Model N, Inc. (NYSE:MODN) Q2 2023 Earnings Call Transcript May 13, 2023

Operator: Good afternoon, and welcome to Model N’s Second Quarter of Fiscal 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. With that, I would now like to turn the call over to Carolyn Bass, Investor Relations. Thank you.

Carolyn Bass : Good afternoon. Welcome to Model N’s Second Quarter and Fiscal 2023 Earnings Call. This is Carolyn Bass, Investor Relations for Model N. With me on the call today are Jason Blessing, Model N’s Chief Executive Officer; and John Ederer, Chief Financial Officer. Our earnings press release was issued at the close of market today and is posted on our website. The primary purpose of today’s call is to provide you with information regarding our second quarter of fiscal 2023 performance and offer a financial outlook for our third quarter and fiscal year ending September 30, 2023. The commentary made on this call may include forward-looking statements. These forward-looking statements are based on management’s current views and expectations as of today and should not be relied upon as representing our views as of any subsequent date.

We disclaim any obligation to update any forward-looking statements or outlook. Actual results may differ materially. Please refer to the risk factors in our most recent Form 10-Q filed with the SEC. In addition, during today’s call, we will discuss non-GAAP financial measures. These non-GAAP financial measures should be considered in addition to, not as a substitute for or in isolation from, GAAP results. Reconciliations of the non-GAAP metrics to the nearest GAAP metrics are included in the earnings press release issued today, which is available on our website. I encourage you to visit our Investor Relations website at investor.modeln.com in order to access our second quarter fiscal 2023 press release, periodic SEC reports and the webcast replay of this call.

Finally, unless otherwise stated, all financial comparisons in this call will be to our fiscal year 2022 results. And with that, let me turn the call over to Jason.

Jason Blessing : Thank you, Carolyn, and welcome to our call today. I am pleased to report that our second quarter results beat expectations across the board. We exceeded guidance for total revenue, subscription revenue and professional services revenue. This was another strong quarter and underscores our commitment to driving profitable growth. Our Q2 SaaS metrics were also strong, driven by SaaS ARR, which grew by 40% year-over-year. In addition, our SaaS net dollar retention accelerated to 138% year-over-year. I am very proud of our team and the business model transformation that we are driving, especially in a difficult macro environment. Given this, I am often asked about the impact of the macro on our business, so I would like to proactively address this question.

First, we serve 2 resilient end markets with secular tailwinds, and Life Sciences in particular is a naturally defensive vertical in times of macro uncertainty. Second, we believe that companies in both verticals that we serve are prioritizing IT investments that deliver tangible ROI and help companies respond to dynamic operating environments, both of which played to Model N’s core value proposition. That said, during the quarter, we did see some customers applying more scrutiny to incremental spend, and in some cases, additional approvals were required to get deals done. Despite the challenging macro, our financial performance this quarter highlights our ability to execute while also delivering further margin expansion with adjusted EBITDA growing 39% year-over-year.

We remain focused on finishing our business model transition and driving long-term profitable growth. In fact, several of our newer solutions are resonating now more than ever given the focus on profitability and increasing complexity of pharma regulations. Next, I’d like to share some of the business highlights from the quarter. Success in Q2 was driven by a healthy contribution from all areas of the business. We signed new deals, closed another large SaaS transition, saw numerous customer expansions, and we also enjoyed solid renewals. Starting with SaaS transitions. During the quarter, we signed Takeda, the largest pharmaceutical company in Asia and one of the top 20 largest pharma companies in the world. Takeda’s decision to move to our SaaS solution was based on several factors, including the following: lower total cost of ownership; access to our automated testing suite, which helps customers validate a new Model N release; new regulatory updates, including those to support compliance with the Inflation Reduction Act; and access to over 30 new features that will drive immediate business improvements for Takeda.

Takeda is the latest example of a longtime customer that sees value in our cloud offering and is renewing their partnership with Model N to help them maintain commercial and regulatory compliance in an increasingly complex operational environment. During Q2, we also expanded our footprint at Amneal Pharmaceuticals, a global company that provides a broad portfolio of generic and specialty pharmaceuticals that make healthy possible. Amneal recently acquired AvKARE to boost its generic business in the U.S. As a part of the team’s operational efficiency initiative, Amneal deployed Model N to support the revenue management needs of AvKARE. This is the latest example of how Model N helps our customers execute on their business objectives, in this case, strategic M&A.

During the quarter, we also signed several meaningful expansion deals, including at strategic customers such as Novo Nordisk, J&J and BMS. Turning to Business Services. We expanded our relationship during the quarter with an existing customer, who is also a leading vaccine provider, to support their new go-to-market partnership with a top 10 global pharma company. These 2 companies required a solution that could be quickly deployed to validate membership eligibility for a new product launch. Model N worked closely with both companies to design the solution, leveraging Model N’s Business Services to support the integrated business process between the 2 companies. Our ability to work quickly with these customers in a creative way, leveraging our broad portfolio of solutions, demonstrates our ability to meet virtually any pharma revenue management use case.

Turning to High Tech. In Q2, we signed a new logo, u-blox, which is a Swiss-based fabless semiconductor company that develops some of the world’s leading IoT and satellite communication modules to support the industrial, automotive and consumer markets. u-blox is transitioning from a direct sales model to a channel sales network and needed a solution to enable them to manage their tremendous distribution partner growth. u-blox selected Model N for our industry-leading technology and expertise in delivering comprehensive deal and channel management solutions. With Model N, u-blox will be able to easily analyze key data sets like point-of-sale information so they can make more informed decisions on how to profitably manage their channel distribution business.

We also had several High Tech expansions in Q2. One example is at Micro Commercial Components, or MCC, which produces high-quality semiconductors for the consumer and industrial markets. MCC expanded their product footprint by adding channel data management to support the growing demand of their various sales channels. We also expanded our relationship with Nexperia, AMD and other High Tech customers in the quarter. Turning to professional services. Our team exceeded expectations with a very strong quarter. The results of our professional services organization symbolized the strong demand for our mission-critical high-ROI solution, especially in the current macro environment as companies seek to drive bottom line improvement. Our professional services team continues to do a terrific job of getting new customers live on time and on budget.

And 2 of the latest examples are Abbott Diagnostics and Edwards Lifesciences. Abbott Diagnostics is one of the early adopters of Model N in the med tech industry. This division of Abbott delivers diagnostic tests that are designed to increase accuracy and drive operational efficiencies. And if you’ve ever used a home COVID test over the last couple of years, it was most likely manufactured by Abbott. Abbott went live on our cloud platform, allowing their users across 9 countries to work from a centralized state-of-the-art revenue management platform. This project allowed Abbott to standardize their contracting approach, retire multiple customizations and dramatically increase system performance. Congratulations to Abbott and our professional services team on another critical milestone as we move all of our customers to the cloud.

Another important go-live in the quarter was at Edwards Lifesciences, a med tech company that specializes in artificial heart valves and other offerings to improve cardiovascular health. Edwards also went live on time and on budget and is taking advantage of several new enhancements to our product to enable them to more efficiently run their business and get their life-changing products to the world. With an eye towards future growth, we also continue to cultivate a partner ecosystem around Model N. A recent example of this is the new strategic partnership with Impartner, a leading provider of channel management technologies in the High Tech vertical. Under the terms of this new agreement, Model N and Impartner will bring to market an integrated offering of Model N’s current channel products with Impartner’s partner relationship management and partner marketing automation solutions.

This will enable high-tech companies to manage their partner relationships and accelerate revenue and profitability through their indirect sales channel. Also during Q2, a new study by Forrester Consulting revealed how improved channel data management leads to better collaboration and bottom line results. This study identified the need for improved channel data management solutions and highlights the importance of optimizing channel revenue within the semiconductor and electronic component manufacturing industries. Accurate channel revenue data is no longer a nice-to-have but instead is a strategic imperative in today’s economic climate. Successfully leveraging channel data management solutions enables suppliers to make informed decisions on partnerships, hiring, operations and more, which leads to higher productivity, profitability and overall business performance.

I encourage you to download this study from our website. Finally, in June, we will be holding Rainmaker, our 19th annual customer conference. I am excited to announce that this year’s event will be held in Nashville. Rainmaker is a great thought leadership event and educational conference focused on Life Sciences and High Tech and will bring together hundreds of executives and industry experts from around the world. I am looking forward to the event and especially looking forward to being back together in person with our customers and partners. Let me conclude by saying that I’m pleased with our continued execution in an uncertain macro environment. Our team takes our DARE core values very seriously, which stands for Dream, Align, Respect and Excel.

These values embrace building an inclusive workplace and a maniacal focus on customer success. Our reported Q2 results reflect this passion. And as we look ahead to the second half of the year, we will continue building a great company, delivering value to our customers, all while driving growth and improving profitability. With that, I’ll turn the call over to John to discuss our Q2 financial results and provide guidance for the second half of the year. John?

John Ederer : Thank you, Jason, and good afternoon to everyone on the call today. As Jason noted, we delivered very solid Q2 results that exceeded all of our guidance metrics. And I was particularly pleased by our profit performance as adjusted EBITDA grew 39% versus Q2 last year. The transformation of our business to a SaaS model has been the key driver of our overperformance on both the top and bottom line. We posted very strong SaaS ARR and SaaS net retention metrics again this quarter, and growth in SaaS revenue is now overcoming the declines in our maintenance stream to drive our overall subscription revenue higher. Looking specifically at our financial results for the second quarter. Total revenue grew 18% to $62.6 million, which exceeded the top end of our guidance.

Subscription revenue increased by 17% to $44.9 million and also exceeded the upper end of our guidance range. Lastly, professional services revenue grew by 18% to $17.7 million, which was well above the high end of our guidance as the team ran at a much higher-than-expected utilization rate. In terms of our profitability, please keep in mind that we’ll be discussing non-GAAP numbers, and a full reconciliation of our results is provided in our earnings release. For the second quarter, total non-GAAP gross profit was $37.8 million, representing a gross margin of 60.3% versus 59.8% in Q2 last year, an improvement of 52 basis points. Non-GAAP subscription gross margin was 68% compared to 66.8% in Q2 of the prior year as SaaS revenue increased as a percentage of total subscription revenue.

Non-GAAP professional services gross margin was 41% compared to 42% in Q2 last year. The higher-than-expected utilization in Q2 also drove overperformance on professional services margin. Looking ahead, we still expect professional service margins to normalize over the second half of the year and be in the mid- to high 30s range. Adjusted EBITDA for the quarter was $9.2 million, an increase of 39% from the second quarter of fiscal 2022 and well ahead of our guidance range. Adjusted EBITDA margin improved to 14.7% compared to 12.4% for the second quarter last year. Finally, non-GAAP net income was $8.6 million, an increase of 71% from Q2 of last year. And non-GAAP earnings per share was $0.22, which was $0.04 above the high end of our guidance.

As I mentioned earlier, our SaaS business is hitting critical mass and starting to drive our overall results. For Q2, our SaaS ARR reached $125.8 million, which was an increase of $35.9 million or 40% versus Q2 of last year. In addition, trailing 12-month SaaS net retention hit 138% in Q2, reflecting our ability to successfully cross-sell and upsell customers. Over the last year, our SaaS ARR growth rate has been accelerating from 17% in Q2 a year ago to 40% this quarter as we’ve been benefiting from SaaS transition activity. The cross-sell and upsell activity that occurs around SaaS transitions has also boosted our net retention number, and we have seen a similar acceleration of that metric over the last year. As we’ve noted on our last couple of earnings calls, SaaS revenue is increasing as a proportion of our total subscription revenue, and that trend continued in Q2 with SaaS revenue representing 69% of our total subscription revenue as compared to 66% in Q1 and 60% for fiscal 2022.

This mix shift is benefiting our overall subscription growth rate as well as our subscription gross margin. In terms of the balance sheet, we ended the second quarter with $270.6 million in cash and equivalents, which was up $95.4 million from Q1. During the quarter, we added $80.3 million in net proceeds from the refinancing of our convertible debt, and we also generated $12.1 million in cash flow from operations. Accounts receivable increased to $76 million, which was up $9.9 million sequentially versus Q1. The increase in accounts receivable was due to record-high invoicing as anniversary billings for several large SaaS transitions occurred during the quarter. Current deferred revenue of $70.8 million was up $3.7 million sequentially versus Q1 and up $13.3 million versus last year.

At a high level, we’ve been seeing increases in SaaS deferred revenue, partially offset by declines in maintenance deferred revenue. In addition to deferred revenue, we also focus on RPO, or remaining performance obligations, as an indicator of the future predictability of our business. For Q2, our total RPO was $338.4 million, which was up 19% on a year-over-year basis. The current portion of our RPO balance was up to $146.1 million, representing growth of 18% year-over-year. While the growth in our current RPO has remained consistent over the last couple of years, the growth rate of our total RPO has slowed and is now more in line with the current RPO. This is primarily due to SaaS transition deals over the last few years, which tend to be longer-term commitments and add extra years to the total contract value reflected in our total RPO for previous periods.

Looking ahead to our guidance for the remainder of the year. Our outlook reflects the uncertainty in the macro environment, which we feel is prudent. We also had an unprecedented customer bankruptcy that will be a small headwind to subscription growth over the second half of the year. In summary, for Q3, we expect total revenue to be in the range of $61.5 million to $62.5 million, with subscription revenue in the range of $45 million to $45.5 million and professional services revenue in the range of $16.5 million to $17 million. We expect adjusted EBITDA to be in the range of $9.5 million to $10.5 million. And for non-GAAP earnings per share, we expect a range of $0.23 to $0.25 per share based on a fully diluted share count of approximately 38.9 million shares.

For the full year of fiscal 2023, we are raising our outlook for total revenue and adjusted EBITDA, reflecting the strong performance in Q2. For subscription revenue, we are tightening the range and increasing the bottom end of our guidance. In summary, for fiscal ’23, we expect total revenue to be in the range of $244 million to $246 million, with subscription revenue in the range of $180 million to $181 million and professional services revenue to be in the range of $64 million to $65 million. We expect adjusted EBITDA to be in the range of $39 million to $41 million and non-GAAP EPS to be in the range of $0.94 to $0.99 per share based on a fully diluted share count of approximately 38.9 million shares. Some additional context regarding our guidance for the remainder of the fiscal year.

First, our guidance reflects the ongoing transition of our business model, which is driving strong SaaS ARR growth but partially offset by steeper declines in maintenance revenue. We continue to expect maintenance revenue to decline by 30% or more in fiscal 2023. Second, while we do not provide specific guidance on SaaS ARR, as we’ve discussed on our last several calls, we expect more moderated growth in Q3 and Q4 as the year-over-year comparisons get increasingly more difficult. We still expect SaaS ARR growth to be above our long-term target of 20% but below the elevated levels that we have seen over the last few quarters due to SaaS transitions. Third, our non-GAAP results for the first half of the year and our outlook reflect the impact of the refinancing of our convertible debt in the second quarter, including adjustments to our accounting treatment of the convertible debt.

More specifically, we have elected to settle both the new 2028 notes and what remains of the 2025 notes using the combination settlement method. To give you a consistent view for your models, we have provided an updated version of our EPS calculation and shares outstanding for Q1 that is consistent with our Q2 report and our outlook for the remainder of the year. You can find this table in the supplemental IR deck that is posted on our website. In summary, we’re very pleased with our execution in Q2 and believe that we are on track for the year. We continue to build strong momentum in our SaaS business, as evidenced by our SaaS ARR growth and our SaaS net retention, and we remain committed to continued improvement on profitability. With that, I’ll turn the call over to the operator for any questions.

Operator?

Q&A Session

Operator: [Operator Instructions] Our first question comes from Joe Vruwink with Baird.

Operator: Our next question comes from Craig Hettenbach with Morgan Stanley.

Operator: Our next question comes from Nick Mattiacci with Craig-Hallum Group.

Operator: Next question comes from Ryan MacDonald with Needham.

Operator: Our next question comes from Matt VanVliet with BTIG.

Operator: Our next question comes from Joe Meares with Truist Securities.

Operator: [Operator Instructions] Our next question comes from Rishi Jaluria with RBC.

Operator: Our next question comes from Brian Peterson with Raymond James.

Operator: There are no further questions at this time. I would like to turn the floor back over to CEO Jason Blessing for closing remarks.

Jason Blessing : Well, thank you, operator, and I’d like to thank everyone for joining today. We appreciate all of the engaged questions as well as your support. And once again, I’d also like to thank all of our employees, customers and partners for supporting us and partnering with us to drive another strong quarter. So thanks again, and have a great night.

Operator: Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.