Kneat.com Inc

TSX:KSI

Earnings Call Analysis

Kneat's Strong Growth and Path to Profitability Highlighted in Q3 Earnings Call

In Q3, Kneat reported a remarkable 52% revenue growth year-over-year, reaching $12.8 million, driven by a 59% increase in annual recurring revenue (ARR) to $49.9 million. The SaaS segment alone saw a 48% rise, underscoring strong customer demand. Gross profit soared 78% to $9.8 million with a notable gross margin of 77%. Operating expenses rose 15%, but the company maintained disciplined spending. As Kneat continues to innovate, Q4 is projected to maintain this strong growth momentum, with further expansions expected from both new and existing customers.

Strong Revenue Growth

In the third quarter of 2024, Kneat Technologies reported remarkable revenue growth. Revenue surged 52% year-over-year, reaching $12.8 million, and annual recurring revenue (ARR) grew an impressive 59% to $49.9 million. The company's Software as a Service (SaaS) revenue also saw a rise of 48% year-over-year to $11.5 million. This progression indicates a robust demand for Kneat's platform and suggests effective customer retention and expansion strategies.

Cost Management and Profitability

Kneat showed positive indicators related to gross profit and margins, with gross profit escalating by 78% year-over-year to reach $9.8 million. The gross margin remained strong at 77% for the quarter. Meanwhile, operating expenses grew at a slower pace of 15% to $10 million. This tightening of cost management amidst rising revenues points to a sustainable pathway towards profitability, especially as the company aims to keep its expense growth disciplined.

Customer Expansion and New Partnerships

Kneat has successfully expanded its customer base, bringing in several new strategic clients across the Americas, Europe, and Asia. Signing 85 total customers reinforces the company's goal to capture a larger market share in a $2 billion total addressable market for its e-validation solutions. Notably, the company emphasizes the importance of enhancing relationships with existing clients to increase user licenses and utilization.

Innovations and Product Development

The recent launch of Kneat Gx 9.3, which improves integration with legacy systems, showcases the company's commitment to product development. This incremental upgrade promises to enhance the user experience and ease the transition for clients using older systems. Strengthening its platform is essential as Kneat aims to expand beyond just validation, venturing into other areas of quality management in the future.

Guidance and Future Outlook

Looking ahead, the management expressed optimism about future growth, confirming that they foresee continued strong performance in Q4 and sustainable customer scaling. The leadership hinted at potential increases in spending across research and development (R&D), customer success, and market engagement activities as beneficial opportunities present themselves. Investors should note that Kneat intends to maintain its growth trajectory while leveraging investments from prior years to support its strategic initiatives.

Focus on Life Sciences Market

Kneat is laser-focused on the life sciences sector, which constitutes its primary $2 billion total addressable market. The company sees a promising opportunity to expand further into adjacent sectors within life sciences, potentially raising its addressable market to $7 billion. As Kneat develops solutions that cater specifically to the regulatory demands of the life sciences industry, the emphasis remains on solidifying its position as a leader in validation solutions.

Earnings Call Transcript 2024-Q3

[Operator]

Good day, and thank you for standing by. Welcome to the Kneat Third Quarter 2024 Earnings Call. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your first speaker today.

[Katie Keita, executive]

Thank you, operator, and welcome, everyone, to Kneat's Earnings Conference Call for the Third 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 the company's relevant filings, which can be found on SEDAR and on the company's website at kneat.com/investors.

Also, during the call, we may refer to certain supplementary financial measures as key performance indicators. Management uses both IFRS measures and supplementary financial measures as key performance indicators in planning, monitoring and evaluating the company's performance. Management believes that these non-IFRS measures provide additional insight into the company's financial results, and certain investors may use this information to evaluate the company's performance from period to period.

For your reference, we have filed our consolidated financial statements and MD&A on SEDAR, and they are also available on our website.

I now 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. After running through the highlights of the past few months, Hugh and I will open up the call for your questions.

We made great strides this past quarter with both revenue and gross profit growth accelerating for the second quarter in a row. Annual recurring revenue grew 59% year-over-year to $49.9 million. Revenue grew 52% year-over-year to $12.8 million. Gross profit grew 78% year-over-year to $9.8 million, while operating expense grew 15% over the same period.

Deal flow in the quarter included the purchase of hundreds of new licenses for use across the Americas, Europe and Asia. The expansion of licenses within existing customers drove our growth as it typically does. The tick-up in services revenue in quarter 3 reflects timing of milestones achieved in the quarter.

As we grow our partner community, they are increasingly able to provide services such as training, pilots and process mapping. We welcomed 2 new partners in quarter 3 to the growing network of businesses eager to take the lead building out and building on Kneat's platform across the ecosystem.

The success we are seeing with our partner program is just one example of the progress we have made this year against our 4 strategic goals, which are to expand within our current customers, gain market share, develop and strengthen the Kneat Gx platform and keep getting closer to profitability.

I'll confess that expanding within our current customers is the easiest of the four since getting validation activities to a high standard of reliability is why customers come to us in the first place. The rollout to get all validation process on a single platform is a natural follow-through.

Expansion within the existing customers contributes to our second objective, which is to gain share of the market for e-validation software in the life sciences. But bringing brand-new customers into the fold is more important to this goal, given the vast array of highly regulated companies that can benefit from digitizing their validation activities.

It's worth noting that our USD 2 billion TAM includes thousands of companies, and we ended 2023 with 85 of these. Each new customer adds to our already solid foundation for longer-term growth. We brought on several strategic new customers in the past month, and we expect each one of them to expand their use of Kneat well beyond their initial implementation.

Our third strategic objective to develop and strengthen the Kneat platform is also a vector for growth. Incremental improvements that come with each new release have immediate utility and they also serve as stepping stones to our longer-term product aspirations, which stretch beyond validation into other areas of quality management.

We took a step forward in October with the availability of Kneat Gx 9.3, which among other features, enables customers to more easily bring data from legacy systems into Kneat.

Finally, and just as important to the longevity of Kneat is our progress towards profitability. Growth in operating expenses slowed in quarter 3 while growth in revenues and gross profit dollars increased, which points us in the right direction.

Given our progress here over the past few quarters, the equity raise we completed last month was an option rather than an obligation and grants us greater flexibility going forward.

All in, we are making great headway across the board. None of this, of course, happens without the focus and dedication of the Kneat team day in and day out. Sustaining success takes perseverance and we are grateful to have a company full of people with this characteristic, whether it's solving hard problems, developing the software or doing demos and workshops to a potential customer who wants to be absolutely sure Kneat is the right fit for their business.

With this, I will pass you over to Hugh to go over the financial results.

[Hugh Kavanagh, executive]

Thank you, 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.

Revenue continued to climb in Q3, expanding 52% over last year's Q3 to $12.8 million. SaaS revenue grew 48% year-over-year to $11.5 million and ARR grew 59% year-over-year to $49.9 million.

The strong revenue growth in Q3 drove year-to-date growth higher. This was up 44% to $35.2 million. SaaS revenue accounted for $32 million of this, up 51% versus the first 9 months of 2023.

As Eddie mentioned, customers expanding their use of Kneat Gx was the biggest contributor to revenue growth in the quarter. Revenue from new customers, that is customers coming on in the past 12 months, grew as well.

In Q3, professional services grew 90% over last year's third quarter, mainly due to the timing of achievement of milestones within various projects.

Gross margin continued in the right direction as cost of revenues for the third quarter of 2024 was $3.0 million, up 2% from the cost of revenues in Q3 of 2023. This brings cost of revenue for the first 9 months of the year to $8.8 million, up 7% for the same period last year.

Gross profit for the 3 months ended September 30, 2024, was $9.8 million, 78% higher than $5.5 million in the third quarter of 2023. Gross margin percentage for Q3 was 77%, its highest level yet.

Year-to-date through Q3 saw gross profit grow 63% to $26.4 million, which represents a gross margin level of 75% for the 9 months period.

Operating expenses grew 15% in the third quarter to $10 million versus $8.7 million in Q3 of 2023.

Sales and marketing expense was up 26% year-over-year to $3.9 million in Q3 versus $3.1 million in the third quarter of 2023.

R&D expense net of R&D capitalizations was up 2% year-over-year to $3.9 million in the third quarter compared to $3.8 million in the third quarter of last year.

Year-to-date, operational expenses totaled $31.5 million, 18% higher than they were in the comparable prior year period.

We ended the quarter with total annual recurring revenue, ARR, of $49.9 million, up 59% from $31.4 million at the end of last year's third quarter.

ARR from SaaS license fees was $49.7 million, also up 59% from $31.3 million of SaaS ARR at the 30th of September 2023.

Overall, we are happy with our financial position. As we shared before the start of this year, our aim was to leverage investment made in years past rather than embark on large new investments. We have done this well. As we contemplate our coming investments for our next leg of growth in 2025 and beyond, we intend to exercise the same discipline in decision-making that we have to date.

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

[Operator]

[Operator Instructions] Your first question comes from the line of Doug Taylor of Canaccord.

[Doug Taylor, analyst]

My first question is on the investment you've made in computer systems validation or CSV. Clearly, starting to yield some results with the new customer you've announced since quarter end. And I'd just like to ask you what you can tell us about the initiatives you have in place or you're working on to take that CSV solution back into your existing customer base to cross-sell? I mean, do you have to wait for an RFP of some of CSV specifically? Or can you sort of creep into that process as well as part of your usual expansion motion? What does that look like?

[Edmund Ryan, executive]

Doug, thanks for your question. Yes, that's a good question. So CSV is ongoing right now and we would say that the value of that is beginning to come forward. The one thing to remember is that Kneat already has CSV, but we're enhancing the existing solution. So our customers are using CSV already and they're using our existing solution. And as we bring out and deliver the newer version of CSV over the next while, the customers will transition over time.

There isn't a new RFP or anything like that. The customers will continue on with their new validation activities in the newer version, and they can also use the older version and discontinue that over time.

[Doug Taylor, analyst]

Okay. I appreciate that color. Perhaps a similar question. You talked about the Kneat Gx 9.3 release having increasing -- or the functionality to transition data from legacy systems into Kneat.

I mean, is that a feature aimed at your existing customer base to help with the expansion process? Or is that more about reducing the barriers to entry for new customers that you'd like to add to the Kneat platform?

[Edmund Ryan, executive]

Yes, there's multiple reasons for that, actually. It's a capability to allow customers to -- if we're -- if they have already validation deliverables that they want to store in a safe place and move into their one platform for validation, they can do that very quickly through this capability.

So we could be talking about thousands and thousands of documents, millions, in fact, and we have the capability now to move them into Kneat in a very robust performance manner.

And there's also a huge amount of documentation that's often transferred in from vendors in the supply chain as part of their deliverables and part of the handover to the client, the manufacturer. And they can do that at bulk as well, depending on the size and the quantity of them.

But it's a really good feature. It's allowing us to transition also out of maybe legacy validation platforms into this also.

[Doug Taylor, analyst]

Maybe one more for me before I pass the line. I guess, this one's probably for Hugh. The gross margin this quarter surprised to the upside despite what was a higher mix of pro service revenue, which is great to see.

I mean, I guess the question is was there any seasonal element around holidays or anything like that in there or onetime that you would flag? Or are most of these gains just the result of your ongoing scale improvements and we should take that as indicative of the future margin profile?

[Hugh Kavanagh, executive]

Yes. So yes, you have noted that we had a jump in pro services revenue this quarter, and that's really reflective of just the timing of the completion of projects -- the achievement of milestones and the completion of projects and then the recognition of the revenue for those projects.

And as I've said on previous calls, I mean, on the cost side, I mean, we recognize the consultancy in pro services type costs as they're incurred. So as a result, if there's a quarter where there's either a spike in revenue, that will have a positive impact on margin or if there was a drop because there's less projects completed in a particular quarter then that would have a slightly down impact on gross margin.

So this quarter, certainly, the revenue is higher, so that has certainly helped the margins for this quarter.

[Operator]

The next question comes from the line of Scott Fletcher of CIBC World Markets.

[Scott Fletcher, analyst]

Just wanted to ask a question on the ARR additions in the quarter and what it might mean for Q4. Obviously, really strong ARR adds in Q3, well above what you added in Q3 last year. Just wondering if that has anything -- if any of that was maybe pulled forward from what's typically a strong Q4? Or are you still expecting Q4 to be typically strong in terms of ARR additions?

[Edmund Ryan, executive]

Yes. So good question, Scott. And yes, so we see that as natural growth for Kneat. I would say we continue and expect that we'll have a strong pipeline for Q4, so we expect to deliver on Q4 also. And this is a result of our customer scaling -- more of our customers scaling and adding new logos, new customers as well.

So this is what I would expect of a result of good, hard work from our sales and marketing team and our product team delivering the capabilities that customers are asking for.

[Scott Fletcher, analyst]

Okay. Great. Good to hear. And then just on the expenses and the proceeds from the equity raise. Obviously, expenses -- expense growth was even down sequentially if you -- like looking at the operating expense lines. How should we expect that to change going forward, obviously, with the proceeds expected to be invested in some of those OpEx lines?

[Edmund Ryan, executive]

Yes. So I would say that -- so we definitely are in the process of evaluating our strategic options regarding the raise and all that. And the raise is there to multiple things, right? But it is also there to allow us to address the opportunity in the marketplace. Our customers telling us where there's value we can add and more things we can do for our customers.

So I think if you look into the year ahead, you're definitely going to see additional spend in the areas of R&D, go-to-market, customer success and support. You will see additional spending there. Not going to be a step change, but it's going to obviously be there. So you can expect a bit more on that going through '25.

[Operator]

The next question comes from the line of Adhir Kadve at Eight Capital.

[Kiran Sritharan, analyst]

This is Kiran on for Adhir. Congratulations on the quarter. Now for my first, I want to circle back on the new medical devices manufacturer customer last week. Can you provide some color as to how the land-and-expand model works with these customers versus the core life sciences vertical?

[Edmund Ryan, executive]

Yes. So they're similar to all our strategic customers, right? And they get announce-able because they have that run rate in front of them. So we see the high probability of being able to scale these to multiple thousands of dollars per annum. But they'll start out smallish, maybe $100,000, $200,000 that type of thing. And over a couple of years, they'll expand to additional licenses.

So they have this runway ahead of them. So new processes. So today, they'll add on new validation processes as they go forward and they'll expand those processes to additional sites across their network.

So they're announced because they have that potential. They have a lot of sites and they have a lot of potential users in them. So we expect them to expand over 3, 4 years to their max from a validation perspective.

[Kiran Sritharan, analyst]

Okay. So that sounds kind of similar. And then I want to touch on the product for the GX platform. Now GX 9.3 launched last week and comes after 9.2 in April. I mean, with upcoming features and well-staffed R&D team, how do you see the processes and time to market with these sprint change?

[Edmund Ryan, executive]

So I'm not sure I got the full question there, but I think I got it. So you're saying that we're releasing it more often now and how does that affect our, I guess, our delivery of features into the marketplace, the speed of delivery. Is that the question?

[Kiran Sritharan, analyst]

Correct. Yes.

[Edmund Ryan, executive]

Yes, exactly. So I mean, that's exactly what it is. It's the ability to have, I guess, smaller changes, higher quality software on a regular cadence, getting features to our customers faster as they need them and also being able to get so any urgent updates to them and stuff like that. But key is to get features into the marketplace more frequently. And obviously, customers are asking for these features and waiting for those, and we want to be able to deliver for them.

[Operator]

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

[Gavin Fairweather, analyst]

Congrats on the strong results. First question for me is kind of zeroing in on your strategic customer cohort. Would it be fair to say that outside of your largest customer, which has an enterprise agreement, the rest of your strategic customers are also expanding nicely?

And maybe just secondly, what are you hearing from that customer cohort in terms of 2025 expansion plans?

[Edmund Ryan, executive]

So yes, it's kind of business as usual. I would say they are all on that journey. And from quarter-to-quarter, different customers are expanding at different rates. Some of those customers are ticking up and looking for enterprise agreements and that type of thing.

So I would say that, that cohort of customers are all heading in that expansion journey. From year-to-year, there will be different customers that will take the lead on the expansion, but they're all heading in that journey and we see the same type of thing playing out with those customers in '25.

[Gavin Fairweather, analyst]

That's great to hear. And then just on the product side, you're clearly positioning to be the one-stop shop for validation end-to-end. So I guess curious what feedback you're heading -- you're getting from customers on your refreshed CSA, CSV offering? And what kind of response are you getting from customers as you kind of make that pitch to be really the one-stop platform for all of their needs?

[Edmund Ryan, executive]

Yes. We're getting, I would say, very positive feedback from our customers and they're supporting the process, giving us additional feedback where we can enhance it further as we go.

But I would say that, yes, the customers love the ease of use of Kneat and they love the fact that they can set their process up their way on our platform, no matter what type of validation activity it is. Like I said earlier on, we already have the CSV capability in the platform, but we believe it's not as good as it should be and we're enhancing that now.

And so it's working really well, Gavin, and the customers love the vision of it and they love what we're delivering. And it will start getting into their use as we go through -- in '25.

[Gavin Fairweather, analyst]

Perfect. And then I know many customers are starting to use the product a bit for processes outside of validation, and it's capable of handling a wide array of regulated workflows and capture the data.

But curious how far away we are from kind of licenses attached to those adjacencies starting to be maybe a more material growth driver for you? I know that's a focus for the R&D team. I guess, I'm just curious when you think that's going to start to be more material in terms of a revenue driver.

[Edmund Ryan, executive]

Yes. So it is happening, Gavin, you're correct. And Kneat continues with its vision of a platform on which you can create an intelligent data-driven regulated process that's really strong on data integrity, easy to use on one platform. And the customers see that very clearly, and they're already asking us to do adjacencies right now.

And yes, we're hearing them and going through the process with them. But we're saying, guys, we want to continue to give you the best validation platform. We're the leaders in validation right now. We're the gold standard. We want to continue to make that great for you because there's still some things to be done there, such as a more enhanced CSV and the like.

But customers are going there and I can see stuff happening not too far away, Gavin. But I don't want to forecast that right now because I want the company to stay focused on doing what we're great at right now and consolidating our leadership position there. But those adjacencies will open up in due course.

[Gavin Fairweather, analyst]

Got it. And then lastly for me, maybe for Hugh. Just on cost of goods sold, can you help me understand how you're holding the line? I mean, when you look at the SaaS revenue growth that's coming through, I would have thought that your hosting costs would be moving quite a bit higher given the top line growth and usage of the platform. Maybe you can walk me through that and help me understand what kind of increase in cost of goods sold we should think about going forward?

[Hugh Kavanagh, executive]

Yes. So I mean, cost of goods sold is made up of the cost of goods sold associated with the different revenue lines. So there's a significant chunk of the cost of goods, as you can see, associated with the professional services, and I mean, that's obviously holding pretty constant.

And then on the license side, I mean, the cost of goods is made up of a few different pieces. It's the support people who respond to tickets and so on. It's also obviously the hosting costs and then the SaaS team who basically look after customers who -- live customers on the platform.

And so I suppose one thing to bear in mind is that as customers grow, it doesn't necessarily drive head count because if you want customer who's on a lot of stuff, on a lot of different processes, then you're obviously not going to add to customer support head count in line with that.

From a hosting perspective, yes, I mean, hosting costs obviously are continuing to creep up all the time associated with things like adding new customers, but also to do with the number of users on the system and also to do with storage and all the rest, the usual sort of drivers of cloud hosting costs. So yes, for sure, that piece is increasing as we continue to add customers and add users.

But we're certainly getting some efficiencies of scale associated with customers expanding and so on. And obviously, on the PS side, then -- the professional services side, then we've had things fairly flat there.

[Operator]

The last question comes from the line of Justin Keywood of Stifel.

[Justin Keywood, analyst]

Just wondering if you have an update on the CPG vertical. I know there was a large win around the fall of last year, if you're continuing to see heightened activity? And what's your outlook for that vertical?

[Edmund Ryan, executive]

Yes, CPG from a validation perspective is still part of our sweet spot and we continue to bring them into our pipeline. We continue to harvest them through the pipeline. And we have had a number of those announcements in CPG this year.

So yes, the short answer is still a very important segment. but it's not as big a segment from, say, an expansion perspective. It's there, it's good, but it's not as big as someone like a pharmaceutical company.

[Justin Keywood, analyst]

And any other verticals that you could be targeting in the short or medium term? I know aerospace was potentially mentioned at one point? Or are you laser-focused on the pharma and perhaps CPG in the near term?

[Edmund Ryan, executive]

Yes. I would say CPG, I treat them as my life sciences customers because they don't dilute any aspect of our business to deal with them or to secure them or to sign them up, right? So they're part of our life sciences business.

So I would -- we look at our life sciences today for validation as a $2 billion TAM, Justin. And when we look beyond that, back to what Gavin asked earlier on, we're talking about the adjacencies within life sciences. We see that in expanding our TAM to $7 billion.

Beyond that, we're talking about what you're mentioning there, which is what can we go to after that. But there's a huge amount to be done here right now and the focus is on that, so we don't have any real exploration done beyond life sciences.

And life sciences today is multiple segments. It's big manufacturers, small manufacturers, biotech, et cetera, medical devices, supply chain into these contract development organizations, contract research organizations, engineering companies, vendor manufacturers of complex equipment. That's what makes up the $2 billion TAM. And even logistics companies playing on both sides of the manufacturing also have to comply with regulations.

All these companies are subject to good manufacturing practice regulations, and that's where our sweet spot for us is right now.

[Operator]

That does conclude the question-and-answer session. I would now like to hand it back to management for closing remarks.

[Edmund Ryan, executive]

Thank you, everyone, for your time and attention today and your support for Kneat. The speed and extent to which digitization occurs in life sciences make a positive difference to speed, cost, and ultimately, quality, which benefits us all.

So we're pleased to have your support, and we'll do our best to keep earning it. Thank you very much.

[Operator]

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.