Kneat.com Inc

TSX:KSI

Earnings Call Analysis

Earnings Call Transcript 2023-Q3

[Operator]

Good morning. My name is Jordan, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Kneat Q3 2023 Conference Call. [Operator Instructions] Speakers, you may now begin your conference.

[Katie Keita, executive]

Thank you, operator, and welcome, everyone, to Kneat's earnings conference call for the third 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 our 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 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 when -- 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 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 the call today. I will share my thoughts on the quarter then Hugh will provide a detailed financial update. And after that, we take your questions.

Our third quarter financial results were solid, with total revenue up 46%, SaaS revenue up 72%, total annual recurring revenue up 64% and SaaS annual recurring revenue up 74%.

Growth in the quarter was driven primarily by expansions in the number of licenses held by current customers, and to a lesser degree, by incremental revenue from new customers deploying for the first time in the quarter, including several that we announced earlier this year. Essentially, what we saw in the quarter was our land-and-expand strategy play out as it has done, uninterrupted, for the past several years.

What makes this year different from previous years is the size and number of both new and expansion deals. The strategic importance of momentum at this stage of our life cycle cannot be overstated as life sciences companies have been understandably careful in their adoption of digital solutions. The majority of their transition to digital validation lies ahead.

By getting in early to serve as the initial foundation on which life sciences companies are preparing for automation, Kneat secures an early lead, greater marketing mind share and can be more influential in building the future of digital validation and quality management.

Once the company has chosen and deployed a digital platform to support validation, switching away from that platform is not easy. Companies are obliged to maintain years' worth of validation records for quality tracking, assurance and audit.

This is why companies put so much effort into their platform selection in the first place. It is not an easy, reversible decision. Integrations with the rest of our customers' IT systems across resource planning, manufacturing, quality, engineering and maintenance further strengthen our position as a pillar in their IT landscape and helps our customers make even more efficient use of their resources.

This is why our R&D team is also building application programming interfaces, so customers can capture even greater efficiencies when they're deploying it.

We brought the total number of our strategic wins year-to-date to 7 with the announcement of 2 more in the third quarter: a contract development and manufacturing organization headquartered in Asia for equipment validation and a manufacturer and distributor of medical supplies headquartered in the United States for computer systems validation. I note that neither of these is a traditional global pharma, underscoring the applicability of the Kneat platform throughout the life sciences ecosystem.

We enjoy the company of customers, prospects and partners coming from all across the pharma supply chain at the Kneat VALIDATE Conference in Miami last month. Spending a few days with true leaders in validation through formal presentations and one-on-one conversations informs our road map and customer interactions and inspires our R&D going forward.

I came away from the conference more enthused than ever about our relationships with customers, our position in the industry and our business strategy. The conference also reinforced for me that digitization and automation will continue unrelenting into the foreseeable future, and that our unmatched focus on eValidation will continue to power our near-term success.

It was a fantastic event and a great showcase of the differentiated talent that powers Kneat and our connection to our customers and partners.

So with that, I will hand you over to Hugh for a review of the financial results.

[Hugh Kavanagh, executive]

Thank you, Eddie. As Eddie mentioned, quarter 3 was another quarter of strong revenue growth and year-on-year gains in our gross margin.

Revenue for the third quarter ended September 30, 2023, was $8.4 million, up 46% from $5.8 million for the third quarter of 2022. SaaS license revenues grew by 72% to $7.7 million compared to $4.5 million for the same period in 2022. This brings us to just over $24 million in revenue 3/4 of the way through the year.

Cost of sales for the third quarter of 2023 was $2.9 million, which is a 31% increase in cost of revenues year-over-year relative to the 46% increase in overall revenues over Q3 2022.

Gross profit for the 3 months ended September 30, 2023, was $5.5 million, 56% higher than the $3.5 million in the same quarter in 2022. Gross margin percentage was 65% compared with 61% for the third quarter of 2022. The increase in gross profit margin was driven by the significant increase in SaaS revenues as compared to the increase in cost of revenues.

I would also note that as partners take on more professional services and the proportion of our license revenues to professional services revenues continues to increase, we expect the gross margin percentage to keep on this upward [ trend ] year-over-year. As we saw last quarter, while this transition adds to headwinds on our year-over-year growth of revenues in the short run, it leaves us much better positioned for the long run in the form of more gross margin dollars available to our business.

Turning now from progress in gross margins to progress in operating margins. R&D expense net of capitalized R&D for Q3 2023 was $3.8 million compared to $2.8 million in Q3 of 2022. And sales and marketing expense was $3.1 million in Q3 2023 compared to $2.1 million in Q3 of 2022. We saw the year-over-year growth in these line items begin to taper as we annualize the investments in hiring that we made over the course of 2022.

Total annual recurring revenue, ARR, which includes SaaS license fees and maintenance fees grew by 64% to $31.4 million from $19.1 million at the same point last year.

As we look at just the proportion of ARR coming from SaaS license fees, SaaS ARR grew 74% to $31.3 million from $18 million at September 30, 2022.

This recurring revenue from sales of our software is central to our growth strategy and explains why ARR is a key performance indicator for Kneat. Revenue from our SaaS offering adds to our annual recurring revenue base, a central tenet to our growth strategy, given the strong staying power of our customer base.

ARR from maintenance fees was $0.1 million at the end of the third quarter of 2023 compared to $1.1 million at September 30, 2022, as nearly all customers have transitioned over to SaaS.

We added to our cash balance at the end of the third quarter by putting the second tranche of our debt facility to use, and we continue to have the third tranche of the facility available to be drawn down.

For your reference, we have filed our unaudited 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]

Your first question comes from the line of Christian Sgro from Eight Capital.

[Christian Sgro, analyst]

You commented that some of the growth you saw in the quarter was due to expansions instead of new business, and I think that's common from Kneat. But as you talk about new licenses, is there any color you could provide around whether those new licenses were across new sites, more people per site, new geographies, new functions? Like where are you getting some of that pickup?

[Edmund Ryan, executive]

Thanks for your question. Yes, so the expansion is a large part of our business and I will say that most of our expansions are in that vein. They're either new processes or expansion to new users or expansion across sites. So it's very common within our expansion business going to new sites, new processes and more user licenses.

[Christian Sgro, analyst]

Okay. And you mentioned -- there was more commentary than normal this quarter already on the stickiness, the moat of the Kneat platform. Is there an update you could provide around the sales cycle and implementation cycles of the Kneat Gx platform? I know historically they've been quite long. For business reasons, it's great to shorten them. But if they're still long, maybe that speaks to how critical the decision is and how sticky the product can be?

[Edmund Ryan, executive]

Yes. So this sales cycle varies from time to time, and I would say the current climate sales cycles are extending a wee bit. Nothing significant when you have a strong pipeline.

But I would say that as we develop more technology, we're also seeing that countering that. So we're enabling the sales process to a more mature business and more features in our technology. And we're also shortening the deployment times for the same reasons.

So -- but in the current climate, that's countering it a wee bit, but I would say that, yes, we're heading in the right direction regarding shortening these cycles.

[Christian Sgro, analyst]

Okay. And one last question from my end on seasonality. Sometimes software companies can have a stronger Q4 just in the calendar, if there's any budget flush or customers looking to spend ahead of the year-end.

Now is that a theme at all for Kneat? Or would you say some of the expansion activity is less predictable and not to think of Q4 as necessarily being stronger for seasonal reasons?

[Edmund Ryan, executive]

Well, I suppose I mean to say -- I always say, Christian, is that certain deals can cause a bit of lumpiness from quarter to quarter. But traditionally, when we look back over our cycles, traditionally, the fourth quarter has been strong for us. And I think that has to do with customers that have budgets there, and they have -- didn't get around to doing what they needed to do and something they have to push in a wee bit quicker at the end of the year.

So there's definitely some seasonality there from our perspective. That doesn't mean -- I can't guarantee there'll be -- but that's what it tends to show from our history.

[Christian Sgro, analyst]

Okay. Perfect. Congrats on the quarter.

[Edmund Ryan, executive]

Thanks, Christian.

[Operator]

Your next question comes from the line of Gavin Fairweather.

[Gavin Fairweather, analyst]

Congrats on all the progress.

[Hugh Kavanagh, executive]

Thanks, Gavin.

[Edmund Ryan, executive]

Thanks, Gavin.

[Gavin Fairweather, analyst]

Maybe just to start, kind of building on one of Christian's questions around expansion. Maybe a lot so around kind of Q4, but maybe you could help us understand what you're hearing from your customers on expansion plans over the course of 2024. What are you hearing in terms of kind of CapEx plans and new plant builds. Any kind of color on that expansion environment maybe over the course of next year would be helpful.

[Edmund Ryan, executive]

Yes. So definitely, our customers are all indicating expansions. And we see lots of opportunities and we believe that we're only touching the surface with our customers. And we see a lot of opportunity there to become more intimate and to push into these other areas with them.

But there's definitely -- all our customers, all our strategic customers certainly are on rollout plans of one sort or another, whether that's new sites or whether it's more users or whether it's capital projects, like you say, that they're applying Kneat to as well, Gavin.

[Gavin Fairweather, analyst]

Okay. That's great to hear. And then just on the new logo acquisition side, I think you said 2 strategic logos in the quarter and 7 year-to-date. What do you see when you look into the pipeline in terms of those strategic logos? Do you have a good number that are kind of in the works?

[Edmund Ryan, executive]

Yes, we do. We do see lots of them in the works, and we're optimistic that we will continue to deliver news like that into the future. So there's a strong pipeline across mid-tier, large strategics and small pharma as well.

[Gavin Fairweather, analyst]

Got it. And then a lot of the effort on the product side has been kind of redoing the data taxonomy and moving to more kind of data-centric structure within the product. Curious for your perspective on kind of what kind of new functionality that might unlock including leveraging AI?

And then also maybe you can touch on how you might see data flowing within the stock? What kind of use cases or efficiencies does the new structure open up?

[Edmund Ryan, executive]

Yes, it's a very good question. We're very optimistic about where the product is going and how aligned we are with our customers. We had a very great VALIDATE conference recently in Miami and the customers are just pointing out how aligned we are with them, and that's really great to hear. And that seems to be getting stronger every year when we meet our customers en masse like that.

So what we're bringing forward is that customers are really excited about is enabling more data centricity within documents and outside the documents on that. So it -- you will get this very strong data structure where it continues to deliver. It gives us the ability then to have really strong data analytics and deliver more value for the customers.

And also the -- it enhances also the integration capabilities and just bringing more value generally to the customer and also giving that data integrity that customers must have in our industry, it's critical. And so there's a huge amount of work that we're doing there and it's all coming through the pipeline as we speak.

[Gavin Fairweather, analyst]

Okay. Great. And then just lastly for me, just on the working capital. I saw that the receivables jumped a little bit this quarter, maybe for Q. Is that just kind of timing? And have you seen any of that kind of reverse so far here in Q4?

[Hugh Kavanagh, executive]

Yes, for sure, Gavin. Yes, so versus last quarter, the trade receivables are up quite a chunk. And in fact, of that $7 million or so that we have of trade receivables at the end of the quarter, the vast majority of that actually has been received at this point.

[Operator]

Your next question comes from the line of Andy Nguyen from Raymond James.

[Andy Nguyen, analyst]

So you have a couple of big wins -- customer wins last quarter and this quarter as well. How is the onboarding process going for those clients with respect to the typical process you see with other customers as well?

[Edmund Ryan, executive]

Yes. Yes, so we're -- our professional service team is very good at delivering deployments and partners where they're involved as well because we get involved with our partners to make sure they go effectively.

So all those deployments of those new customers are on target. And we would say assume a 6-month plus from the time we announce them to be complete from a deployment perspective on the first phase of the deployment. Thereafter, it's about expansion into the future.

[Andy Nguyen, analyst]

Got you. And with respect to the partner network, I think you have about 77 partners and services provider this Q compared to like 50 of the previous year. How should we think about the growth of that partner network going into fiscal 2024?

[Edmund Ryan, executive]

Yes. So the partners are -- belong in different categories. And if you think about our strategic partners, that base is growing and those partners are evolving in their capabilities. They would have started out as trained service partners, being able to use Kneat in industry and then going to, from there, to be able to deploy Kneat and expand Kneat with the customer's process mapping and the like to expand the product across the customer sites. And then from there, moving into capable enough to be potential resellers.

So we see that model working really well, and we see a number of customers really stepping -- partners, excuse me, stepping up to become these strategic partners that can also resell our platform into the industry and especially into the mid and smaller customers as well.

So yes, that's gone very well for us and we expect that to continue, and we have a strong focus on it.

[Andy Nguyen, analyst]

Got you. And then final question for me. I'm assuming the retention rate remained 100% this quarter for your customer base.

[Edmund Ryan, executive]

So just repeat that again. Yes, sorry.

[Hugh Kavanagh, executive]

Can you repeat? Retention rate.

[Andy Nguyen, analyst]

Yes. So I just want to know your retention -- yes, yes, remained 100% for the quarter?

[Edmund Ryan, executive]

Yes. So we would say that we have 0 churn. And what I would say from that is there are some exceptions from that. But by and large, it's still 0 churn as far as we're concerned. But you may see the odd small customer that may, whatever, for one reason or another, go back smaller. But by and large, I would say, still 100% from that perspective.

[Operator]

The final question comes from the line of Steve Li from Raymond James.

[Steven Li, analyst]

I joined a little late, so I may have missed it, but what was the FX impact on the revenues, positive or negative?

[Hugh Kavanagh, executive]

Yes. So the impact on revenues quarter-over-quarter -- in this quarter was actually versus the same quarter last year was essentially there's no impact on revenue versus the same quarter last year.

[Steven Li, analyst]

How about year-over-year, Hugh?

[Hugh Kavanagh, executive]

Year-over-year, yes. So over the course of the year, yes, there is a tailwind in the several hundred thousand dollar type range, yes.

[Steven Li, analyst]

Okay. Perfect. Okay. And on the potential ARR from current customer, on your website you still show $50 million ARR, which you've been using for quite some time. Do you have an updated number?

[Edmund Ryan, executive]

Yes, we do. But the question, Hugh, is that number publicized?

[Hugh Kavanagh, executive]

And no, we haven't put it out in press releases, no. So yes, so we certainly have updated the number and we'll probably refer to it in our next -- our year-end press release, yes.

[Edmund Ryan, executive]

Yes. But just safe to say there the number definitely is revised upwards and we will release that, I guess, in due course.

[Operator]

We have another question from Gavin Fairweather.

[Gavin Fairweather, analyst]

Just a follow-up maybe for Hugh. We saw the gross margins tick down very modestly from Q2 levels despite kind of the SaaS mix moving higher. Is that just kind of lower services utilization? And maybe, yes, just unpack that a little bit, that would be helpful.

[Hugh Kavanagh, executive]

Yes. No, you're spot on there in your comments, Gavin. Yes. So essentially, the lower professional services revenue this quarter is really the driver of that. That slight tick down quarter-on-quarter. But yes, so the situation continues to be that we have very strong SaaS margins. We continue to have -- our focus is not on margin there, so those are low margins. But quarter-on-quarter, where PS revenues go up or down, then that can have an impact on the overall gross margin from the perspective of we essentially recognize costs in the quarter that the cost is incurred, but then revenues sometimes vary because of the timing of finishing out on projects, et cetera.

[Gavin Fairweather, analyst]

And do you see -- like when you think about the building partner network, should we think about services revenue being relatively flat? I mean, I guess, if I look back the last few years, it's probably averaged about $1 million, maybe a tick over $1 million a quarter. Is that a decent run rate? Or is some of that going to be increasingly given away to partners as well?

[Hugh Kavanagh, executive]

So yes, no, I mean partner is probably a little more than the historic run rate, for sure. The partners are certainly -- that program is kicking in well.

But yes, no, I mean, it's not a case that the PS revenue is going to go away. We will be maintaining it. We don't expect to grow it usually, but -- or maybe at all, but certainly, we expect to continue to maintain a good service -- good level of professional services revenue.

[Operator]

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

[Tanvi Gabriel, analyst]

I'll be speaking on behalf of Rob Goff. I just wanted to ask regarding the year-to-date wins. What were some of the key factors that led to the year-to-date wins as well as the traction within medium and small clients, both directly as well as through distribution partners?

[Edmund Ryan, executive]

Yes. So yes, the wins are based on the strength of the Kneat technology and the success -- proven maturity and success in the marketplace and the reference-ability of that and the known brand of the Kneat technology delivering success. And that's been the key reason.

Ultimately, Kneat delivers high-quality product that enables your compliance and your data integrity right the first time in an industry that really values that and also cuts the cost of the man-hours associated with these processes by 50% and brings -- and enables them to get their products to market faster.

So these are huge value -- it's a huge value proposition and it's proven to deliver on all of those, which is one of the key things of Kneat at this point in time: it's maturity of product and maturity of company within the marketplace. And that's [ spilling ] down to all customer sizes.

[Tanvi Gabriel, analyst]

Right. Okay. And in terms of your current pipeline, do you see -- or what's the division between the medium and small clients?

[Edmund Ryan, executive]

The division between the medium and small clients. Okay, so there's 3 layers: there's strategic, there's enterprise and then there's medium and small. So small would be companies that have probably up to 500 employees. And then up to 2,000 becomes your next layer, which is medium. And then above that is enterprise and above 5,000 becomes strategic. Yes, I think I have those numbers right.

[Operator]

There are no further questions at this time. Mr. Eddie Ryan, CEO of Kneat, I turn the call back over to you for final remarks.

[Edmund Ryan, executive]

We've come a long way since we got our first customer nearly 10 years ago. There's still so much to accomplish. We are looking to have a great team in place getting us there and building capabilities our customers are excited about because it accelerates their progress.

I close with a sincere thanks to everyone on the call today for your interest in and support of Kneat.