Kneat.com Inc

TSX:KSI

Earnings Call Transcript 2023-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to Kneat Quarter 2 2023 Earnings Conference Call. My name is Jenny, and I will be your conference operator today. This call is being recorded.

I would like to turn the presentation over now to Katie Keita, IR Lead for Kneat. Katie, please go ahead.

[Katie Keita, executive]

Thank you, operator, and welcome, everyone, to Kneat's earnings conference call for the second quarter of 2023. Today's call will be hosted by Eddie Ryan, Kneat's CEO; and Hugh Kavanagh, CFO at Kneat.

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 by its nature is 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 our relevant filings which can be found on SEDAR and on our website at investors.kneat.com (sic) [ [e-mail] ]. Also during the call, we may refer to certain supplementary financial measures as key performance indicators.

Management uses both IFRS measures and supplementary measures as key performance indicators when planning, monitoring and evaluating our performance. Management believes that these non-IFRS measures provide additional insight into Kneat's financial results, and certain investors may use this information to evaluate our performance from period to period.

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

[Edmund Ryan, executive]

Good morning, everyone, and thank you for joining today's call. I will begin with some high-level comments before passing the call to Hugh to provide a detailed financial update. At the end, we will open the call for questions.

Our strong growth continued in the second quarter with total revenue up 45%, SaaS revenue up 80%, total annual recurring revenue up 75% and SaaS annual recurring revenue up 86% as we expanded to more sites and processes within existing customers and as new customers went live on our platform.

The revenue growth we achieved this past quarter is a result of efforts and achievements several months and even years ago. This dynamic bodes well for needs of revenue growth into the future given our high customer retention and the steady pace of wins we have had in the first half of this year.

The large wins we signed since the start of quarter 2 include a division of one of the top pharmaceutical companies in the world; one of the top 20 life sciences contract development manufacturing organizations; a global pharma manufacturer; and in July, another contract development manufacturing organization. This one, expanding Kneat's footprint in Asia.

This pace of large customer wins underscores the growing recognition of Kneat as a leader in digital validation for life sciences and excellent progress on our near-term goal of consolidating our leadership position in this space.

Beyond the revenue momentum from our land and expand strategy, it is worth noting that the life sciences space includes a large number of medium and smaller companies, both smaller pharmas as well as companies operating throughout the pharma supply chain. I'm talking about vendors, distributors and those working in the R&D space.

Given that these, and in fact, any organization subject to life sciences regulatory oversight are already represented in our customer base and are potential customers today, we estimate our total addressable market for revalidation within life sciences to be in excess of $2 billion. This $2 billion total addressable market is global as we expand our global footprint and because validation within a single large enterprise is global in scope.

The increased diversity of our customer base is evident in the shift of revenue toward this greater number, with 56% of our overall revenue coming from our top 10 customers in quarter 2 2023 versus 65% for quarter 2 of last year and 78% for quarter 2 of 2021.

This expansion of our customer base also demonstrates Kneat's strength as a platform. Rather than building to any single large customer specification, every new feature is one that strengthens the platform at large.

It is with this approach that we are incrementally equipping Kneat Gx for ever broader applicability, enhancing validation applications today while getting better at addressing additional use cases in the future.

As we bring on new customers and as the Kneat platform supports more sites and more processes within our existing customers, we must build a structure that can support Kneat at a size in the years ahead that is several times where it is today.

We made 2 important moves in the second quarter to help us. First, we are pleased to welcome Colum McNamara to Kneat. Colum joined us in early June to serve as our first Senior Vice President of Global Operations. In his career in tech, Colum has run just about everything from support to network operations for some admirable companies. So he is well equipped to build out Kneat's professional services, strategic partnerships, Kneat Academy and customer success and support.

Second, we secured debt financing of up to EUR 15 million from IPF Partners, a financing partner focused exclusively on the health care sector. Leveraging this flexible and non-dilutive option augments our own funds from operations on our path towards profitability.

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

[Hugh Kavanagh, executive]

Thanks, Eddie. Quarter 2 was another quarter of strong revenue growth and continuing progress on our year-over-year gross margin.

Revenue for the quarter ended June 30, 2023, was $8 million, up 45% from $5.5 million for the second quarter of 2022.

SaaS license revenue, which, as you know, is a key metric for Kneat grew 80% to $7 million compared with $3.9 million for the same quarter in 2022. As is usually the case, existing customers scaling their use of Kneat Gx primarily drove our year-over-year revenue growth in the quarter, aided by first-time revenue from new logos.

This brings the first half 2023 revenue to $16 million, up 49% from $10.7 million for the first half of last year. SaaS license revenue year-to-date grew much faster than overall revenue year-to-date, up 86% to $13.4 million from $7.2 million for the same period in 2022.

Cost of revenue for the second quarter of 2023 was $2.7 million, which is not too far off for where we were in Q1 and up $0.4 million from $2.3 million in Q2 of 2022. This is a 20% increase in cost of revenue compared with last year's Q2. The 6 months year-to-date cost of revenue increased by 26%. These are relative to 45% and 49% increases in overall revenue for the 2 periods, respectively.

Gross profit for the 3 months ended 30th of June 2023 was $5.3 million, 62% higher than the $3.3 million in the same quarter of 2022. Gross margin percentage was 66% compared with 59% in the second quarter of 2022. The increase in gross profit margin for the quarter was driven by a significant increase in SaaS revenue as compared to the increase in cost of revenue.

For the year-to-date, we see similar expansion of gross margin year-over-year at 67% for the first 6 months of 2023 versus 61% for the first half of 2022, an increase in gross profit dollars of 63%.

We continue to see increased technical proficiency in our partner channel with more and more partners providing services and training with only consultative support from the Kneat professional services team. While this transition adds a headwind to our year-over-year revenue growth in the short run, this positions us much better for the long run and allows us to grow gross profit and gross margin by focusing on the higher-margin SaaS revenue business.

As we look to operational expenses, sales and marketing expense was $3.3 million for Q2 of 2023 compared to $1.7 million in Q2 2022. And R&D expense, net of capitalized R&D for Q2 of 2023 was $4.2 million compared to $2.7 million in Q2 2022.

The growth in OpEx is as apparent year-to-date with sales and marketing expense of $6.3 million versus $3 million for the same period last year. And R&D for the 6 months of 2023 at $8.1 million versus $5.2 million last year.

The biggest driver of the increases for both the second quarter and the year-to-date was hiring as we invested substantially in our sales and marketing and R&D teams last year. We expect the year-over-year growth in OpEx to slow going forward as our 2022 investment has started to be more fully reflected in OpEx for the second half of last year.

Total annual recurring revenue, ARR, grew by 75% to $28.4 million from $16.3 million at June 30, 2022. Total ARR includes SaaS license fees and maintenance fees. Growing ARR through recurring revenue from sales of our software is central to our strategy. And that is why we consider ARR, and in particular, SaaS ARR to be a key performance indicator for Kneat.

SaaS ARR, the proportion of ARR attributable to SaaS licenses grew 86% to $28.3 million from $15.2 million at June 30, 2022. ARR from maintenance fees was $0.1 million at the end of the second quarter of 2023 compared to $1.1 million at June 30, 2022, and we expect the last remaining significant on-prem customer to transition to SaaS in the coming quarters.

I will end my prepared remarks with a brief word on the financing that we completed in the quarter. After exploring a number of options with several parties, we are very pleased with where we ended up with IPF. While it took quite a bit of time to go through the process, we met our objective of securing straightforward and non-dilutive debt financing that offers flexibility and carried practical and achievable terms.

I want to thank the Kneat team, especially the finance team for the work that went into getting this done. While adding debt to our balance sheet adds to our costs, it gives us the flexibility we need as we execute on our growth plans. And execution is a strength for Kneat where we have proven ourselves time and again.

For your reference, 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] Your first question comes from the line of Mr. Doug Taylor of Canaccord.

[Doug Taylor, analyst]

Can I get you to speak to -- you referenced a record period for strategic new customer signings so far this year. Can you speak to the go-lives that you anticipate through the back half of this year? And whether all of those new customers are tracking to original timetables?

[Edmund Ryan, executive]

Doug, Eddie here. I can speak to that. Thanks very much for your question. Yes, all these customers are tracking to time lines we would expect. They'd all go live within that 6-month period that is normal for our customers.

So we're very happy with those customers that we have announced. And just to remind you that we signed many other customers, but we don't announce them as we don't see them as material as the bigger ones.

[Doug Taylor, analyst]

Okay. Can you talk then to the -- you've had -- you obviously had a strong period for pipeline conversion, but can you speak to the pipeline of additional potential new customers within your core life sciences vertical?

[Edmund Ryan, executive]

Yes, I can. Doug, there -- it's very strong and it continues to strengthen. And it's a reflection of our -- the investment we made in sales and marketing and our maturity -- our product and customer maturity in the industry. So I'm very happy to say that, that pipeline continues to grow as we are executing through the sales and marketing channels.

[Doug Taylor, analyst]

Okay. You mentioned Colum McNamara's hiring is consistent with the objective of growing your professional services business, which has been, I'll say, sort of flat for the last couple of quarters and not pacing the same as your software revenue growth. Should we anticipate then an inflection in professional services revenue at some point to sort of match your software growth?

[Edmund Ryan, executive]

No. I would say professional services will continue on in the same vein where it is right now. And we're looking to remodel our professional services based on the success we're having with our partners. The primary goal is to enable partners to -- the strategies to enable partners to deliver professional services in the marketplace.

And we see our professional service team as being an enabler for ARR and SaaS revenues and partner in enablement, but also as strategic consultants to our customers. So I would say there won't be any much change in that line for now, Doug.

[Doug Taylor, analyst]

Okay. And maybe one last question for me. You've spoken to how you front-end loaded investments in sales and marketing and R&D ahead of the growth that you anticipate here in the second half of the year and beyond.

Has the availability of additional capital that you've got now or you're afforded with your new credit facility at all changed your appetite to invest further, potentially kind of hit the gas on growth? Any change there?

[Edmund Ryan, executive]

Well, going into an announcement of any [indiscernible], we were confident that we would continue to grow with the current resources and grow into the resources that we hired last year. I mean that doesn't take away the fact that we will continue to hire key resources as you've seen from Colum McNamara we brought in recently.

So there's no immediate change to the plans from that perspective. We have a lot on our plate, a lot of activities in our pipeline and customers. So we're confident that we will continue through the year, Doug, to deliver on our expectations.

[Operator]

Your next question comes from the line of Kiran Sritharan from Eight Capital.

[Kiran Sritharan, analyst]

Kiran on for Christian here. Congratulations on that TAM increase, it's pretty significant. I'm just curious how much of that increase came from any partner-led impact? Was there some sophistication expertise that they had in geographies or subsectors that have led to that increase?

[Edmund Ryan, executive]

So you're referring to the increase in the TAM, Kiran, just to clarify that point.

[Kiran Sritharan, analyst]

Correct.

[Edmund Ryan, executive]

Yes. Okay. Yes. So the original TAM that we would have estimated is primarily for pharmaceutical and medical device manufacturers within the U.S. and EU. Now seeing where our customers are using our product and where our additional customers are coming from, we relooked at all of that.

And we were able to see a larger addressable market in these additional sort of related segments, primarily in chemical, health care, health -- personal care, diagnostics and also the life sciences supply chain. So when we look at all that holistically, the TAM has increased significantly, as you can see, over $2 billion in our validation space.

[Kiran Sritharan, analyst]

That's good to hear. And for my second one here, just curious with the flushing out of the on-prem business. Are there any efficiency gains you expect from either your R&D or other internal teams? Essentially, like what is the impact of these resources being reallocated?

[Edmund Ryan, executive]

Well, yes. So we've been transitioning for the last couple of years, Kiran, right? And to all intents and purposes, we've been pure-play SaaS, just been washing out those remaining customers.

But yes, there is obviously benefits as on-prem and SaaS are 2 different products really when you line them up against each other, and focused solely and wholly on one product definitely gives us greater speed in that area and allows us to push forward with innovation there.

So there's definitely benefits to be had there. And -- but we've been watching that out for a while just as to be clear out there as well, Kiran. [ One piece ] is not just -- it's been happening over the next couple of years.

[Operator]

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

[Gavin Fairweather, analyst]

Can you hear me?

[Hugh Kavanagh, executive]

Gavin, we hear you.

[Edmund Ryan, executive]

Yes. We hear you, Gavin.

[Gavin Fairweather, analyst]

Okay, good. Maybe just a follow-up to start on the new TAM. If you look at just the opportunity for life sciences and medical devices, did the TAM increase from that $600 million that you published previously?

[Edmund Ryan, executive]

I would say looking at the original, which was U.S. and Europe only, and we're now looking at global, I guess, in all of our TAM. So not any real change with regard to medical devices and pharma manufacturers.

But I would say when you look at -- into the supply chain around all of them, yes, but that would be the additional TAM that's contributing to the additional TAM. So no real change from that perspective other than we've added in new segments and adjacencies from a regulator perspective and global, Gavin.

[Gavin Fairweather, analyst]

Okay. Got it. That's helpful color. And then maybe just on kind of the customer base and expansion plans for the back half. Can you just discuss what you're hearing from your larger customers heading into the back half. The ARR added in the second quarter was a bit lower than previous quarters, although it can be lumpy. Curious what you're hearing on expansion kind of coming out of your 9.0 release and your big user conferences there?

[Edmund Ryan, executive]

Yes. So these are very intimate relationships, and we have continuous engagement with our customers regarding their expansion plans, and we're very optimistic that everything is going to go according to plan from that perspective from our internal expectations.

So yes, we don't see any negative impact from the macro really. There's a few -- you may see a few little slower deals happening mostly in the smaller customers and maybe a slower quarter and maybe a customer might hang on to the next quarter, but nothing significant. Everything is -- seems to be business as usual from that perspective, Gavin.

[Hugh Kavanagh, executive]

Just to that, Gavin -- I'd just add -- Gavin, I'd just add one additional comment, and I'm sure you're probably already conscious of this. But just in terms of ARR growth quarter-on-quarter, exchange rates do play a role here. We haven't drawn -- really drawn attention to it in our press release, et cetera.

But yes, as you know, revenue comes in, in dollars and -- principally dollars but also euro. And then we look at ARR at quarter end, then we convert it at quarter end rates and the quarter-end rates have essentially brought a headwind on the ARR front to the tune of $500,000 or $600,000. But I'm guessing that you probably have made a good estimate of that already yourself.

[Gavin Fairweather, analyst]

Got it. That's helpful color. And then maybe just can you discuss within the Tier 2 and Tier 3 space within life sciences, kind of how your win rates are tracking versus your expectations as you build out the channel? I know it is a more kind of competitive space. So curious how those are tracking now that the channel is starting to mature?

[Edmund Ryan, executive]

Yes. We -- our win rate is very good, Gavin. And there's -- customers, when they get to a certain size, they may not be as attractive to us. But definitely, when they go down into those mid-market, we're good with that.

And we would be -- we would -- our objective would be to improve delivery through the channels to the smaller customers as well. But yes, no, our win rate is good. I mean, as I say, the macro climate is affecting smaller customers a little bit more than the bigger customers, but that doesn't mean that it's affecting us in any way significantly either, you know.

[Gavin Fairweather, analyst]

Okay. Great. And then just lastly for me. Any thoughts around how generative AI or kind of Copilot could help with dev efficiency or testing efficiency? Is there some automation that you can put in place there to just help with the speed of innovation within the R&D teams?

[Edmund Ryan, executive]

Absolutely. The team are leveraging that as we go through, especially in the whole area of testing and co-development. It's a small part of the overall thing, but if you're developing a [indiscernible] or a function, it can help there.

And there is -- we see opportunity for us in the whole area of data analytics as well as we go forward. And we're building out all that reporting capability, and hopefully, we can leverage that in the not-too-distant future as well. So [indiscernible] research and some use of it going on, but nothing major at this point in time, Gavin.

[Operator]

There are no further questions at this time. And I would like to turn the call back to our host, Katie.

[Katie Keita, executive]

Thanks, Jenny. We have a few closing remarks from Eddie. Eddie, I'll pass it over to you.

[Edmund Ryan, executive]

Let me close today's call with a reminder that with every new customer added and with every new feature we build, we make progress on our goals over the longer term, which is to extend our best-in-class framework into the total quality management space beyond the multiple validation processes is being adopted for today.

At the 6-month mark of 2023, we see strong progress on our goals at the start of the year, adding and deploying new customers, expanding to new work processes and new sites within our existing customer base, further developing the Kneat Gx platform in collaboration with our customers, selectively building out our company structure and leveraging our partner relationships to expand global reach.

Before closing, I want to express my thanks to the entire Kneat team. Ours is an incredible group of people. The value Kneat is bringing to life sciences is only possible through their discipline and focus. This is a team that makes our software better every single day and get better themselves in the process.

To everyone on the call, thank you all for your time today, and we look forward to updating you again in October. Thank you, and that's it for today.

[Operator]

This concludes today's conference call. You may now disconnect.