Good morning. My name is Jordan, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Kneat Q3 2023 conference call. 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 this time, simply press star followed by the number one on your telephone keypad. If you'd like to withdraw your question, again, press star followed by the number one. Thank you. Speakers, you may now begin your conference.
Thank you, operator, and welcome everyone to Kneat's earnings conference call for the third quarter of 2023. Today's call will be hosted by Eddie Ryan, Kneat CEO, and Hugh Kavanagh, CFO at Kneat. Before we begin, I would like to draw your attention to the safe harbor statement on slide 2 and the forward-looking statements disclosure at the end of our earnings release. Comments made on today's call may contain forward-looking information. This information, by its nature, is subject to risks and uncertainties, and as such, actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult our relevant filings, which can be found on SEDAR and on our website at www.kneat.com/investors. Also, during the call, we may refer to certain supplementary financial measures as key performance indicators. Management uses both IFRS measures when...
supplementary financial measures as key performance indicators when planning, monitoring, and evaluating, the company's performance. Management believes that these non-IFRS measures provide additional insight into Kneat's financial results, and certain investors may use this information to evaluate our performance from period to period. I will now pass the call to Eddie Ryan, CEO of Kneat.
Good morning, everyone, and thank you for joining the call today. I will share my thoughts on the quarter, then Hugh will provide a detailed financial update, and after that, we'll take your questions. Our third quarter financial results were solid, with total revenue up 46%, SaaS revenue up 72%, total annual recurring revenue up 64%, and SaaS annual recurring revenue up 74%. Growth in the quarter was driven primarily by expansions in the number of licenses held by current customers, and to a lesser degree, by incremental revenue from new customers deploying for the first time in the quarter, including several that we announced earlier this year. Essentially, what we saw in the quarter was our land and expand strategy play out as it has done uninterrupted for the past several years.
What makes this year different from previous years is the size and number of both new and expansion deals. The strategic importance of momentum at this stage of our life cycle cannot be overstated. As life sciences companies have been understandably careful in their adoption of digital solutions, the majority of their transition to digital validation lies ahead. By getting in early to serve as the initial foundation on which life sciences companies are preparing for automation, Kneat secures an early lead, greater marketing mindshare, and can be more influential in building the future of digital validation and quality management. Once a company has chosen and deployed a digital platform to support validation, switching away from that platform is not easy. Companies are obliged to maintain years' worth of validation records for quality tracking, assurance, and audits.
This is why companies put so much effort into their platform selection in the first place. It is not an easy reversible decision. Integrations with the rest of a customer's IT systems across resource planning, manufacturing, quality, engineering, and maintenance further strengthen our position as a pillar in their IT landscape and helps our customers make even more efficient use of their resources. This is why our R&D team is also building application programming interfaces so customers can capture even greater efficiencies when they deploy Kneat. We brought the total number of our strategic wins year-to-date to 7, with the announcement of two more in the third quarter. A contract development and manufacturing organization headquartered in Asia for equipment validation and a manufacturer and distributor of medical supplies headquartered in the United States for computer systems validation.
I note that neither of these is a traditional global pharma, underscoring the applicability of the Kneat platform throughout the life sciences ecosystem. We enjoyed the company of customers, prospects, and partners coming from all across the pharma supply chain at the Kneat Validate Conference in Miami last month. Spending a few days with true leaders in validation through formal presentations and one-on-one conversations informs our roadmap and customer interactions and inspires our R&D going forward. I came away from the conference more enthused than ever about our relationships with customers, our position in the industry, and our business strategy. The conference also reinforced for me that digitization and automation will continue unrelenting into the foreseeable future, and that our unmatched focus on e-validation will continue to power our near-term success.
It was a fantastic event and a great showcase of the differentiated talent that powers Kneat and our connection to our customers and partners. With that, I will hand you over to Hugh for a review of the financial results.
Thank you, Eddie. As Eddie mentioned, quarter three was another quarter of strong revenue growth and year-on-year gains in our gross margin. Revenue for the third quarter ended September thirtieth, two thousand and twenty-three was $8.4 million, up 46% from $5.8 million for the third quarter of two thousand and twenty-two. SaaS license revenues grew by 72% to $7.7 million, compared to $4.5 million for the same period in two thousand and twenty-two. This brings us to just over $24 million in revenue three quarters of the way through the year.
Cost of sales for the third quarter of 2023 was $2.9 million, which is a 31% increase in cost of revenues year-over-year, relative to the 46% increase in overall revenues over Q3 2022. Gross profit for the three months ended September 30, 2023, was $5.5 million, 56% higher than the $3.5 million in the same quarter in 2022. Gross margin percentage was 65%, compared with 61% for the third quarter of 2022. The increase in gross profit margin was driven by the significant increase in SaaS revenues as compared to the increase in cost of revenues.
I would also note that as partners take on more professional services and the proportion of our license revenues to professional services revenues continues to increase, we expect the gross margin percentage to keep on this upward year-over-year. As we saw last quarter, while this transition adds to headwinds on our year-over-year growth of revenues in the short run, it leaves us much better positioned for the long run in the form of more gross margin dollars available to our business. Turning now from progress in gross margins to progress in operating margins. R&D expense, net of capitalized R&D for Q3 2023 was $3.8 million, compared to $2.8 million in Q3 of 2022.
Sales and marketing expense was $3.1 million in Q3 2023, compared to $2.1 million in Q3 of 2022. We saw the year-over-year growth in these line items begin to taper as we annualized the investment in hiring that we made over the course of 2022. Total annual recurring revenue, ARR, which includes SaaS license fees and maintenance fees, grew by 64% to $31.4 million from $19.1 million at the same point last year. As we look at just the proportion of ARR coming from SaaS license fees, SaaS ARR grew 74% to $31.3 million from $18 million at September 30, 2022.
This recurring revenue from sales of our software is central to our growth strategy and explains why ARR is a key performance indicator for Kneat. Revenue from our SaaS offering adds to our annual recurring revenue base, a central tenet to our growth strategy, given the strong staying power of our customer base. ARR from maintenance fees was $0.1 million at the end of the third quarter of 2023, compared to $1.1 million at September 30, 2022, as nearly all customers have transitioned over to SaaS. We added to our cash balance at the end of the third quarter by putting the second tranche of our debt facility to use, and we continue to have the third tranche of the facility available to be drawn down.
For your reference, we have filed our unaudited interim consolidated financial statements and MD&A on SEDAR, and they are also available on our website. I will now turn the call over to our operator for your questions.
Your first question comes from the line of Christian Sgro from Eight Capital. Your line is live.
Hi, good morning. You had commented that some of the growth you saw in the quarter was due to expansions instead of new business, and I think that's what's common from Kneat. But as you talk about new licenses, is there any color you could provide around, you know, whether those new licenses were across new sites, more people per site, new geographies, new functions? Like, where are you getting some of that pickup?
Hi, Christian. Thanks for your question. Yes, so you know, expansions is a large part of our business, and I will say that most of our expansions are in that vein. They're either new processes, or expansion to new users, or expansion across sites. So it's very, very common within our expansion business, going to new sites, new processes, and more user licenses.
Okay. And you mentioned, there was more commentary than normal, this quarter already on, you know, the stickiness, the moat of the Kneat platform. Is there an update you could provide around the sales cycle and implementation cycles of the Kneat Gx platform? I know historically they've been quite long for business reasons. It's great to shorten them, but, you know, if they're still long, maybe that speaks to, how critical the decision is and, and how sticky the product can be.
Yeah. So the sales cycle varies from time to time, and I would say the current climate, sales cycles are extending a wee bit. Nothing, you know, significant, when you have a strong pipeline.
But, I would say that as we develop more technology, we're also seeing that countering that. So we're enabling the sales process to a more mature business and more features in our technology. And we're also shortening the deployment times for the same reasons. So, but, you know, in the current climate, that's countering it a wee bit. But I would say that, yes, we're heading in the right direction regarding shortening these cycles.
Okay, and one last question from my end. On seasonality, sometimes, you know, software companies can have a stronger Q4 just in the calendar if there's any budget flush or customers looking to, you know, spend ahead of the year-end. Now, is that a theme at all for Kneat, or would you say some of the expansion activity is less predictable and not to think of Q4 as necessarily being stronger for seasonal reasons?
Well, I suppose the other thing to say, Chris—the thing that I always say, Christian, is that, you know, the, you know, certain deals can, you know, cause a bit of lumpiness from quarter to quarter. But traditionally, when we look back over our cycles, traditionally, the fourth quarter has been strong for us. And I think that is to do with customers that have budgets there, and they have didn't get around to, you know, doing what they needed to do when sometimes they have to push in a wee bit quicker at the end of the year. So there's definitely some seasonality there from our perspective. That doesn't mean I can't guarantee it every year, right? But, you know, that's what it tends to show from our history.
Okay, perfect. Thanks for taking my questions, Eddie, and congrats on the quarter.
Thanks, Christian.
Your next question comes from the line of Gavin Fairweather. Your line is live.
Oh, hey, good morning, good afternoon. Congrats on all the progress.
Thanks. Thanks, Gavin.
Maybe just to start out- kind of, kind of building on one of Christian's questions, you know, around expansion, maybe less so around kind of Q4, but maybe you could help us, you know, understand what you're hearing from, you know, your customers on expansion plans over the course of 2024. You know, what are you hearing in terms of kind of CapEx plans and new plant builds? You know, any kind of color on that, you know, expansion environment, maybe over the course of next year would be helpful.
Yeah. So definitely, you know, our customers are all, you know, indicating expansions, and we see lots of opportunities, and we believe that we're only touching the surface with our customers and, you know, we see a lot of opportunity there to, you know, become more intimate and to, push into, these other areas with them. But there's definitely, all our customers, all our strategic customers, certainly are on roll-out plans, of one sort or another, whether that's new sites or whether it's, more, more users or whether it's capital projects, like you say, that are, that they're, you know, applying Kneat to as well, Gavin.
Okay, that's great to hear. And then just on the new logo acquisition side, I think you said 2 strategic logos in the quarter and, you know, seven year to date. You know, what do you see when you look into the pipeline in terms of, you know, those strategic logos? Do you have a good number that are kind of in the works?
Yeah, we do. We do see lots of them in the works, and we're optimistic that we will continue to deliver news like that into the future. So there's a strong pipeline, you know, across mid-tier, large strategics, and small pharma as well.
Got it. And then a lot of the, you know, effort on the product side has been kind of redoing the data taxonomy and moving to more kind of data-centric structure, you know, within the product. Curious for your perspective on kind of what kind of new functionality that might unlock, including, you know, leveraging, you know, AI. And then also maybe you can touch on, you know, how you might see data flowing within the stack. What kind of use cases or efficiencies does the new structure open up?
Yeah, it's a very good question. We're very optimistic about where the product is going and how aligned we are with our customers, you know. We had a very great Validate conference recently in Miami, and, you know, the customers are just pointing out, you know, how aligned we are with them. And that's really great to hear, and that seems to be getting stronger every year, when we meet our customers en masse like that. So you know, what we're bringing forward is that customers are really excited about is enabling more data centricity within documents and, and without outside of documents and that.
So, you know, when you get this very strong data structure, where we're continuously delivering, it gives us the ability then to, you know, have really strong data and analytics and deliver more value to the customers. Also it enhances the integration capabilities and just bringing more value generally to the customer, and also giving that data integrity that customers must have in our industry. It's critical. So there's a huge amount of work that we're doing there, and it's all coming through the pipe as we speak.
Okay, great. And then just lastly for me, just on the working capital, I saw that the receivables jumped a little bit this quarter, maybe for Hugh. Is that just kind of timing, and have you, you know, seen any of that kind of reverse so far here in Q4?
Yeah, yeah, for sure, Gavin. Yeah, so versus last quarter, the trade receivables are up quite a chunk. In fact, of that $7 million or so dollars that we have of trade receivables at the end of the quarter, the vast majority of that actually has been received at this point.
Okay, great to hear. I'll pass it on. Thank you.
Lovely. Thank you very much.
... Your next question comes from the line of Andy Nguyen from Raymond James. Your line is live.
Hi. Thank you for taking my question. So, you had a couple of big win, customer wins last quarter and this quarter as well. How's the onboarding process going for those clients with respect to, you know, the typical process you see with other, you know, customers as well?
Yeah. Hi, Andy. Yes, so we're, you know, our professional services team is very good at delivering deployments and partners where they're involved as well, because we get involved with our partners to make sure they go effectively. So, you know, all those deployments of those new customers are on target, and we would say, you know, assume a six-month plus from the time we announce them to be complete from a deployment perspective, on the first phase of the deployment. But thereafter, it's about, you know, expansion into the future.
Gotcha. Thank you. And with respect to the partner network, I think you have about 77 partners and service provider this quarter, compared to, like, 50 of the previous year. How should we think about the growth of that partner network going into fiscal 2024?
Yeah. So the partners, you know, are belong in different categories. You know, and if you think about our strategic partners, that base is growing, and those partners are evolving in their capabilities. You know, they would have started out as, you know, trained service partners, being able to use Kneat in industry, and then going to from there to be able to deploy Kneat and expand Kneat with their customers, process mapping and the like, to expand the product across the customer sites. And then from there, moving into, you know, capable enough to be potential resellers. So we see that model working really well, and we see a number of customers really stepping...
partners, excuse me, stepping up to become these strategic partners that can also resell our platform into the industry, and especially into the mid and smaller customers as well. So, yeah, that's going very well for us, and we expect that to continue, and we have a strong focus on it.
Got you. And the final question for me, I'm assuming the retention rate remained 100% this quarter, for your customer base?
So-
Sorry, just repeat that again? Yeah, sorry.
Yeah, the retention rate. Can you repeat?
Yeah. So I just-
Retention rate.
The retention. Yeah, yeah, remained 100% for the quarter.
Yeah. So we would say that we have zero churn, and what I would say from that is, you know, there are some exceptions from that, but by and large, it's still zero churn as far as we're concerned. But you may see the odd small customer that may, whatever, for one reason or another, go back a small bit. But by and large, I would say still 100%, from that perspective.
Gotcha. Thank you, and I'll pass the line.
Your final question comes from the line of Steve Li from Raymond James. Your line is live.
Hey, thanks. Hi, Eddie. Hi, Hugh. I joined a little later, so I may have missed it, but what was the FX impact on the revenues, positive or negative?
So yeah, the impact on revenues quarter-over-quarter in this quarter was actually versus the same quarter last year, was essentially. There's no impact on revenue versus the same quarter last year.
How about year-over-year, Hugh?
Year over year, yes, over the course of the year, there is a tailwind, you know, in the $ several hundred thousand type range.
Okay, perfect. Okay. And on the potential ARR from current customer, on your website, you still show $50 million ARR, which you've been using for quite some time. Do you have an updated number?
Yes, we do, we do. But question, Hugh, is that the number publicized?
No, we haven't put it out in press releases, no. So, yeah, so we certainly have updated the number, and we'll probably refer to it in our next year-end press release. Yeah.
Yeah, but just safe to say there, you know, the number, you know, definitely is revised upwards, and, you know, we will release that, I guess, in due course.
Okay, got it. Thanks. That's all for me. Thank you.
Thanks, Steven.
Okay. Thanks, Steven.
We have another question from Gavin Fairweather. Your line is live.
Hey, just to follow up, maybe for Hugh, we saw the gross margins tick down very modestly from Q2 levels, despite kind of the SaaS mix moving higher. Is that just kind of lower services utilization? And maybe, yeah, just unpack that a little bit, that'd be helpful.
Yeah, no, you're spot on there in your comment, Gavin. Yeah, so essentially the lower professional services revenue this quarter is really the driver of that slight tick down quarter-over-quarter. But yeah, so just, you know, the situation continues to be that, you know, we have very strong SaaS margins. We continue to have, you know, the PS, you know, our focus is not on margin there, so those are low margins.
But, you know, quarter on quarter, where PS revenues go up or down, then that can have an impact on the overall gross margin from the perspective of, you know, we essentially recognize costs in the quarter, in the quarters that the cost is incurred. But then revenues, you know, sometimes vary because of the timing of finishing out on projects, etcetera.
... Do you see, like, when you think about the building partner network, you know, should we think about services revenue being relatively flat? I mean, I guess if I look back at the last few years, you know, it's probably averaged about $1 million, maybe a tick over $1 million a quarter. Is that a decent run rate, or is some of that gonna be, you know, increasingly given away to partners as well?
So yeah, no, I mean, the quarter is probably a little lower than the historic run rate for Q4. You know, the partners are certainly that program is kicking in well. But yeah, no, I mean, it's not a case that the PS revenue is going to go away. You know, we will be maintaining it. We don't expect to grow it hugely, or maybe at all, but certainly we expect to continue to maintain a good level of professional services revenue.
Okay. Thanks so much.
Your next question comes from the line of Tanvi Gabriel from Echelon Wealth Partners. Your line is live now.
Hi. I'll be speaking on behalf of Rob Goff. I just wanted to ask regarding the year-to-date wins. What were some of the key factors that led to the year-to-date wins as well as, the traction within medium and small clients, both directly as well as through distribution partners?
Yeah. Hi there. So yeah, the wins are, you know, based on the strength of the Kneat technology and the success, proven maturity and success in the marketplace, and the reference-ability of that, and the known brand of the Kneat technology delivering success. And that's been, you know, the key reason. You know, ultimately, Kneat delivers a high-quality product that enables your compliance and your data integrity, right first time in an industry that really values that. And, you know, also cuts the costs of the man-hours associated with these processes by 50% and enables them to get their products to market faster. So these are huge value...
It's a huge value proposition, and, you know, it's proven to deliver on all of those, which is one of the key things of Kneat at this point in time, is maturity of product and maturity of company, within the marketplace. And that's filtering down to all customer sizes, you know?
Right. Okay. And in terms of your current pipeline, do you see... Or what's the division between the medium and small clients?
The division between the medium and small clients? You know, okay, so there's 3 layers to most. There's strategic, there's enterprise, and then there's medium and small. So small would be, you know, companies that have probably up to 500 employees, and then up to 2,000 becomes your next layer, which is medium. And then above that is enterprise, and above 5,000 becomes strategic. Yeah, I think I have those numbers right.
Right. Okay. Thank you.
There are no further questions at this time. Mr. Eddie Ryan, CEO of Kneat, I turn the call back over to you for final remarks.
We've come a long way since we got our first customer nearly 10 years ago. There's still so much to accomplish. We are lucky to have a great team in place, getting us there and building capabilities our customers are excited about because it accelerates their progress. I close with a sincere thanks to everyone on the call today for your interest in and support of Kneat.
That concludes today's call. You may now disconnect.