase in ARR -- in the SAAS ARR?

[Hugh Kavanagh, executive]

Yes, Andy. Yes, so the growth in this quarter is primarily expansion of existing customers. So yes, I mean, some of the customers that we would have out of last year and previous years as incremental on those. Typically, I suppose what I'd add is that we're starting to see -- we have seen a little bit of a cadence around new customers in the early part of the year are getting up and going. And then as we go on through the year, the activity tends to increase the [indiscernible]. Yes, so is expansions primarily.

[Edmund Ryan, executive]

And just to point out there as well is that the new customers are the expanders of tomorrow. They start out small. So the contribution that they have in the quarter is usually low. And as you said, as the year progresses and the second year progresses, they become the expanders. So that's a key point here. And is the landing expand model is truly aligned with the Kneat's business model.

[Andy Nguyen, analyst]

And I noticed that's like a small contribution from the kind of the on-premise license revenue. How should we think about it for the remaining of the year?

[Edmund Ryan, executive]

So on the on-premise, we've only got one customer left on-premise now. And in fact, that customer has completed -- all our customers audit our systems and our control systems and our security and everything to do with our SaaS and cloud environment. And that customer has already completed a SaaS audit of us recently. So that customer, we expect will be on-premise within a year, worst-case scenario. And that's the last customer that we have. So it's -- you won't -- it's unlikely to see -- you're unlikely to see, I would say, any expansion more on-prem licenses. Pretty sure that's the case, actually.

[Operator]

We will take our final question from Justin Keywood with Stifel GMP.

[Justin Keywood, analyst]

On R&D, it ticked up in the current quarter. Wondering if there's anything onetime in nature there? And what's a good run rate for the R&D line?

[Edmund Ryan, executive]

Yes, Justin. Sorry, I'll just take the first few and I'll pass it on to you there. Just to say, Justin, that we have been growing in R&D last year, and -- but we expect it to ease off this year. But I would say the uptick is the final hires coming in early in the year and now being deployed and optimized. So if you want to add some color to that, Hugh.

[Hugh Kavanagh, executive]

Yes, sure. I mean it's pretty much as you said, Eddie. The uptake is driven by a couple of things. But obviously, we pay merit increases, which taken in the first quarter. So there's a small element of that there, also the effect of people who started during the last quarter who are here for a full quarter this quarter, but were only there for a partial quarter in the previous quarter. And also some people who have been hired in -- had the hiring has happened in Q4, but they only actually started in the fourth quarter, they were the primary changes. There are a few other little odds and sales beyond that, but they are the main drivers. So I think looking at this quarter and the spend there is probably not a bad basis.

[Justin Keywood, analyst]

Got it. And I assume with the additional hiring that's to preempt the new clients onboarding, where we haven't seen that sales yet per se?

[Edmund Ryan, executive]

Yes, absolutely. I think the key thing to say is that we did quite a bit of hiring last year and expanding our teams. And we're growing into those teams for the one of the better world this year, and we don't see ourselves expanding those functions, but except for critical key hires that we may need through this year. So you can take it that there's a lot of runway in that team at this point in time. And working on that to come out of that already in the pipeline, yes.

[Operator]

I will now turn the call back to Eddie Ryan for closing remarks.

[Edmund Ryan, executive]

I will close off today's call with 3 thoughts. First, just a reminder of Kneat's truly unique positioning right now, not just with our software, but within the life science industry itself. With innovation on an exponential growth curve moving forward without a digital solution and I meant truly digital, not just paper on glass, seems increasingly impossible. Second, with annual recurring revenue approaching $30 million, nearly all of it coming from SaaS and the investments in our team we made last year, these economics are better than they've ever been.

With our Tier-1 customer base solidly in place and growing, our future has never looked brighter. Finally, I want to reiterate how pleased I am with our Q1 results and the team that made that possible. While we have come a long way since those first few lines of code, the vast majority of our journey lies ahead. And I couldn't feel better about the team we have in place for that journey. As always, thank you, and thanks again for everyone on the call for your interest in Kneat.

[Operator]

And ladies and gentlemen, this concludes today's conference, and we thank you for your participation. You may now disconnect.