Kneat.com Inc

TSX:KSI

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Hello, and thank you for standing by. At this time, I would like to welcome you to the Kneat Solutions Inc. Q2 2024 Earnings Call. [Operator Instructions]

I would now like to turn the conference over to Katie Keita, IR Lead. Please go ahead.

[Katie Keita, executive]

Thank you, operator, and welcome, everyone, to Kneat's earnings conference call for the second 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. These inform you that some of the comments made on today's call contain forward-looking information, which, 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 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 from planning, monitoring and evaluating our performance. Management believes that these non-IFRS measures provide additional insights into our financial results and certain investors may use this information to evaluate Kneat's performance from period to period.

With that, I pass the call to Eddie Ryan, CEO of Kneat.

[Edmund Ryan, executive]

Thank you, Katie. Good morning, everyone, and thank you for joining the call today. Hugh and I have prepared a few brief remarks about the business and our financial results. And then we will open up the call for your questions.

Our strong performance we started 2024 with carrying into the second quarter, with annual recurring revenue up 60% over last year's second quarter to $45.4 million. SaaS license fee revenue in the quarter grew by nearly $4 million from last year's quarter 2, a 54% increase to $10.8 million. This acceleration helped lift overall revenue to $11.7 million, a 45% increase over last year's Q2. With this solid growth in revenue and cost of sales up minimally year-on-year, gross profit margin in the quarter was 74%, up from 66% in last year's second quarter. The steady deal flow momentum we experienced in the first quarter continued into quarter 2, split roughly evenly between the U.S. and Europe.

While expansions within our existing customers drove most of our incremental revenue, we added a number of new customers in the quarter and are still tracking to outpace last year's number of new customer adds. More companies and more departments and teams within companies are actually on the need to digitize validation. Paper-based and hybrid processes are increasingly out of step with everything that is propelling the pharma industry forward. Even updating other parts of an IT infrastructure can require an e-validation solution, and this was a catalyst for one of our wins in the quarter. This drive to digitize validation across the life science industry is contributing to the progress we are making with our partner program. We signed several new partners so far this year, including Korber Pharma Consulting, which we announced in June.

With Korber as just one of several European partners brought on, we are making progress in expanding our geographic coverage. Every regulated company, no matter where it's located, should have access to e-validation from Kneat, and we are working closely with the partner community to help achieve this. Partners leaned in heavily to help us put on our best-ever VALIDATE User Conference in May in Berlin. Customers and future customers alike joined us to dig in on the features that we've already added that we plan to add and that they would like us to add. We talked about a lot of things at VALIDATE, among them best practices, artificial intelligence and multi-tenancy with the goal that we all come away from the 2 days together smarter and better equipped to capture the many benefits that still lay ahead to digitization. I'll close here with a big thank you to our partners, our customers and our lead team that made VALIDATE the huge success that it was.

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

[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.

Our solid financial results in Q2 underscore the growing demand that Eddie just talked about, as revenues grew 45% year-over-year to $11.7 million. SaaS revenues grew 54% year-over-year to $10.8 million, and ARR grew 60% year-over-year to $45.4 million. Scaling Kneat Gx within existing customers drove most of this growth while revenue from new customers added a contribution as well. Revenue from professional services was $0.8 million. This is lower than Q2 a year ago as we grew our partner community to take on more services. This transition aims to focus more of our resources on developing our platform and incentivizing our partner community to [ seed needs ] across life sciences to help consolidate a leadership position in e-validation. This brings the first half 2024 revenue to $22.4 million, up 40% from $16 million for the first half of last year.

SaaS license revenue year-to-date grew faster than overall revenue year-to-date, up 53% to $20.6 million from $13.4 million in the same period in 2023. The acceleration in top line growth after a strong first quarter was accompanied by a slowdown in growth of cost of sales and by carefully controlling growth in operating expenses. Cost of revenues for the second quarter of 2024 was $3 million, up 10% from the cost of revenues in Q2 of 2023. The 6 months year-to-date cost of revenue also increased by 10%. These are relative to 45% and 40% increases in overall revenue for the 3-month and 6-month periods, respectively. Gross profit for the 3 months ended at June 30, 2024, was $8.7 million, 63% higher than the $5.3 million in the second quarter of 2023.

Gross margin percentage for Q2 was 74%, same as last quarter. For the year-to-date, we see similar expansions of gross margin year-over-year at 74% for the 6 months of 2024 versus 67% for the first half of 2023, an increase in gross profit dollars of 55%. Operating expense grew 22% in the second quarter to $11.3 million versus $9.3 million in Q2 of 2023. Sales and marketing expense was the primary driver of OpEx growth, up 31% year-over-year to $4.4 million in Q2 versus $3.3 million in the second quarter of 2023. VALIDATE 2024, which was held in May, was a key driver of the expense growth in the quarter. R&D expense, net of capitalized R&D, was up 13% year-over-year to $4.8 million in the second quarter compared to $4.2 million in Q2 of last year, driven in significant part by an increase in amortizations of the intangible assets.

We ended the quarter with total annual recurring revenue ARR of $45.4 million, up 60% from $28.4 million at the end of the last year's second quarter. ARR from SaaS license fees was $45.2 million, also up 60% from $28.3 million of SaaS ARR in June 30, 2023. As we continue on our planned trajectory, that is revenue growth outpacing growth in our costs, we are energized to pursue our strategic plans with even greater confidence. 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] Our first question comes from Doug Taylor from Canaccord Genuity.

[Doug Taylor, analyst]

Yes. The continued evolution of your business mix with strong momentum in the channel partners is again evident this quarter. Can you speak to the visibility you have into the pipeline with your channel partners for new customers or expansions versus your direct sales efforts?

[Hugh Kavanagh, executive]

You're on mute, Eddie. Sorry, there.

[Edmund Ryan, executive]

Doug, yes, we have good clarity. We've actually detailed clarity on the pipeline and what partners are working on, and we've very strong, I guess, go-to-market cadence with our partners. So we would be in with them early on a low touch type of approach and -- but enabling them to do the full life cycle from resales through to implementation and support of the partners. So yes, so we do see that model evolving for us, and it is having an impact. And we see it still early in our life cycle, but it's beginning to bubble up stronger all the time. And we do see more clarity on the pipeline and the leads that are going to partners, and we're supporting them, not just the leads that we bring to them, but also the leads they're bringing themselves. Hope that answers that. Okay.

[Doug Taylor, analyst]

Yes. Well, maybe just to follow up on that. We've historically seen some substantial seasonal ARR addition in the Q4 time frame, which we're approaching here. That's really helped drive momentum in operations into the new year. Do you believe that the setup is still for that to happen this year as your mix of channel versus -- or partner versus direct changes and evolves?

[Edmund Ryan, executive]

Yes. I would say our pipeline has ever been stronger, Doug. And I would say that right from the top of funnel through to customer delivery is a high quality funnel that we have, that's getting more quality-driven all the time. So yes, I'd be optimistic, but there's no guarantee on that. Sometimes deals can slow a little bit here and there depending on the size of the deals and all of that. But we have a good pipeline that we believe will be impactful through the year.

[Doug Taylor, analyst]

Okay. Can you speak a bit about the progress you're making in building out your systems validation, the product development there to add to the clear success you've had and are having with process validation?

[Edmund Ryan, executive]

Yes. So we're making great progress and 9.2 would be our most recent release. And we would say that we brought forward some really strong capabilities that will go to a fuller more sort of digitized agile type approach to CSV, Computer System Validation, for the customer. So we have -- we're at, I would say, the first stage of that, and it's really impactful and the customers love what we're doing, and they're waiting patiently for the next phase of that. So we're very positive about where that solution is right now.

[Doug Taylor, analyst]

Okay. Maybe last question for me, and this one would be I think for Hugh. Leverage over both COGS and OpEx has been showing through here significantly in the quarter, which is great to see. My question specifically about the COGS -- cost of goods, which has basically been flat for over a year now. I mean, at what point do you need to start incrementally investing in your infrastructure to support your SaaS platform as it continues to grow?

[Hugh Kavanagh, executive]

Yes. Now for sure, I think that's what we flagged for the last while that we had intended that we put in place the structures. We particularly talked about R&D and sales and marketing, but that also did apply to, obviously, the cost of sales lines, the customer support and so on. And so we had those structures in place, which have allowed us to continue to grow the revenue while not significantly growing those various cost lines. Now for sure, as we go into 2025, we'll need to continue to look at that, and there will be a need to add resources at some point in the future. I don't think it's going to be through the remainder of this year, but as we go into next year, that's something that we will continue to reassess as to vendors need to add more resources in those various areas.

[Doug Taylor, analyst]

Okay. Congrats on another strong quarter.

[Hugh Kavanagh, executive]

Lovely. Thanks, Doug.

[Operator]

Our next question comes from Gavin Fairweather from Cormark.

[Gavin Fairweather, analyst]

Congrats on the strong results. Maybe just to kick it off for me after your VALIDATE Conference in May. Any kind of takeaways as you debrief with the sales team in terms of the outlook for customer expansions or perhaps whether some of the product work that you're undertaking, whether that's unlocking kind of new use cases or workflows for customers?

[Edmund Ryan, executive]

Yes. Good question, Gavin. That VALIDATE conference, as you know, is -- and we keep reiterating this, is a very positive experience for Kneat and for the Kneat employees in the different departments to enable them to be clear about where we're delivering value for our customers and also to be able to continue that in a focused way. The intimacy with the customers is very important to us. And as you know, prior to the VALIDATE Conference in general, we have the Customer Advisory Board, where a lot of our key customers come together and we share details on where the product is, where it's going and we show them where it's going. That's very, very impactful for us. And we're very, very excited about the alignment we have with our customers, especially our strategic customers.

So it also informs us and where the customers want to -- what features will enable them to expand further in certain areas, and we are able to take that back to the R&D team and focus on that. So I think that's a really strong pillar of our customer intimate model, where we learn -- where we can add the value and continue to add value for our customers.

[Gavin Fairweather, analyst]

That's great to hear. Then maybe just on the partner side, you added Korber, which seems like a pretty exciting partner. Maybe you can discuss what you're seeing with them? Are they resourcing up to work with Kneat and sell Kneat? And then what are you seeing in terms of the pipeline for new partners, particularly within the -- more of the kind of larger [ SI ] space?

[Edmund Ryan, executive]

Yes. So there's different variations to the partner model, and there's different value through different partners. The Korber partner is -- Korber, they're a customer, plus a reseller, plus an implementation partner. So they are really domain-focused. They're very focused on life sciences and pharmaceutical manufacturing. So they're really sweet spot from the partnership perspective. They understand the customer intimately. They understand our products. They understand -- and they also have their own IT products. So we are -- our products is going to enable them to deliver their product to market faster. It's also going to give them another product to resell as an add-on to their own capabilities, their own suite of products and also allow them to maximize their services division through implementing these as well. So that's a special type of partner where you touch a value point in 3 different places with them, right? The other partners often just resell your product or implement your product, may not have the usages themselves directly. So customer plus partner, which we're very excited about.

The partner channel is robust, Gavin. It's still -- we signed on probably 6 new partners this year. So as I said, there's, what I call, domain specialist partners that are kind of on the business side, on the quality side, the validation side and they live in that space. And then you have the IT partners, the systems integration partners, and the Korber are kind of in the middle, we would say. And since the integration partners are really interested in integration within our big customer space, helping us expand our software across all the different sites within the big customers. So we have the -- we have opportunities running in all those 3 categories.

[Gavin Fairweather, analyst]

Yes. It's great to hear. And then maybe just lastly, excuse me, on the buying environment. I know last year, you saw sales cycles move out a little bit, a bit more scrutiny around deals. I'm curious whether you've seen any kind of shifts in the buying environment more recently. I mean some other enterprise software players have kind of noted a renewed scrutiny around deals and longer sales cycles. Just curious if you've noticed any change this summer in Q3 here.

[Edmund Ryan, executive]

Yes. I would say year-to-date, we are going a bit quicker than we were last year on new -- especially new logo acquisition. Some -- there are, I would say, it's still a bit early, hopefully, back in the year is faster, but we are still very optimistic about the back of our year. But I would say that relative to the last year, there's not a huge change, probably the same type of sentiment, a little bit improved, I would say, where budgets are being freed up a little bit better. But we didn't -- we don't suffer from the budgets on our larger customers. The strategic customers and the enterprise customers are not suffering from that perspective as much as the mid-market and the smaller customers.

[Operator]

Our next question comes from Christian Sgro from Eight Capital.

[Christian Sgro, analyst]

I wanted to dig into the composition of the pipeline as you look out from here. Maybe if we don't talk about the size of the customers in the pipe, if we focus on vertical, would you say most are in the life sciences domain? Or are you seeing more and more opportunities and adjacencies like CPG and such?

[Edmund Ryan, executive]

Yes. So, Christian, as I said, we have very good clarity of our pipeline -- in our pipeline, and it's very strong. It's stronger than it's ever been, and it's a higher quality than it would have been a couple of years ago where we put a lot more rigor into managing it. I would say that just on the size of the customers, the -- we have customers in all the spaces, but primarily life sciences. But I treat like, I say, I treat consumer product goods companies as life sciences companies. I see them as that because they're using Kneat for validation, which is -- enables them to -- it's part of their business that enables them to be compliant with the regulations. So they're the very same as a big pharma company to us really. So we have those type of companies in the pipeline. We have supply chain customers in the pipeline or equipment manufacturers, systems integrators, and also on the discharge side, logistics type companies.

So we still see what we categorize as life sciences in that vertical, supply chain and manufacturers, especially in the [ biopharma ], core business for us. We see them still dispersed across those areas. And we're probably seeing maybe a little bit more medical device companies coming through as well.

[Christian Sgro, analyst]

Okay. Great. And then I'll ask a second question on the professional services team and the growth there. It's incredible to see professional services revenue sort of flat or steady quarter-over-quarter as the software grows. So my question would be, do you find that you have capacity maybe on the pro services team? Are you structurally repurposing some of the professional services headcount? Are they getting more engaged with your partners? Like how are you managing the growth in the professional services team?

[Edmund Ryan, executive]

Yes, very good question. So we would be forensic on the professional services to make sure our people are -- we have the right -- we are never -- because you can't bring people in and have them trained in this business overnight, right? So you have to keep a bench there. You have to make sure that bench is available. You have to leverage that bench and cross multiple areas. So we've done a lot of work in the last -- I guess, in the last 9 months in optimizing our professional services functions, and we split it up in the different capabilities in that. And we're watching that very closely. And I would say that we're also -- the partners are taking more of the services in the marketplace, which is great. But we would be -- from the new customers, especially in the enterprise and strategic size customers, we would be -- have a real direct impact. So we would have that professional services team ready to deploy new customers very quickly. And they're all delivering very well, and it's working very well.

So it's something that we would be continuously monitoring it. And I believe at this point in time, it's suitable for purpose, and I believe that it's actually getting more productive as we go forward. And we're getting with better models of -- and better revenue streams through better products that we can sell to our customers through professional services now as well. So I think that, that whole area is going to improve further as we go forward.

[Operator]

Our next question comes from Rob Goff from Ventum.

[Rob Goff, analyst]

Congrats on the quarter. Yet another question on the partnership development. Can you give us a sense of how you see this scaling up? Is it something like partners could be responsible for 15% of 2025 revenues or how do you see them penetrating that way?

[Edmund Ryan, executive]

That's a good question. Rob, so -- yes. So partners for us are, I would say, it's something that will take some time to mature to that type of a number, Rob. It's -- that would not be the case. A lot of our thinking that our strategic customers are the customers and the enterprise customers is where -- and customers that are already deployed are the customers will give you the growth every year. So the new customers today become the expanders of tomorrow and beyond. And a lot of that stuff is direct, especially for the strategic and enterprise customers. So we do see it tacking up, but not at that extent in that shorter period of time, Rob.

[Rob Goff, analyst]

Okay. And it certainly didn't appear in the revenues, but did you note any customers holding back a little bit just to see how 9.2 comes out, see how some of the new services come out?

[Edmund Ryan, executive]

Yes. So that's also a good question, and there's always a bit of that. Customers are always waiting to go to the next release if they can. And that's something that's just part of the business. But I think we're getting into a better approach to this, where we're enabling customers all to go up to the next release a lot faster. And it's becoming part of our kind of contractual partnership with the customers as opposed to giving the customer more time to delay releases. So we're getting more focused on that, and we're putting a lot of effort into making sure that customers now move forward with the releases, so that -- because in the SaaS environment, you need to have them upgraded with the latest technology because there's often security patches and stuff coming into each release and all that. So it's a better business for us and for the customer. So we are seeing that. But there's always some customers -- it's a transition for us, and it's going to transition over the next year or so where all the customers will be going up together at each release. But it has started, and a lot of our customers are on that cadence now.

[Operator]

Our next question comes from Steven Li from Raymond James.

[Steven Li, analyst]

Very good quarter, guys. A couple of questions for me. First one, FX tailwind or a headwind this quarter?

[Hugh Kavanagh, executive]

Very disciplined really. I mean there's -- if you look at the ARR number, there is certainly a little bit of a tailwind there in the hundreds of thousands. I mean, it's easy enough to calculate about 80% of our revenue is U.S. dollar. And if you just look at the U.S. dollar rates last -- end of last quarter versus this quarter, you'll find it's about $0.5 million. In terms of revenue and expenses, really very little impact.

[Steven Li, analyst]

Okay. That's great. And Hugh, you're still burning a little cash with the capitalized R&D. At what level of quarterly revenues would you expect to be closer to cash breakeven?

[Hugh Kavanagh, executive]

So again, as you have heard us saying before, Steven, we don't forecast these, but at a more general level, I suppose what I have said in the past is that you need to take account of -- in terms of overall cash situation, you take account of some of the working capital impacts as well because we invoice a big proportion of our cost -- of our annual revenue, a good proportion gets invoiced in the first half of the year. So as a result, our cash is typically stronger in the first half, and you will have seen that in the first quarter, we were cash positive. This quarter, we're slightly cash negative. And over the rest of this year, we will continue to be -- expect to continue to be cash negative overall. But then when we go into the first quarter -- first and second quarter of next year, I think I expect the first and second half again, first and second quarter, first half of next year to be strong. And while it'll slip back again a little bit in the second half, I would hope that overall for the year, we should be neutral or maybe even a little positive.

[Steven Li, analyst]

Okay. Very helpful color, Hugh.

[Edmund Ryan, executive]

Okay.

[Hugh Kavanagh, executive]

Thanks, Steven.

[Operator]

Yes, there are no further questions at this time. So I'll turn the call back over to Eddie Ryan, CEO.

[Edmund Ryan, executive]

I'll close the call today with a few final thoughts. First, we believe the momentum we've seen this year has staying power. Demand is there and with many companies still early in their rollouts, we expect demand to be durable. Second, our team is there. The sales and marketing teams we have invested in are coming into their own, and our results are showing it. Our partner team is off and running, and consequently, we expect to benefit from growing our network of Kneat subject matter experts. Finally, our long-term potential is there. Users are looking to leverage Kneat's flexibility, ease of use and scalability in more ways, and we are all in on developing our platform to its fullest potential. Thank you all.