Ladies and gentlemen, good morning. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Kneat First Quarter 2023 earnings conference call. Today's conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during that time, simply press the star key followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one once again. Thank you, and I will now turn the conference over to Katie Keita. You may begin.
Thank you, operator, and welcome everyone to Kneat's earnings conference call for the first quarter of 2023. Today's call will be hosted by Eddie Ryan, Kneat's CEO, and Hugh Kavanagh, Kneat's CFO. Before we begin, I would like to draw your attention to the Safe Harbor statement on slide two and the forward-looking statements disclosure at the end of the earnings release. Comments made on today's call may contain forward-looking information. This information is, by its nature, 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 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 when planning, monitoring, and evaluating the company's performance. Management believes that these non-IFRS measures provide additional insight into the company's financial results, Certain investors may use this information to evaluate the company's performance from period to period. I will now pass the call to Eddie Ryan, CEO of Kneat.
Thank you, Katie. Good morning, everyone, and thank you for joining today's call. I will begin with some high-level remarks before passing the call to Hugh to provide a detailed financial update. At the end, we will open the call for questions. In short, 2023 has gotten off to a fantastic start for Kneat. We closed the quarter with total revenue up 53%, SaaS license revenue up 94%, and annual recurring revenue up 100% compared with the first quarter of last year. The acceleration of all three of these revenue metrics for Kneat comes from a combination of things. First, as we continue to make strides in our core market, the benefits of using the Kneat platform are becoming more well-known.
This should not be surprising given that our approach, which is revolutionary compared to current standard practice, enabling customers to derive significant value through greater efficiencies and a higher compliance standard. Second, our customers are increasingly discovering Kneat's value as a platform, and they're applying it beyond what they'd initially implemented it for more teams, more sites, or more quality processes. This means we are expanding within our customers' organizations, a major contributor to revenue growth and into the companies that are part of their supply chains as well. Finally, the investments we made last year to grow our team are paying off. With a larger R&D team, we can tackle more of what we have planned for the Kneat platform sooner. With more sales resources, we can better and more broadly showcase what Kneat can do as the industry builds towards Pharma 4.0.
We saw ample evidence of all these factors at work in the first quarter of 2023. The wins of three large new customers continued to build our market leadership momentum. In January of Fresenius Kabi, in February of the manufacturer with more than 80 sites worldwide, and in March of the division of a top 20 pharma. Expansion within our existing footprint drove the majority of our SaaS revenue growth in the quarter. The ongoing expansion of Kneat licenses within long-standing customers supports the sustainability of revenue growth, particularly as Kneat continues to win new logos. Finally, our sales team is now well over twice the size it was last year and are bringing in smaller new deals that don't get announced. We are excited to see what they achieve as they continue to ramp up.
There was a lot of interest in the power of the Kneat platform at our user conference VALIDATE, which we hosted in Dublin last month for our European customers. I'd like to commend the Kneat team that carried it out as it got stellar reviews by users and sponsors alike. Over 150 attendees got to see some of the creative ways our customers are putting the platform to work. Most of the top 15 global pharmaceutical companies were there, with several sharing their digital validation journeys using Kneat, from selection through to successful global rollouts. After experiencing how transformative Kneat has been for their own productivity across teams and processes, these customers were eager to contribute, knowing that further adoption of digital validation will add velocity to their industry's mission.
After all, to fully realize the benefits of digitization, influencers need the other players connected to the ecosystem to get on board. Customers at VALIDATE also got a preview of Kneat 9.0, which is now launched. 9.0 is a fundamental step forward for Kneat Gx as we continue to innovate. Several years ago, we transitioned from on-prem to SaaS. Today, 9.0 further modernizes Kneat with next-gen software approaches like containerization and multi-tenancy, as well as other architectural advances. This foundational work enables Kneat to go further in terms of efficiency, functionality and speed of delivery, valuable to ourselves and to our customers. We are incredibly proud of our development teams, every single one of which contributed materially to this release. Definitely not easy, of course the work that is worth doing rarely is.
In addition to customers promoting our product as they did at VALIDATE and the efforts of our expanded sales force, our growing partner community is also leaning in. All three together make a powerful formula for growth. These partners and service providers are taking on more services to support our customers and are bringing new customers onto the Kneat platform as well. In fact, the large strategic customer that we announced in early April came to us through one of our partners, a large global consulting firm. Like our customers, they too are eager to help the industry shed the onerous legacy approach to compliance and instead turn it into a power tool with Kneat, one that removes friction and adds value.
Whether you are a part of Kneat as a customer, a team member, a partner, or a shareholder, right now is an excellent time to be on board with us. We look forward to reporting our continued progress as 2023 unfolds. I will now hand you over to Hugh for a review of the financial results.
Thanks, Eddie. As Eddie mentioned, we saw excellent top line growth in Q1, led by an acceleration of our SaaS license revenues. Revenues for the quarter ended March 31st, 2023 was $8.0 million, up 53% from $5.2 million for the first quarter of 2022. SaaS license revenues, which is a key metric for Kneat, was $6.4 million compared with $3.3 million for the same period in 2022. This is an increase of 94%. Our accelerated revenue growth in the quarter was driven by existing customers scaling their use of Kneat Gx, while the purchase of license subscriptions by new customers also contributed.
Cost of revenues for the first quarter of 2023 was CAD 2.6 million, which is actually down from last quarter and up CAD 0.7 million from CAD 1.9 million in Q1 2022. This increase was mainly due to an increase in payroll and cloud hosting costs. Gross profit for the three months ended March 31st, 2023 was CAD 5.4 million, 64% higher than CAD 3.3 million in the same quarter in 2022. Gross margin percentage was 67% compared with 63% for the first quarter of 2022, and 63% for the fourth quarter of 2022. The increase in gross profit was driven by a significant increase in SaaS revenue, which carries a higher gross margin.
As we continue to scale our license revenues and as the proportion of license revenues to professional services revenues continues to increase, we expect the gross margin percentage to continue to trend upwards towards SaaS industry norms. Moving on to operational expenses. Sales and marketing expense was CAD 3 million for Q1 2023, compared to CAD 1.3 million in Q1 2022. While R&D expense for Q1 2023 was CAD 3.9 million compared to CAD 2.5 million in Q1 2022. We grew both teams substantially since Q1 of last year, so the incremental salaries and benefits associated with these investments is primarily behind the expense growth here. Annual recurring revenue, ARR, is a key performance metric for Kneat. ARR includes SaaS license fees and maintenance fees.
The proportion of our SaaS offering, which adds to our annual recurring revenue base, is essential to our growth strategy. ARR doubled over last year from $13.4 million at March 31, 2022, to $26.9 million at March 31st, 2023. ARR for SaaS alone grew by 113% from $12.4 million at March 31, 2022, to $26.3 million on March 31st, 2023. ARR from maintenance fees decreased by 44% to $2.6 million from $1 million over the same period in 2022, reflecting the shift of legacy customers transitioning from on-prem to SaaS since the end of Q1 2022. As we look ahead, we are optimistic for the remainder of the year.
We have a high retention of a base of high quality customers, and that base gets bigger every quarter. The revenue they generate is increasingly SaaS revenue. SaaS revenue carries much higher gross margins than service revenues, which we do not expect to grow as much into the foreseeable future, as these services are increasingly directed towards our partners. With the hiring we did through 2022, our teams can spend more of their time in 2023 developing great products and getting it out to the world.
As a reminder, 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.
Thank you. At this time, I would like to remind everyone in order to ask a question, press star and then 1 on your telephone keypad, and we will pause for just a moment to compile the Q&A roster. We will take our first question with Christian Sgro with Eight Capital. Your line is open.
Hi. Good morning, and congrats on the quarter and as well as, momentum with the partner channel, which is growing quickly. My first question is there on the partner channel, Eddie and Hugh. Are you finding that you're building more of a template, like, a structured way of adding partners? Or is there more investment to do there where you think you'd get them online and up and running quicker? How have those conversations been going maybe with the consulting firms, where it seems like you're seeing some traction?
Hi, Christian. Eddie here. Hopefully you can hear me clearly. Definitely, as we go forward, we're able to repeat and, you know, a standard process that we build with our partner managers. We have a very strong partner management team for bringing partners up to speed and getting them enabled and getting them into projects with us or if they can go directly to the customers. There's. I will say it's continuously improving. There's. We're finding better ways to improve that. Like all our business, I guess, better ways to deliver our solution to the marketplace, to go to market and that's happening through the partner channels and to, you know, software delivery as well.
Okay, perfect. I'll ask one more question before passing the line. More on the market opportunity on your pipeline. If there's any verticals or geographies that are exciting you just now, if anything's changed since the last conference call and where you see where you've seen any momentum in your end markets as you talk to customers?
Regarding the geographies, there's no major change there. Europe and the U.S. is primarily our key areas. We do have some customers also in Asia, but they'd be customers that are there to our existing large global customers, you know. We're not actually pushing out that direction at this point in time. You know, we continue to do that. Our customers that we have, we're very excited about how our customers are using our technology. We're going deeper and broader with our existing customers, and we're adding new customers, and our customers are considering us for adjacencies within their organization. Regarding, you know, other segments, I would say there's a lot of activity in the supply chain and on the distribution side of the manufacturing.
We are seeing a lot of activity from there as well. Of course, consumer product goods companies continue to be something that's a very strong opportunity for us.
Got it. Appreciate all that color, Eddie. Congrats again on the quarter, and I'll pass the line here.
Thanks, Christian.
We'll take our next question from Doug Taylor with Canaccord. Your line is open.
Yeah. Thank you. Good morning, Eddie and Hugh, and the rest of the team. Congrats as well on a good, top-line growth performance. You've obviously had a period here of an exciting period of new MSA announcements over the last couple of months. A couple of questions on that. I mean, firstly, can you refresh us on, you know, the go live timetable and the ramp-up schedules from these agreements? Are you on track to work through the implementation, along the original timetable, which I think was Q2, Q3?
Hi, Doug. Absolutely. One thing I'm really proud of across the Kneat organization is our delivery of our capital projects and the first deployment phase. They're, you know, they're out between four months and five months approximately for those delivery times for the first go live with our customers. Everything's on target there for those. There might be some processes that might be quicker than that, but generally none longer than that. I'm very proud of our delivery rate there. Everything's on target from that perspective.
Okay. I understand that these MSAs, you know, sort of start small and expand over time. I think you've demonstrated that in spades. But I'm hoping I can get you to either, you know, qualitatively or quantitatively, if you can, help us understand, you know, the relative significance of these recent signings in terms of potential ARR or any other way you wanna frame it. Can you help us out there?
Yeah. I'll have to default to my standard approach there because the standard approach continues to be the standard approach. It really is, you know, starting out small. You know, all our customers are, you know, they start usually small. As we mature in the marketplace, those earlier deals may become a bit larger. The ability to reach, full, fully, scaled out, with our customers in a certain area is getting a bit better as well. There's still some resistance within the companies in that, you know, different sites have different variations and stuff like that, but by and large, they're all being overcome.
I think, I think the, the line really, Doug, is that it could start out with CAD 200,000 and, you know, they all become these customers multimillion-dollar opportunities, as they move forward, you know. Typically, if I was to say how long does it take to scale a customer for validation within these organizations? I think anywhere between three years and five years, depending on how quickly they go. There's multiple processes within validation, up to eight processes in general.
Okay, maybe one last question for me, and this one's probably for Hugh. If even if we exclude the perpetual license revenue, the one-time kinda upfront revenue in the quarter, gross margins would have been, I think, north of 65%, which is, you know, certainly a new high and pretty impressive. Is that a reasonable place to build from here, 65% as you bring on these new customers in the coming quarters and considering, you know, your scaling and the rest of the factors that go into that?
Hi, Doug. Yes. Yeah, I suppose, but the way you've looked at it there is the way I think is probably the best way to look at it in terms of rolling forward and backing out the on-prem to get what the underlying gross margin is. As you indicate there, it's in excess of 65. It's 65.5, 66, just over 65.5%, excluding the on-prem. Yeah, no, I think that's not a bad basis to look to sort of as a basis to look forward and try and estimate what future gross margins will be.
Again, as, you know, as I said lots of times before, that's, that gross margin is a composite of, the, very low margins that we get on, professional services, but they're very good margins that we get on SaaS revenues. You know, essentially, if you look back, you can sort of back into those, relative margins and roll those forward to estimate, where you think, we will be into the future.
All right. Thank you. I'll pass the line.
Very good. Thank you, Doug.
We will take our next question from Rob Goff with Echelon. Your line is open.
Thank you very much, and let me also congratulate you on a very solid quarter and a great start to the year.
Thanks, Rob.
Thanks, Rob.
Most welcome. Could you talk to the wins that you have recorded for the year to date and some of the competitive dynamics that may have been around those wins? What points you saw as your winning hand on those?
Absolutely, Doug. Sorry, Doug. Rob. Yeah. They're, they're all strong competitive competitions to win. This is a, you know. You can imagine this is a corporate decision that's been made. They're deciding on a highly compliant rate to manage their mission-critical regulated processes within their organization. They don't make decisions lightly around these. What I would say is that, you know, some of them would have gone on for quite a while, some of the evaluations, looking at alternatives within the marketplace. Very competitive, I would say is the summary, Rob. In some cases, they went on for quite a while.
In some cases, you know, we're going in where maybe a competitor already is, you know, because they're not fully happy with the competitor in the marketplace.
Okay. Thank you. Perhaps more of a macro question. Could you give your perspective on potentially expanding on your definition of the total addressable market and such, your thoughts there?
Absolutely. You know, as we go along and look outside of validation, today, we assess the, you know, the validation space alone within manufacturing for medical devices and pharmaceutical companies as around the $600 million mark. When we look outside that into the supply chain and, you know, and the distribution side, we see this being a multi-billion, several billion marketplace TAM for us. And that's before we look at adjacencies that also can come into play within our existing customers.
Very good. You know, once again, back to the cadence of your wins. Like, are these wins perhaps encouraging you to up your investment in R&D product development to capture what's coming to you faster and faster?
One other thing to say, Rob, that I should have said earlier, right, is that, you know, why are we winning these deals? You know, our maturity, our product maturity and company maturity in the marketplace, the service that the customers are getting from our technology and the reputation we have with the largest, companies in the world. You know, these are all strong, very strong reference, referencability, situations, and our customers are sharing that information amongst each other. I think, you know, that's the, you know, the key thing. Our technology is very solid. We're bringing on new technology, and, you know, we're also able to show new customers and existing customers, this new technology at this point in time. You know, our recent release is significant.
It's a major release for Kneat, and there's some great features coming through there. Our customers are showing telling us back that these are great features that we're bringing through for them. They're very happy. It's all, you know, these features are all being built around their needs and close discussion with our customers, a real intimate relationship.
Very good. Congrats again. Thank you.
Thanks.
Thanks, Rob.
We will take our next question from Andy Nguyen with Raymond James. Your line is open.
Hi. Congrats on the quarter, guys. Just quick questions for me. I'm looking at the IR for this quarter, and can you break it down, like the growth from the existing customer and also the contribution from the new customer of that increase in AR and the SaaS AR? Thank you.
Yeah. Hi, Andy. Yeah, so the growth in this quarter is primarily expansion of existing customers. Yeah, I mean, the, you know, some of the customers that we would have added last year and previous years as incremental on those. You know, I typically, I suppose what I'd add is that, you know, we're starting to see or we have seen a little bit of a cadence around, you know, new customers, you know, in the early part of the year are getting up and going. Then, as we go on through the year that, you know, the activity tends to increase a little bit. But yeah.
It was, expansion is primarily.
Just a point to point out there, and it's just a point to point out there as well, is that the new customers are, you know, the expanders of tomorrow. They start out small, so the contribution that they have in a quarter is usually low. As you said, as the year progresses and the second year progresses, they become the expanders. That's a key point here. It's the land and expand model is truly aligned with the Kneat business model, you know.
Got you. Thank you. I noticed there's like a small contribution from the on-premise license revenue. How should we think about it for the remaining of the year?
On the on-premise, you know, we've only got one customer left on-premise now. You know, in fact, that customer's completed. You know, all our customers audit our systems and our control systems and our security and everything to do with our SaaS and cloud environment. That customer has already completed a SaaS audit of us recently, that customer we expect will be on-premise, you know, within a year, worst case scenario. That's the last customer that we have. You're unlikely to see, I would say, any more on-prem licenses. Pretty sure that's the case actually.
Got you. Thank you. Congrats on the quarter again.
Thanks.
Thanks, Andy.
We will take our final question from Justin Keywood with Stifel GMP. Your line is open.
Hi. Thanks for taking my call. On R&D, it ticked up in the current quarter. Wondering if there's anything one-time in nature there, and what's a good run rate for the R&D line?
Yeah.
Uh-
Hi, Justin. Sorry, I'll just take the first cue, and I'll pass it on to you there just to say-
Okay.
Justin, that we have, you know, been, we've been growing in R&D last year and, you know, we expect it to ease off this year. I would say the uptick is the final hires coming in early in the year and now being deployed and, you know, optimized. If you wanna add some color to that, Hugh, go ahead.
Yeah. Sure. I mean, it's pretty much as you said,Eddie . The uptick is driven by a couple things. You know, obviously, we pay merit increases, which tick in the first quarter, so there's a small element of that there. Also the effect of, you know, people who started during the last quarter, who are here for a full quarter this quarter but weren't, were only there for a partial quarter in the previous quarter. Also people, some people who have been hired, in, you know, where the hiring is happening in Q4, but where they only actually started in the first quarter. They were the primary things.
There were few other little odds and sods beyond that, but that, they were the main drivers. You know, I, you know, I think, you know, looking at this quarter, and the spend there is probably not a bad basis.
Got it. I assume with the additional hiring, that's to preempt the new clients onboarding, where we haven't seen that sales yet, per se.
Absolutely.
Yeah. Okay.
So-
Go ahead.
Yeah, absolutely. I think, you know, the key thing to say is that we did quite a bit of hiring last year and expanding our teams and, you know, we're growing into those teams for want of a better word this year. We don't see ourselves, you know, expanding those functions, except for critical like you know, key hires that we may need through this year. You know, you can take it that there's a lot of runway in that team at this point in time. We're seeing the outcome of that already in the pipeline. Yeah.
Okay. Thank you very much.
Very good. Thank you, Justin.
I will now turn the call back to Eddie Ryan for closing remarks.
I will close off today's call with three thoughts. First, just a reminder of Kneat's truly unique positioning right now, not just with our software, but within the life science industry itself. With innovation on an exponential growth curve, moving forward without a digital solution, and I meant truly digital, not just paper on glass, seems increasingly impossible. Second, with annual recurring revenue approaching CAD 30 million, nearly all of it coming from SaaS, and the investments in our team we made last year, Kneat's economics are better than they've ever been. With our tier one customer base solidly in place and growing, our future has never looked brighter. Finally, I want to reiterate how pleased I am with our Q1 results and the team that made that possible.
While we have come a long way since those first few lines of code, the vast majority of our journey lies ahead. I couldn't feel better about the team we have in place for that journey. As always, thank you. Thanks again for everyone on the call for your interest in Kneat.
Ladies and gentlemen, this concludes today's conference, and we thank you for your participation. You may now disconnect.