Morning, ladies and gentlemen, welcome to Kneat.com Quarter Two 2023 earnings conference call. My name is Jenny, and I will be your conference operator today. This call is being recorded. I would like to turn the presentation over now to Katie Keita, Investor Relations Lead for Kneat.com. Katie, please go ahead.
Thank you, operator. Welcome everyone to Kneat's earnings conference call for the second 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 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, 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 investors.kneat.com. During the call, we may refer to certain supplementary financial measures as key performance indicators.
Management uses both IFRS measures and supplementary measures as key performance indicators when planning, monitoring, and evaluating our performance. Management believes that these non-IFRS measures provide additional insight into Kneat.com's financial results. 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.com.
Good morning, everyone, and thank you for joining 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. Our strong growth continued in the second quarter, with total revenue up 45%, SaaS revenue up 80%, total annual recurring revenue up 75%, and SaaS annual recurring revenue up 86%, as we expanded to more sites and processes within existing customers and as new customers went live on our platform. The revenue growth we achieved this past quarter is a result of efforts and achievements several months and even years ago. This dynamic bodes well for Kneat's revenue growth into the future, given our high customer retention and the steady pace of wins we have had in the first half of this year.
The large wins we signed since the start of quarter two include a division of one of the top pharmaceutical companies in the world, one of the top 20 life sciences contract development manufacturing organizations, a global pharma manufacturer, and in July, another contract development manufacturing organization, this one expanding Kneat's footprint in Asia. This pace of large customer wins underscores the growing recognition of Kneat as a leader in digital validation for life sciences, and excellent progress on our near-term goal of consolidating our leadership position in this space. Beyond the revenue momentum from our land and expand strategy, it is worth noting that the life sciences space includes a large number of medium and smaller companies, both smaller pharmas as well as companies operating throughout the pharma supply chain. I'm talking about vendors, distributors, and those working in the R&D space.
Given that these, and in fact, any organization subject to life sciences regulatory oversight, are already represented in our customer base and are potential customers today, we estimate our total addressable market for e-validation within life sciences to be in excess of $2 billion. This $2 billion total addressable market is global as we expand our global footprint and because validation within a single large enterprise is global in scope. The increased diversity of our customer base is evident in the shift of revenue toward this greater number, with 56% of our overall revenue coming from our top 10 customers in Q2 2023, versus 65% for Q2 of last year and 78% for Q2 of 2021. This expansion of our customer base also demonstrates Kneat's strength as a platform.
Rather than building to any single large customer's specification, every new feature is one that strengthens the platform at large. It is with this approach that we are incrementally equipping Kneat Gx for ever broader applicability, enhancing validation applications today while getting better at addressing additional use cases in the future. As we bring on new customers, and as the Kneat platform supports more sites and more processes within our existing customers, we must build a structure that can support Kneat at a size in the years ahead that is several times where it is today. We made two important moves in the second quarter to help us. First, we are pleased to welcome Colum McNamara to Kneat. Colum joined us in early June to serve as our first Senior Vice President of Global Operations.
In his career in tech, Colum has run just about everything from support to network operations for some admirable companies, so he is well-equipped to build out Kneat's professional services, strategic partnerships, Kneat Academy, and customer success and support. Second, we secured debt financing of up to EUR 15 million from IPF Partners, a financing partner focused exclusively on the healthcare sector. Leveraging this flexible and non-dilutive option augments our own funds from operations on our path towards profitability. I now hand you over to Hugh for a review of the financial results.
Thanks, Eddie. Quarter two was another quarter of strong revenue growth and continuing progress on our year-over-year growth margin. Revenue for the quarter ended June 30, 2023, was $8 million, up 45% from $5.5 million for the second quarter of 2022. SaaS license revenue, which, as you know, is a key metric for Kneat, grew 80% to $7 million, compared with $3.9 million for the same quarter in 2022. As is usually the case, existing customers scaling their use of Kneat Gx primarily drove our year-over-year revenue growth in the quarter, aided by first-time revenue from new logos. This brings the first half 2023 revenue to $16 million, up 49% from $10.7 million for the first half of last year.
SaaS license revenue year-to-date grew much faster than overall revenue year-to-date, up 86% to $13.4 million from $7.2 million for the same period in 2022. Cost of revenue for the second quarter of 2023 was $2.7 million, which is not too far off where we were in Q1 and up $0.4 million from $2.3 million in Q2 of 2022. This is a 20% increase in cost of revenue compared with last year's Q2. The six months year-to-date cost of revenue increased by 26%. These are relative to 45% and 49% increases in overall revenue for the two periods, respectively.
Gross profit for the three months ended June 30, 2023, was $5.3 million, 62% higher than the $3.3 million in the same quarter of 2022. Gross margin percentage was 66%, compared with 59% in the second quarter of 2022. The increase in gross profit margin for the quarter was driven by a significant increase in SaaS revenue as compared to the increase in cost of revenue. For the year-to-date, we see similar expansion of gross margin year-over-year at 67% for the first six months of 2023 versus 61% for the first half of 2022, an increase in gross profit dollars of 63%.
We continue to see increased technical proficiency in our partner channel, with more and more partners providing services and training, with only consultative support from the Kneat professional services team. While this transition adds a headwind to our year-over-year revenue growth in the short run, this positions us much better for the long run, and allows us to grow gross profit and gross margin by focusing on the higher margin SaaS revenue business. As we look to operational expense, expenses, sales and marketing expense was $3.3 million for Q2 2023, compared to $1.7 million in Q2 2022. R&D expense, net of capitalized R&D for Q2 2023 was $4.2 million compared to $2.7 million in Q2 2022.
The growth in OpEx is as apparent year-to-date, with sales and marketing expense of $6.3 million versus $3 million for the same period last year, and R&D for the six months of 2023, at $8.1 million versus $5.2 million last year. The biggest driver of the increases for both the second quarter and the year-to-date was hiring, as we invested substantially in our sales and marketing and R&D teams last year. We expect the year-over-year growth in OpEx to slow going forward, as our 2022 investment has started to be more fully reflected in OpEx for the second half of the, of last year.
Total annual recurring revenue, ARR, grew by 75% to $28.4 million from $16.3 million at June 30, 2022. Total ARR includes SaaS license fees and maintenance fees. Growing ARR through recurring revenue from sales of our software is central to our strategy, and that is why we consider ARR, and in particular, SaaS ARR, to be a key performance indicator for Kneat. SaaS ARR, the proportion of ARR attributable to SaaS licenses, grew 86% to $28.3 million from $15.2 million as of June 30, 2022. ARR from maintenance fees was $0.1 million at the end of the second quarter of 2023, compared to $1.1 million at June 30, 2022.
We expect the last remaining significant on-prem customer to transition to SaaS in the coming quarters. I will end my prepared remarks with a brief word on the financing that we completed in the quarter. After exploring a number of options with several parties, we are very pleased with where we ended up with IPF.
While it took quite a bit of time to go through the process, we met our objective of securing straightforward and non-dilutive debt financing that offers flexibility and carried practical and achievable terms. I want to thank the Kneat team, especially the finance team, for the work that went into getting this done. While adding debt to our balance sheet adds to our costs, it gives us the flexibility we need as we execute on our growth plans. Execution is a strength for Kneat, where we have proven ourselves time and again. For your reference, we have filed our unaudited, condensed interim consolidated financial statements and MD&A on SEDAR, they are also available on our website. I will now turn the call over to our operator for your questions.
At this time, I would like to remind everyone, in order to ask a question, press star, then one on your telephone keypad. Your first question comes from the line of Mr. Doug Taylor of Canaccord. Doug, your line is open.
Yes, thank you. Good morning. Can I get you to speak to, you, you reference a, a record period for strategic new customer signings so far, this year. Can you speak to the, the go lives that you anticipate through the back half of this year, and whether, all of those new customers are tracking to original timetables?
Hi, Doug. Eddie here. I can speak to that. Thanks very much for your question. Yes, all these customers are tracking to timelines we would expect. They'll all go live within that six month period that is normal for our customers. You know, we're very happy with the, those customers that, that we have announced. Yes, just to remind you that, you know, we sign many other customers, but we don't announce them, as we don't see them as material as the bigger ones.
Okay. Can you talk then to the, you know, You've obviously had a strong period for pipeline conversion, but can you speak to the pipeline of additional, potential new customers within your, your core life sciences vertical?
Yes, I can, Doug. There, it's very strong, and it continues to strengthen. It's a reflection of our, you know, the investment we made in sales and marketing and our maturity, our product and customer maturity in the industry. So I'm very happy to say that that pipeline continues to grow as we are executing through the sales and marketing channels.
Okay. You, you mentioned Colum McNamara's hiring as consistent with the objective of growing your professional services business, which has been, you know, I'll say sort of flat for the last two quarters, and not pacing the same as your software revenue growth. Should we anticipate then an inflection in professional services revenue at some point to sort of match your, your software growth?
No, I, I would say professional services will continue on in the same vein, where it is right now. Our we're looking to, you know, remodel our professional services based on the success we're having with our partners. The primary goal is to enable partners to, the strategy is to enable partners to deliver professional services in the marketplace. We see our professional service team as being a, an enabler for ARR and SaaS revenues and partner enablement, but also as a strategic consultant to our customers. I would say, you know, there won't be any much change in that line for now, Doug.
Okay. It may be one last question for me. You've spoken to, you know, how you front-end loaded investments in sales and marketing and R&D, you know, ahead of the growth that you anticipate here, you know, in the second half of the year and beyond. Has the, you know, availability of additional capital that you've got now or you're afforded with your new credit facility, you know, at all changed your appetite to invest further, you know, potentially hit, you know, kind of hit the gas on, on growth? Any change there?
You know, going into an announcement of any debt, we were confident that we would continue to grow with the current resources and grow into the resources that we hired last year. I mean, that doesn't take away the fact that we will continue to hire key resources, as you've seen from Colum McNamara, who we brought in recently. There's no immediate change to the plans from that perspective. We have a lot on our plates, a lot of activity with our pipeline and customers, so we're confident that we will continue through the year, Doug, to deliver on our expectations.
Thank you. I'll pass the line.
Thanks.
Your next question comes from the line of Kiran Sritharan from Eight Capital. Kiran, your line is open.
Hey, morning, guys. Kiran from Christian here. Now, congratulations on that TAM increase. That's pretty significant. I'm just curious, how much of that increase came from any partner-led impact? Was there some sophistication expertise that they had in geographies or subsectors that led to that increase?
You're referring to the increase in the TAM, Kiran, is it? Yeah, just to clarify that point.
Correct.
Yeah. Okay. Yeah, so the original TAM that we, you know, would have estimated is primarily for pharmaceutical and medical device manufacturers within the U.S. and E.U. Now, seeing where our customers are using our product and where additional customers are coming from, we, we looked at all of that, and we're able to see a larger addressable market in these additional sort of related segments, primarily in chemical, healthcare, personal care, diagnostics, and also the life sciences supply chain. When we look at all that holistically, the TAM has increased significantly, as you can see, over $2 billion in our e-validation space.
That's good to hear. For my second one here, just curious, with the flushing out of the on-prem business, are there any efficiency gains you expect from either your R&D or other internal teams? Essentially, like, what is the impact of these resources being reallocated?
Well, yeah. We've been transitioning for the last two years, Kiran, right? To all intents and purposes, we've been pure play SaaS. It's just been washing out those remaining customers. Yeah, there is obviously benefits. You know, on-prem and SaaS are two different products, really, when you, when you, when you line them up against each other. Focused solely and wholly on one product definitely gives us greater speed in that area and allows us to push forward with innovation there. There's definitely benefits to be had there. You know, we've been washing it out for a while now, just to be clear out there as well, Kiran. It's been happening over the last two years.
Thanks, Eddie. I'll leave it to you.
Yeah, thanks.
Your next question comes from the line of Gavin Fairweather of Cormark. Gavin, your line is open.
Oh, hey, good morning. Can you hear me?
Hi, Gavin.
Yes, indeed, Gavin.
Okay, good. Maybe just to follow up, to start on the new TAM, if you look at just the opportunity for life sciences and medical devices, did, did the TAM increase from that $600 billion that you published previously?
I would say looking at the original, which was U.S . and Europe only, we're now looking at global, I guess, in all of our, our TAM. Not any real change with regard to medical devices and pharma manufacturers. I would say when you look out into the supply chain around all of them, yes, but that would be the additional TAM that contributing to the additional TAM. No real change from that perspective, other than we've added in new segments and adjacencies from a regulated perspective and global, Gavin.
Okay, got it. That's helpful color. Then maybe just, you know, on kind of the, the customer base and expansion plans for the back half, can you just discuss what you're hearing from, you know, your larger customers heading into the back half? You know, the ARR added in the second quarter was a bit lower than previous quarters, although it can be lumpy. Curious what you're hearing on expansion kind of coming out of your 9.0 release and your big user conferences there.
Yeah. These are very intimate relationships, we have continuous engagement with our customers regarding their expansion plans. You know, we're very optimistic that, you know, everything is going to go according to plan from that perspective, from our internal expectations. Yeah, you know, we don't see any negative impact from, you know, the macro, really. There's a few You may see a few little slower deals happening, mostly in the smaller customers, maybe a slower quarter, maybe, you know, a customer might hang over to the next quarter, but nothing significant. Everything is, seems to be, you know, business as usual from that perspective, Gavin.
Great
Yeah, just Gavin, I'll just add, add Gavin, I'll just add one additional comment, and I'm, I'm sure you're probably already conscious of this, but just in terms of ARR, you know, growth, quarter-on-quarter, ex-exchange rates, do, do play a, a role here. We, we haven't drawn, really drawn attention to it in our, in our, our press release, et cetera. Yeah, the, you know, as, as, as you know, revenue, comes in, in dollars and principally dollars, but also euro. Then we look at ARR, you know, at quarter end, and we convert it at quarter end rates.
You know, the quarter end rates, have essentially brought a headwind on, on the ARR front, you know, to the tune of $500,000-$600,000. I'm guessing that you probably have made a good estimate of that already yourself.
Yeah, got it. That's, that's helpful color. Then maybe just, can you, can you discuss, within the tier two and tier three space within life sciences, kind of how your win rates are tracking versus your expectations as, as you build out the channel? I know it is a more kind of competitive space, so curious how those are tracking now that the channel is starting to mature.
Yeah. Well, our win rate is very good, Gavin, and, you know, there's customers, you know, when they get to a certain size, they may not be as attractive to us. But, definitely when they go down into those mid-market, we're good with that, and our objective would be to improve delivery through through the channels to the smaller customers as well. But yeah, no, our win rate is good. I mean, as I say, the macro climate is affecting smaller customers a little bit more than the bigger customers, but that doesn't mean that it's affecting us in yeah, any, any way significantly either, you know?
Okay, great. Then just lastly for me, any thoughts around how generative AI or kind of copilot could help with dev efficiency or testing efficiency? You know, is there some automation that you can, can put in place there to just help with the speed of innovation within the R&D team?
Absolutely. You know, the team are leveraging that as we go through, especially in the whole area of testing, and code development. You know, it's, it's a, a small part of the overall thing, but if you're developing a, a subroutine or a, or a function, it can help there. There's we see opportunity for this in the whole area of data analytics as well, as we go forward. We're building out all that, reporting capability, and hopefully, we can leverage that in the not-too-distant future as well. There's plenty of research and some use of it going on, but nothing major at this point in time, Gavin.
Thanks so much. I'll pass the line.
Thanks.
There are no further questions at this time, and I would like to turn the call back to our host, Katie.
Thanks, Jenny. We have a few closing remarks from Eddie. Eddie, I'll pass it over to you.
Let me close today's call with a reminder that with every new customer added and with every new feature we build, we make progress on our goals over the longer term, which is to extend our best-in-class framework into the total quality management space beyond the multiple validation processes it's being adopted for today. At the six-month mark of 2023, we see strong progress on our goals at the start of the year: adding and deploying new customers, expanding to new work processes and new sites within our existing customer base, further developing the Kneat Gx platform in collaboration with our customers, selectively building out our company structure, and leveraging our partner relationships to expand global reach. Before closing, I only want to express my thanks to the entire Kneat team. Ours is an incredible group of people.
The value NEAT is bringing to life sciences is only possible through their discipline and focus. This is a team that makes our software better every single day and gets better, and get better themselves in the process. To everyone on the call, thank you all for your time today, and we look forward to updating you again in October. Thank you. That's it for today.
This concludes today's conference call. You may now disconnect.