Kneat.com Inc

TSX:KSI

Earnings Call Transcript 2024-Q1

[Operator]

Good day, and welcome to the Kneat First Quarter 2024 Earnings Call. [Operator Instructions] And finally, I would like to advise all participants that this call is being recorded. Thank you. I'd now like to welcome Katie Keita to begin the conference. Katie, over to you.

[Katie Keita, executive]

Thank you, operator, and welcome, everyone, to Kneat's earnings conference call for the first quarter of 2024. Today's call will be hosted by Eddie Ryan, Kneat's CEO; and Hugh Kavanagh, Kneat's CFO. Please note the safe harbor statement on Slide 2 and the forward-looking statements disclosure at the end of the earnings release, informing you that some comments made on today's call contain forward-looking information.

This information by its nature is subject to risks and uncertainties, so actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult our relevant filings, which can be found on SEDAR and on our website at www.kneat.com/investors. Also, during today's call, we may refer to certain supplementary financial measures as key performance indicators. We use both IFRS measures and supplementary financial measures as key performance indicators when planning, monitoring and evaluating our performance.

We believe that these non-IFRS measures provide additional insight into meets financial results and certain investors may use this information to evaluate Kneat's performance from period to period.

I will now pass the call to Eddie Ryan, CEO of Kneat.

[Robert Goff, analyst]

Thank you, Katie. Good morning, everyone, and thank you for joining the call. Hugh and I will talk this morning about what we are seeing across the business. We'll discuss what we're seeing in our end markets, and we will talk about how we are building for the future. After that, we will take your questions.

As you saw in the numbers, we reported yesterday 2024 is off to a solid start in our first 3 months with annual recurring revenue up 57% over last year's first quarter, gross profit margin up to 74% from 67% in the first quarter of last year. And operating expense growing at a fraction of last year's pace, up 17% year-over-year versus 77% in quarter 1, 2023.

With strong top line growth on much lower expense growth highlights the expansion potential baked into our customer base and the returns accruing from earlier expenditure on resources. In the first quarter alone, our existing customers across North America, Europe and Asia added substantially to the Kneat Gx license base, and we expect them to continue expanding.

Many have sites in processes where they have not yet deployed Kneat, and their goal is to harmonize these processes across all their sites and divisions. Standardizing on a single platform improves quality, efficiency and time to market and standardizing on the Kneat platform appears to be emerging as best practice.

As our existing customer scale Kneat with confidence and places increasing trust in our platform, this compels other companies to embark on their digital validation journey with Kneat. We announced 2 large strategic customer additions in January and February and added several other smaller customers in the quarter, putting us on pace to surpass last year's number of new customer additions.

Our healthy pipeline gives us confidence that we will continue on that track. Based on our strong land and expand capability and the history is our guide, these incoming customers are the expanders of tomorrow. So I'm pleased to report that we are executing to plan. We have the teams and processes in place to support the increase in customers and the activity we are expecting this year. And most importantly, the teams themselves are in better shape than ever.

When I look at our win reports, the one thing I see again and again is the salesperson attributing the win to teamwork. The collaboration between sales, engineering, customer success, our contracts team and others is core to our culture and a competitive advantage. I believe it contributes significantly to our success and I'm glad to see it thriving.

With that, I will pass it over to Hugh to go over the financials.

[Hugh Kavanagh, executive]

Thanks, Eddie. As I take you through the numbers, please keep in mind that all the numbers I will be discussing are in Canadian dollars unless otherwise noted. As Eddie said, our results for the first quarter put us on a solid footing for the rest of 2024. Revenue for the quarter ended March 31, 2024, was $10.8 million, up 35% from $8 million for the first quarter of 2023. $9.7 million of this was SaaS license revenue, which grew 52% over the $6.4 million of SaaS license revenue we did in Q1 of 2023.

As has been the case for some time, the increase in revenue was primarily driven by expansion by our existing customers use of Gx. New customers since Q1 2023 also contributed to the growth, albeit to a lesser degree. Revenue from professional services was approximately $1 million, about the same as Q1 of 2023, reflecting the increased contribution from our strategic partners in this area.

Cost of revenues for the first quarter of 2024, was $2.8 million, on par with Q4 2023 and slightly higher than cost of revenues for Q1 of 2023 of $2.6 million. Gross profit for the 3 months ended March 31, 2024, was $7.9 million, 48% higher than $5.4 million in the first quarter of 2023. Gross margin reached another record at 74%. This is a material increase from the 67% gross margin we reported in last year's first quarter.

The expansion of our gross margin reflects the services transition I mentioned above. So gross margin is starting to look more like that of a company that is a pure SaaS. Operating expenses grew by 17% in the first quarter to $10.2 million versus $8.7 million in the first quarter of 2023. The largest contributors to this growth include R&D expense. Net of capitalized R&D for Q1 of 2024 was $4 million, up 5% compared to $3.9 million in Q1 2023.

And sales and marketing expense at $4 million in Q1 of 2024, up 36% versus $3 million in Q1 of 2023. We are pleased to see the leverage on the investments we made in 2022 and early 2023. We ended the quarter with a total annual recurring revenue ARR of $42.1 million, up 57% from $26.9 million at the end of last year's first quarter.

ARR from SaaS license fees was $41.8 million, up 59% from $26.3 million for SaaS ARR at March 31, 2023. We shored up our balance sheet in February with an equity offering that added approximately $18.5 million to our cash balance. Together with the debt financing completed in 2023, and are ramping up revenue alongside material gains in gross margin and a slower ramp in operating expenses.

We feel confident in our cash position for this year and our momentum towards profitability. For your reference, we have filed our unaudited consolidated financial statements and MD&A on SEDAR and they are also available on our website. I will now turn the call over to the operator for your questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Christian Sgro from Eight Capital.

[Christian Sgro, analyst]

Also congrats on another good ARR addition quarter. As we look out through the year and at the current pipeline, would you say it's largely comprised of life sciences customers? A lot of the filings and the report spoke to your focus there? Or is your pipeline starting to get more mix to cross other verticals as well?

[Edmund Ryan, executive]

Christian, thanks, Eddie here. Yes. So I would say, Christian, the mix is like life sciences. I mean that's our pipeline, and everybody in there is part of our TAM that we believe is over $2 billion. So it's life sciences, which includes everything from pharma, biotech, device manufacturers, the supply chain into those regulated manufacturers and also on the distribution side, we're all regulated to a similar or higher -- or a similar degree.

So across the board there, Christian, life sciences, yes. There are obviously some consumer product goods companies as well. And I treat them as life sciences because we're applying to their regulated side of their business, which is the validation space.

[Christian Sgro, analyst]

Got it. I'll sneak in 2 more questions. The first of these 2 on the partner channel, there was some explicit commentary on how the partner channel has matured or evolved even at the start of this year. So Eddie, what could you share on -- I think there's a tiered system as well as more focus on the systems integrators does that help you get to market in a lower-touch format? Does that help you get to new geographies? How has the structure of the team changed? What color could you provide around this evolving channel?

[Edmund Ryan, executive]

Yes. That's a good question, Christian. So the product channel is continuing to evolve, and we have partners in the different segments and some might be more focused on integration. Others are also -- they've come up to a level where they can be resellers. So we have different, I guess, partner agreements now. Some are interested in being that more pure-play integration channel and others are interested in being resellers and integrators and follow-on support -- in other words, managing the life cycle of the customer. So yes, so there are different tiers. And the goal is that the partners will be successful in the nonstrategic customers from our perspective.

[Christian Sgro, analyst]

Great. And then my last question here might be more for Hugh. The gross margin is 74%, a little bit higher than what I was looking out for. Was there any benefit on the services side from utilization or otherwise? Or is this 74% steady-state trend going forward, driven by the software? And what could you say about any puts and takes in the quarter there?

[Hugh Kavanagh, executive]

Sure. Thanks, Christian. Yes, so I'd say we're very pleased with the 74%. It's tacking along the right way, thankfully. But yes, I think there are a few nuances in there that is probably we're being aware of. And it's probably most -- in terms of professional services, most to do with timing of when projects get completed and when they get recognized in revenue. We expense our professional services as being core to cost. And then obviously, projects can finish 1 quarter or they may slip into the next and that can impact the amount of revenue recognized in a particular quarter, and that certainly kind of impact the gross margins to a small degree, but also the results are certainly efficiencies on the whole professional services side.

And there's a lot of focus on, as you mentioned, utilization and having that group focused on providing professional services as opposed to doing other stuff, which belong in other areas. So yes, absolutely, there's better utilization, but also to do with the timing of projects.

[Operator]

Your next question comes from the line of Gavin Fairweather from Cormark.

[Gavin Fairweather, analyst]

Congrats on the results. Maybe just to start out, can we just check in on kind of the health of the pipeline entering Q2? And I think the MD&A referenced -- a lot of referenced that it was pretty strong, but I am kind of cognizant that you're coming off a very strong Q4 for ARR and then a very strong addition in Q1 and what's normally kind of a slower seasonal period. So I'm wondering if maybe pulled a little bit forward from Q2, Q3. So can you just touch on kind of that pipeline health as we're entering the next couple of quarters here?

[Edmund Ryan, executive]

Yes. That's a good question, Gavin. And I'm very buoyant about our pipeline. It's a strong, stronger than it's ever been. And customers like across all the life sciences space that are across our target markets. It's got big and small and small strategic enterprise, et cetera. So you're right in saying that there could be a seasonal impact. We don't know that. We're off to a very good start.

We do think there's more buoyancy in the market than there was last year. It's early days. One quarter doesn't make a year, but we think it's a better -- starting out a better year this year. So we keep executing harder and faster. And our teams are evolving and coming up to a higher standard as we move forward, and we put a lot of structure in place last year and we hired a lot of people in the last 1.5 years, and all this is coming to bear and we see that in the pipeline. So I would be optimistic that we will continue to execute strongly.

[Gavin Fairweather, analyst]

Great to hear. And then Obviously, a lot of your big customers are continuing to expand that. That's clear from the numbers. I guess there's 2 main verticals for expansion. One is kind of site driven with existing processes and then 1 is with new processes. Can you just speak more fully to the new process part.

How strong is that been recently? I guess that's more of a sales customer success function probably harder to get over the line, but also really extends the runway with those customers as they add new use cases. So how strong has that been recently with your major customers?

[Edmund Ryan, executive]

Yes, that's very good, Gavin. And I think it's improving as we focus on it more and more especially with the strong customer success function that we put in place in the last 6 to 9 months. So I would say that our customers are purchasing the platform for all the validation processes for harmonizing validation across all their sites. And that's for multiple use cases. And we're seeing them moving along those use cases to additional use cases from where they started.

So there's a huge amount of upside in our customer base from that perspective and they are moving along. And we believe it's getting stronger as we go along, and it's a result of technology, being able to reach in there better and also our customer success culture that we've built over the last quarter. It's always been there. We've just made it stronger.

[Gavin Fairweather, analyst]

Great to hear. And then just lastly for me on the product. I can't remember [ 9.2 or 9.3 ] I think you had a release planned in Q2, not sure if it's out yet. Can you just touch on the major functional changes in this release and kind of the initial reception from the ecosystem?

[Edmund Ryan, executive]

Yes. So we're 9.2 is the number you're referring to there. And we've -- I suppose we're out with that now and customers are beginning to see that. And beginning to move into it over the next few months. And we would say that the customers are very excited about what we're developing and the value we're delivering and both in the short and longer term. So there's been a real positive response to us.

We've put a lot of great technology in there and that is part of the very strong vision that we're building out in parallel with the customer intimacy from a day-to-day perspective. So giving them what they need, but also building where we want our platform to be in the future. So yes, it's going very well on that perspective, Gavin.

[Gavin Fairweather, analyst]

Do you think that that's a catalyst for expansion? Because I think that I remember that a lot of your big customers haven't yet moved on to 9.0 or 9.1 where you brought in kind of the entity management and some of the new kind of cloud-native functionality. So do you think that some of your bigger customers now moving on to this newer data structure could be a catalyst for expansion?

[Edmund Ryan, executive]

Absolutely. And so obviously, we're moving into the multi-tenant space now, and they'll be getting into a regular cadence of upgrading customers and that's happening and going very well and really excited about the R&D team have delivered here. So I expect just to be clear, the future is about expanding our existing customers, the huge opportunities we have there.

And everything we do is about that. So it definitely will be a catalyst. But it won't happen overnight. It will happen as we go through the months and the half year in that.

[Operator]

Your next question comes from the line of Tanvi Gabriel from Echelon.

[Tanvi Gabriel, analyst]

Congratulations on the quarter. I'll be speaking on behalf of Rob Goff. And we were just wondering if you could perhaps elaborate on your capacity to increase your revenue just given the current existing resources that you have available.

[Edmund Ryan, executive]

Yes. Thanks, Tanvi. So I think the key thing that we are seeing, and especially as we go forward, you can see that our revenues are increasing relative -- significantly relative to our cost or cost are staying steady. And I think that's a result of the team that we built over the last 1.5 years, and it's coming to really beginning to deliver over time and continue to do.

So I think we strongly believe that -- we've said from the start of the year that our expenses aren't going to go up significantly in this year in '24. And we continue to maintain that thought. So we will put in some strategic hires as we go along to build the future of the company. But we're very strong on the capability that we still have a lot of bandwidth in our team.

[Tanvi Gabriel, analyst]

Right. Okay. And in terms of your expansions within life sciences and markets, could you share perhaps any recent developments that you've noticed in the competitive dynamics within your RFP?

[Edmund Ryan, executive]

Yes. So not a lot has changed there. Today, still down selection still consists of probably 2 companies. There are entrants coming into the marketplace and they all have different value propositions and different levels of maturity associated with that product.

I guess one of the things that we're really strong on is our maturity and how long we've been at this business and today, we're a leader in the validation space. And that doesn't happen overnight. That these big -- large companies take you and roll you across all their sites, you have to be a very scalable, secure, easy-to-use platform that delivers value. And I guess we continue to articulate that value proposition to our customers, and it's very well received and so improving in the marketplace. So yes, just to be sure, Tanvi, there's definitely competitors, and they come in different guises. But we still believe in our vision and what we have, and we constantly are focused on deep value for our customers.

[Operator]

Your next question comes from the line of Justin Keywood from Stifel.

[Justin Keywood, analyst]

Key industry drivers we've seen a record level of FDA approvals in 2023 and there's a record level of FDA submissions this year. Is that contributing to some of the strong growth we're seeing at Kneat? Or is it just overall improvements in efficiency and digitizing operations? And then also, obviously, with the GLP-1 momentum continuing. Is that a material contributor to Kneat as well?

[Edmund Ryan, executive]

Justin, these are all very strong factors, drivers within our space. And all these new product approvals and all of that mean that down the line, these companies are going to be doing more validation of new facilities and ongoing operations of these new process lines and all of that. So anything that's bringing more products to the marketplace is good for validation.

And there's a huge amount of that happening in not just big product category, but also in small product category in the personalized medicines in that. So I'd be very, very buoyant about the industry and the future of the industry and the growth of the industry. And I think the bigger pharmaceutical companies are not as restricted by the potential macro environment out there.

I would also say that I think the macro is easing a little bit this year, but it's still a bit early to call. But yes, for sure, these are big drivers for validation. Our goal is to help these companies. Our purpose is to help these companies to deliver their medicines and therapies to their patients at the highest quality and safety standard. That's a huge purpose and these are delivering new medicines, and that's where we fit in. And that's where we want to continue to enhance our value.

[Justin Keywood, analyst]

Okay. And then just on the net retention rate, if there's a number in the quarter, I know it was quite high last year at 158% if there's a quarter number.

[Hugh Kavanagh, executive]

Yes, no, I was going to say, we don't release a quarter number. So I think the number in the last maybe 138%, 158% the previous year, but while this was not disclosed publicly on a quarter, I mean, we still remain very, very confident in maintaining those numbers at that sort of level.

[Operator]

There are no further questions at this time. I'd like to hand back to Eddie Ryan.

[Edmund Ryan, executive]

We are ready, with our leadership position in validation for life sciences, our unique data-centric software platform getting better all the time. Our increasingly skilled sales force and the traction we are seeing with our partner program, we feel good about the rest of this year. When we look back on all the progress we have made and how we have gotten better as we have grown, we are energized. We are passionate about making validation better for more companies in more places because the end result is better for us all. Thank you.

[Operator]

That does conclude our conference for today. Thank you for participating. You may now all disconnect.