kneat.com, inc. (KSI) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the kneat.com's Third Quarter 2021 Update and Results Conference Call. Please be advised that today's conference call is being recorded. 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 remind you that except for historical information, the comments in today's conference call contain forward-looking statements, including statements regarding these future financial outlook and financial performance, market growth, the release date for and benefits from the use of Kneat solutions, our strategies and general business conditions. Any forward-looking statements contained in this presentation are based upon Kneat's historical performance and its current plans, estimates and expectations and are not a representation that such plans, estimates or expectations will be achieved. These forward-looking statements represent Kneat's expectations as of today. Subsequent events may cause these expectations to change and Kneat disclaims any obligation to update the forward-looking statements in the future. These forward-looking statements are subject to known and unknown risks and uncertainties that may cause actual results to differ materially, including our quarterly results and limited operating history, which makes it difficult to predict future results, our expectation for future growth of our revenues, unauthorized access to our customers' data, dependence on revenues from new customers, the rate of adoption of our SaaS model, acceptance of our applications and services by customers, loss of one or more key customers, adverse changes in general, economic or market conditions, particularly in the life sciences industry, delays or reductions in information technology spending, particularly in the life sciences industry, including as a result of mergers in the life sciences industry, the development of the market for enterprise cloud services, particularly in the life sciences industry. Competitive factors, including, but not limited to pricing pressures, industry consolidation, entry of new competitors and new applications, marketing initiatives by our competitors, our ability to manage our growth effectively and changes in sales that may not be immediately reflected in our results due to the revenue recognition criteria under International Financial Reporting Standards. Further to these risks, these forward-looking statements do not include a full assessment or reflection of the unprecedented impacts of the COVID-19 pandemic occurring since the first quarter of 2020 and the ongoing and developing situation resulting in direct global and regional economic impacts. This has resulted in significant economic uncertainty. And even though the company has to date experienced no significant impact to its operations. Any potential impact on our future is difficult to understand our measure at this time. Further information on potential risks that could affect actual results will be included in other filings we make on www.sedar.com. The press release, the MD&A and the unaudited condensed interim consolidated financial statements are all posted on our website. And if you wish to receive a copy of any of these documents, please do not hesitate to contact us. I will now pass the call to Eddie Ryan, CEO of Kneat.

Thank you, Sinead. Good morning, everyone, and thank you for attending 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. We are pleased to report a strong third quarter, where we delivered 276% growth in SaaS license revenue compared with the third quarter of 2020. In addition, at September 30, total annual recurring revenue grew to $12 million, up 217% from $3.8 million a year ago, and total revenue increased 91% over quarter 3 2020. The acquisition of new customers and the expansion of existing customers to additional processes and sites continues to drive growth. As customers expand their use of Kneat, our technology is becoming an integral part of their operations. While our growth trajectory continues upward, these large scaling events are somewhat unpredictable in their timing. And given the early growth stage of the company, they can result in period-to-period variability in annual recurring revenue growth rates. During the quarter, we added to our list of top-tier companies with another of the world's leading health care brands selecting Kneat as their enterprise e-validation platform. This win is further evidence that the Kneat Gx platform is the leading validation solution on the market, replacing legacy solutions that are inefficient and error prone with one that delivers speed, data integrity and compliance. Our customer base is growing across all tiers, and more than half of the top 20 global pharmaceutical companies have selected Kneat as their enterprise e-validation platform. We are also adding new customers in the supply chain and in the mid-market. We expect these segments to also be contributing drivers of future growth. Our strategy of partnering with professional services companies continues to show promise. Within our fast-growing list of partners, we are seeing increased technical proficiency, and several are at the stage where they can implement deployments with limited assistance from Kneat. Over time, our goal is for our partners to provide an increasing share of professional services, allowing Kneat to focus on our key growth driver, the promotion of our SaaS platform. Kneat Academy, which is used to train and certify customers and partners is seeing increasing utilization. The Academy team have conducted almost 1,000 training sessions to date this year. Several of our larger customers have requested that their supply chain vendors input their data directly into Kneat, which drives further training to our Kneat Academy and creates new customers. We believe our recent investments in both sales and marketing will drive future growth, create value for our shareholders and help solidify the Kneat Gx platform as the leading validation solution on the market. In addition to growing revenues, we continue to strengthen our corporate structure and build out our management teams. On the R&D front, we are building our platform in close collaboration with our customers to drive faster time to customer value and to increase our addressable market. Subsequent to quarter end, we received conditional approval to uplist to the Toronto Stock Exchange. We believe this listing will help broaden the company's visibility and access to domestic and institutional investors. Despite the challenges presented by the pandemic, we are experiencing no significant adverse effects on our business across customer acquisition, fulfillment and operations. Our customers tell us that our technology has aided their business continuity efforts joined the pandemic, because it allows them to manage a large proportion of their validation process remotely. In addition, Kneat is supporting their ESG goals by enabling them to reduce travel and remove large volumes of paper records and the associated printing, storage and management costs. I'm very proud of our dedicated employees as they continue to execute across all the functions, ensuring ongoing growth and value creation for our shareholders. Our plan for the remainder of 2021 is to continue to add and deploy new SaaS customers to expand to new work processes and new sites within our existing customer base to further develop the Kneat Gx platform to build out our company structure and to leverage our partner relationships to expand our global reach. I will now hand over to Hugh for a review of the financial results.

Thanks, Eddie. For the financial review, please keep in mind that all the numbers I will be discussing are in Canadian dollars. I am happy to report that we have seen a strong revenue growth trajectory from previous quarter continuing into the current quarter. Revenue for the 3 months ended September 30, 2021, was $3.7 million. This was an increase of 91% from $2 million in the same period in 2020. SaaS license fees are a key metric for Kneat. Compared with the third quarter of 2020, SaaS license fee of $2.6 million increased by 276%. The increase in revenue was driven primarily by existing customers scaling their use of Kneat Gx through departures of additional licenses. Cost of revenues of $1.7 million for the 3 months ended September 30, 2021, increased from $1.2 million for the third quarter of 2020. This increase reflects additional salaries and benefits related to higher headcount in the customer support teams, the recognition of a year-to-date staff bonus accrual and increased hosting costs and consulting fees. Gross margin for the 3 months ended September 30, 2021, was $2 million. This is an increase in gross margin of $0.7 million for the same quarter of 2020. Gross margin percentage has also increased to 54% compared with 37% in the third quarter 2020. The increase in gross margin reflects an increase in revenue over the same quarter of 2020, coupled with a smaller increase in related cost of revenue over the same quarter in 2020. Although there has been some positives in gross margin. The underlying trend since the third quarter of 2020 has been an open trajectory. Annual recurring revenue, ARR, is the key performance measure for Kneat. ARR includes SaaS licenses and maintenance fees. The promotion of our staff offering, which adds to our annual recurring revenue base, is the key strategy for Kneat. Progress on this front continues to be reflected in the growth in ARR at September 30, 2021 to $12 million, a 217% increase compared with September 30, 2020. More specifically, ARR for SaaS license increased by 274% to $11.3 million and ARR from maintenance fees decreased by 10% from September 30, 2020. As a reminder, we have filed our unaudited condensed interim consolidated financial statement and MD&A on SEDAR, and they are also available on our website. We are now ready to take questions, and we give a priority to sell-side financial analysts.

[Operator Instructions] So the first question comes from the line of Gavin Fairweather.

Eddie, Hugh, congrats on another set of strong results. I wanted to start -- just I dig again a little bit on the ARR kind of growth in the quarter. Obviously, $4 million, a big number. Maybe just starting out on the Tier 1 set of clients that you have. Was that kind of the driving force? Obviously, you noted some large scaling events that were included. So was there 1 or 2 kind of large bulk purchases? Or was there also kind of a broader set of maybe license purchases that were distributed across the Tier 1 base?

Gavin, thanks for your question. So yes, that's a good question. And over the last while, we have had some scaling events or scaling steps with our larger customers. And these are the continuous expectation we have from them to scale at different rates as they go forward. So they would have created a strong growth in our ARR. And as we look forward, it's hard to understand exactly when they will land in the future. But obviously, all our customers are scaling to one extent or another. And some of the early customers are beginning to stay -- earlier newer customers will scale a bit later than the other ones. I think the best way to look at our ARR growth is year-over-year, it's probably a more even way to look at this.

Yes. That's fair. And I think we've chatted about the buying patterns before, right? And it tends to be -- some of these larger trends of buying bulk and then kind of use of the licenses and then come back perhaps in the next year. Are we thinking about that then correctly?

Yes. So some -- the good news is they're all scaling in line with what we expect, some going faster than others. And a customer may have multiple scaling events depending on what processes are scaling to, how many users are going to be needing licenses in that period. So there can be different size gating steps, we call them really as we go forward with those big customers. And it's safe to say that none of our big customers are fully scaled, where we can expect them to be in the longer term.

That's great. And then the press release also referenced increasing success, both in Tier 2s and the supply chain. And my sense is that while you often press release kind of the Tier 1 wins, what's going on with the Tier 2s and the supply chain is a little bit more kind of under the radar. So maybe you can just talk about how meaningful of a contribution that's becoming, how things are progressing, both downmarket and within the supply chain and perhaps whether those 2 verticals are providing kind of a baseline of ARR growth for you that perhaps is maybe a bit less visible?

Yes, that's a good question. So definitely, we see the mid-market, we'll say, we'll call it the mid-market. We see the mid-market being contributing to our revenues and ARR growth into the future. So we have a lot of activity in that mid-market. We are signing a good number of customers in that mid-market, and we have a robust pipeline. We are seeing that pipeline developing as a result of the recent investments we've made in sales and marketing as well. And we're also seeing the supply chain being directed towards Kneat by our bigger customers, bigger customers asking the supply chain to put their data directly into the Kneat system as part of any work or any equipment or any services they're providing to big pharma to put the data directly in and they're then coming to need to be trained. And we're also getting customers through that referrer type situation as well. So we definitely see mid-market being instrumental going forward in growth as well as the larger companies.

Okay. Just on the supply chain to dig in a little bit further on that dynamic. I think that you're working on some functionality, which would allow the supply chain to put their data into Kneat and then transfer that seamlessly over to the Life Sciences onset. Is that now live? And is that being kind of a catalyst towards some of the Life Sciences companies asking or requiring that the supply chain use Kneat to for the validation data?

Yes. So there's a number of ways where they can work together in the same system. So the bigger company customer can ask them to put their data directly into Kneat in a controlled manner where they can give them access. That's one way of doing it. Another way, if the supply chain has Kneat itself, they can do their services and their work in these and didn't supply handover to the actual big customers system afterwards. And yes, that handover capability is there. It probably isn't being used at this time in a great way, but we expect it to start getting used now as we go forward.

That's great. And then just before I kind of pass the line, it's kind of interesting to see the professional services revenue line flat despite the growth in your recurring revenue base and your client scaling. So maybe you can just talk about the amount of services load that's now being taken up by the channel and just provide a general update on your partner network, how that's growing and the profile of some of your partners? Like are these still mostly kind of boutiques independents? Are you starting to get any attention from some of the larger players in your space?

Yes. I'll take the first part of that and I'll hand it over to then Hugh on the financial side of it. So the product channel is developing very well for us. As I said, the big pharma is sending a lot of potential partners to Kneat. The success primarily is in the boutique space in the sense of companies that could have up to 500, maybe 1,000 engineers, they would be the larger ones. And then you have smaller ones that might have 50, 60, 100 engineers, that type of thing. So that's where the success is right now. These companies tend to be very close to the pharmaceutical manufacturers in the validation space. And they tend to have a lot of interaction with them. And so we're seeing that has been very strong. Today, this year alone, we've probably -- I think we said we had almost 1,000 training sessions. And these are primarily with mostly -- more than 50% of these are with the supply chain with partners. So the patent model is doing well. The partners are becoming more proficient in the usage. And we're seeing them that we're now able to -- we're moving them from working with SaaS and Kneat professional services to work on projects with us, where now they're getting to presume where they can lead projects with customers and with oversight from Kneat to ensure the quality is maintained into the future as they go into the world more on their own. So I hope that answers your question, Gavin.

Yes. And I suppose, just in terms of the financial piece, yes. So for sure, the professional services, I mean, this quarter has increased a little bit over the previous 2 quarters. And the timing of recognition of the professional services revenue, there's an element of variability there relating to when projects get completed and all the rest. And obviously, some of that is determined by the customer and the resources that they apply to a project and et cetera. So I know, for example, in previous year that we've seen our strong Q4 with customers trying to close projects before the end of the year. So I mean, that's an example of the type of variability that is possible. The next question comes from the line of Rob Goff.

And congrats on a strong set of results coming forward. My question would be on the distribution partners. To what extent are the professional services companies or the supply side companies that are being referred to you by large pharma, are they just users of the platform? Or can they be sales agents of the platform? And can you also talk to where you are independently signing up distribution partners? Talk to the traction? And do you see distribution partner being 20% of your new sales 18 months out? Or can you just give us a bit more of a picture here?

Yes. Thanks, Rob. So the partners, just to say that there would not be resellers right now. They're implementation partners right now. So there's a number of sort of situations there. One is the partner becomes proficient at Kneat because Kneat is a new way of doing validation activities in the big pharma companies. And the Kneat engineers to be -- come in to work on these projects, and they can be there for quite some time. So the partners have been trying to provide debtors, and they themselves would generate revenues by second ONO engineers and doing projects on behalf of big pharma companies. So that's one aspect of partners. And then there's partners who want to deliver their services, be it a deploy an ERP system on behalf of a big pharma company. And they want to use Kneat themselves to be able to deliver their services and hand over the information to the big engine -- the big pharma company at the end. It doesn't have a big pharma company, it could be a mid-tier pharma company as well. So today -- and then the sales capability and relationship comes to referral and comes through those collaboration where partners invite us in to companies they know where they think Kneat will be beneficial to them, and they're involved in the deployment of Kneat once we sign a license agreement with the big pharma company or the mid pharma company whatever the case may be. So the license agreement today is still between Kneat and the end-use of the pharma company. But partners can be implementation partners to support that. Reseller, which you asked about and a percentage of that would be applicable in the future. We don't have a number on that, Rob, and we don't have that modern evolved to resell status yet. I hope that I give you some color, Rob.

That does help. And could you perhaps talk to your pipeline, if you would, in terms of activity on RFPs? Any change that you have seen or foresee in terms of the competitive dynamics?

Yes. So we continue to engage with customers and RFPs, and we're signing customers on an ongoing basis. And so I'm optimistic about our pipeline and the recent investments have made our pipeline more robust, and there's a lot more activity going on. Regarding competitors, we have not seen anything in the marketplace to suggest that there's any competitor changing anything at this point in time.

The next question comes from the line of Christian Sgro.

Congrats on another really good quarter. My first question, maybe just to dig a little deeper on what visibility you could give $2 million of ARR added in Q2 and then 4 this past Q3. And we recognize the potential for some lumpiness quarter-to-quarter, of course. But I'm just wondering, looking out from here, if there's any visibility that you guys have into the near term, I'm wondering how conversations are going with your direct sales force and with partners? And even if there's anything you offer qualitatively there?

Yes, I suppose it. Christian, the key thing is the scaling steps, we call them are scaling events, whether they happen or don't happen in a quarter, it's difficult to know. So the customers are moving towards that. But I know for sure that there's scaling events in the future, but I can't say what quarter they'll lend in, right? So even some of the customers that have scaled in these past couple of quarters, they'll still scale again. I mean they're still scaling step -- lots of scaling steps left within that customer cohort. So unfortunately, I story differently put his time stamp on them. Safe to say that they are out there. And we have new customers that are scaling along as well, and they usually take a bit of time before they get to the stage where they're now saying that, okay, Kneat is well embedded now. It's an integrate part of our operations. We need to get a lot more licenses because we have a lot more users that want to use it. And that time comes along, and we saw that in the last 6 months or so. And that is a great response to our -- what we're providing the value we're providing to the customer. And I suppose you could call these -- some of these scaling events are approaching enterprise license agreements, right? So they're looking out into their next couple of years and a license they're going to Kneat, and they're looking to buy both licenses. So unfortunately, I can't put the time ones. Christian, fair to say that we're confident that they're there and they're coming, right?

That's helpful, Eddie. I'll ask. If it is more granular. There was a new disclosure this quarter. The ARR rebuild was provided. So maybe this is a question for Hugh. From a first glance, it looks like that could help us understand some of the new versus expansion split in the future. Is there anything else to read into -- in the rebuild there he? Or is that more just a supplemental data to help us reconcile everything?

Yes. You're referring to essentially sort of reconciliation between revenue and ARR. Yes. So I mean, this has really meant to provide some additional disclosure because essentially, ARR is not an IFRS measure. So we said it is appropriate that given that we have included ARR and a non-IFRS disclosure that we would do that reconciliation. And it's also -- so I think it's useful in terms of providing information to users as to how do to sort of marry up with each other.

Okay. Got it. That's helpful. And the on-premise revenue was 0 this quarter. So I think the response there, congratulations. On the transition to SaaS, not in the financials, but more broadly, I want to ask how that transition is going with the last couple of customers who are on-prem? Is that moving ahead or behind schedule for you guys?

I think about unscheduled, Christian? Still very optimistic that a lot of it will be done this year. We probably have less than a half dozen customers that we see transitioning that are left, and we see them transitioning over the next 12 to 18 months. And there'll still be the potential for a little bit of revenue to trickle in if some of those customers expand their on-prem licenses. Is that correct? Yes, that's possible. But that's -- it's quite unlikely because the conversations are on regarding transition over, and it's unlikely there'll be expansions, but you could see some, yes.

Awesome. Okay. Just one more question for myself. And this is on opportunities in health care and CPG and other verticals. Does the core meet Gx platform meter be retooled or reconfigured at all to attack those markets? Is that something in the works? Or would you say the core product, the core code right now is already suitable to start going after those markets more aggressively if you wanted to?

Yes, that's a great question. So everything we do is about building the platform, so that's an intelligent data-driven workflow process, right? So we are confident that the way it is, it to be applicable to other industries without too much overhead. And really need is a configurable system. You don't call to set it up, you don't have to quote anything.

And the next question comes from the line of Martin Toner.

Congrats, another great quarter. And most of my questions have been answered, but I'd love to hear from you just what you think you need to do over the medium term, say, 2, 3 years, to continue to support growth, what kind of additions and building do you need to put into sales and marketing part of the organization?

Yes, that's a good question, Martin. I think since we raised our finance area this year, we have been building our -- the 3 pillars of our business, I guess, R&D, sales and marketing. And so we see ourselves continuing there. And probably, there will be some R&D spend, for sure, to accelerate the development of our platform to the vision, where it is scalable to all these new adjacencies and that. So I think it's more the same, and it's a question of how aggressively we push that.

Yes. Just a quick follow-up. Just on gross margins. Obviously, you're gaining a lot of scale on your SaaS revenue line. And we've talked about in the past, the gross margins on that line being perhaps lower than what we would expect for kind of a scaled platform. So can you just give us a sense of kind of where your SaaS gross margins are trending now? And how you see those playing out over the next year as you gain some more scale?

Yes. So I mean, if you look at our gross margins in the current quarter, it's 54%, which obviously is a mix of both the license, particularly the SaaS license margins and then the professional services, e-services margins. And as we've talked about previously, our objective for professional services is much more about driving the license revenue rather than being a high-margin contributor. And so obviously, the overall gross margin is a reflection of the mix of those 2 elements of revenue and the weighting of those within that overall revenue. So I mean, if you were to take it from even the numbers we have there, if you take the professional services as being pretty low margin, but then by default, if you can sort of conclude our SaaS margins are not unreasonable at the moment. But as we continue to scale, then we would expect those to continue to move up. And ultimately, that we will, as we've talked about before, our margins will move towards industry norms for SaaS companies.

Got it. And maybe just a quick clarification. Just on the pro serve margin. So you now -- you are now modestly profitable on that line?

Yes. So our objective in terms of professional services is to breakeven or a little better. And so it can vary a little bit from quarter-to-quarter, but yes, that's where we are generally, yes.

Okay. I'm not seeing any other hands at this point in time. So -- in which case, we'll conclude today's question and -- sorry, if I -- sorry, I see another hand going up here. So there's a question from the line of John Kim.

This is a private investor. I was just wondering, just following up on -- I believe it was Christian, I was asking about other verticals because you won a CPG client a while back. Just wondering if you can update that. And if you are making any more headway into the CPG space?

Thanks, John, for the question. Yes. So that customer is on nicely. And we do have others in our pipeline that are in that space as well. So while we're not targeting it aggressively, they are there, and we are working with them. And some of our key big companies also have consumer product divisions, whom we're also talking to and actually working with.

Okay. With the absence of further questions then, we will conclude today's question-and-answer session. I would like to now hand it back to Eddie for his closing remarks. Eddie, over to you.

In summary, we are very pleased with the progress we've made in the third quarter of 2021, and we're very proud of all our employees as they continue to develop quality compliance software, focus on growth initiatives to win and scale customers across all tiers and provide excellent end-to-end customer service. Today, amongst our many customers across all tiers, we can count 7 of the top 10 global pharmaceutical companies who have chosen me as a corporate solution, gives us great pleasure to be trusted by this industry to support and is in its mission to bring life enhancing and life-saving therapies to its customers. Before I finish, thanks to our shareholders, our partners and our team for their ongoing support and belief in what we do. We look forward to the journey ahead. Thank you all for your attention. Back to you, Hugh.

Okay. On behalf of you, thanks, everybody, and that ends our call today.