Simulations Plus, Inc. (NASDAQ:SLP) Q1 2023 Earnings Call Transcript

Simulations Plus, Inc. (NASDAQ:SLP) Q1 2023 Earnings Call Transcript January 4, 2023

Simulations Plus, Inc. misses on earnings expectations. Reported EPS is $0.06 EPS, expectations were $0.09.

Operator: Greetings, and welcome to the Simulations Plus First Quarter Fiscal 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brian Siegel, from Hayden IR. Thank you. Mr. Siegel, you may begin.

Brian Siegel: Good afternoon, everyone. Welcome to our first quarter fiscal 2023 financial results conference call. With me today is our CEO, Shawn O’Connor; and CFO, Will Frederick. After their portion of the call, we will open the floor to questions. Before we begin, I want to remind everyone that except for historical information, the matters discussed in this presentation are forward-looking statements that involve a number of risks and uncertainties. Words like believe, expect and anticipate mean that these are our best estimates as of this writing, but that there can be no assurances that expected or anticipated results or events will actually take place. So our actual future results could differ significantly from those statements.

Factors that could cause or contribute to such differences include, but are not limited to, our ability to maintain our competitive advantages, acceptance of new software and improved versions of our existing software by our customers, the general economics of the pharmaceutical industry, our ability to finance growth, our ability to continue to attract and retain highly qualified technical staff, our ability to identify and close acquisitions on terms favorable to the Company, market conditions, our ability to identify and enter into a definitive agreement with a broker to administer the share repurchase program authorized by our Board in a sustainable market. Further information on our risk factors is contained in our quarterly and annual reports and filed with the U.S. Securities and Exchange Commission.

With that said, I would like to turn the call over to Shawn O’Connor. Shawn?

Shawn O’Connor: Thank you, Brian. Happy New Year, everyone, and thank you for joining us on our first quarter conference call. This afternoon, we reported first quarter results in line with our fiscal ’23 guidance for both revenue and profitability. First quarter revenue was approximately $12 million, down about 4% year-over-year and in line with the expected changes in seasonality we discussed on our last earnings call. As a reminder, the reason for the change in seasonality relates to deliberate changes we made to simplify our software renewal process by aligning customer renewals across groups and products within each customer. Years of acquisitions, new product introductions and penetration into multiple groups within multiple products within individual customers drove these changes.

For the first quarter, EPS was $0.06, and our adjusted EBITDA margin was 25%. As anticipated in our guidance, investment in employee growth, retention and recruiting impacted our operating leverage and will continue to do so throughout fiscal ’23. This impact is reflected in our first quarter results just proportionately as it is now our seasonally lowest revenue quarter. Finally, we are also currently seeing a change in behavior at some new and existing customers with new sales and upsells aligning to early calendar 2023 budgets. These near-term changes as a whole do not change our outlook for our business in fiscal ’23 and beyond. Modeling and simulation tools have become a key component of the drug development workflow and we expect continued growth.

The first quarter was highlighted by significant achievements in support of our clients in both our software and service businesses. We were recently awarded two new FDA grants developing and validating novel model approaches for local gastrointestinal and pulmonary delivery routes. These newly funded awards achieve a significant objective for us as we will now be partnering with the FDA to provide validated, innovative solutions for all major dosing routes around the body. There are a few, if any, organizations that have six funded partnerships with the leading global health authority entering 2023 like Simulations Plus. A large pharmaceutical company utilized GastroPlus to perform virtual bioequivalence trial simulations, assess potential pH-dependent drug-drug interactions and justify product specifications for their new tablet formulation of CALQUENCE with the aim to offer physicians and patients increased flexibility when devising treatment plans.

The results were used to inform regulatory decisions and accelerate approval. A large pharmaceutical company, in partnership with the experts at Simulations Plus, developed GastroPlus models to evaluate the impact of meal contents and intake timing on drug exposure for new dosing regimens of Trulia with the aim to increase patient compliance and tolerance. The results were used to inform regulatory decisions and accelerate approval. We are wrapping up a project with a top 20 pharma client on a major clinical trial optimization effort. In a scenario with significant recruitment and endpoint selection challenges, the client uses our QSP disease modeling tools to pick the correct patient population and the endpoint for efficacy. Regulators are being approached now with the results.

We are targeting more projects like these where we provide end-to-end program directives. And in fact, we already have another similar program in the works. In another project with a top 20 pharma client, we completed the general analysis of the target mechanism of action in NASH with our NAFLDsym software, allowing them to reprioritize in-house assets in their pipeline. This will bring cost savings and efficiencies for the client and has led to more work to come with the client. For a midsized pharma client, DILIsym identified the mechanism for a clinically known liver safety issue and help them pick the correct dosing range to take forward safely. An investment firm that takes equity positions in publicly traded clinical-stage life science companies hired us for a rapid turnaround project.

The goal was to predict a clinical trial outcome using only publicly available information for one of their holdings before it made a public announcement. After running simulations, our prediction suggested positive results from the trial. The investment firm then significantly increased its position in this company ahead of the public release of the trial results, which came approximately two weeks later. The results were positive as our science predicted and the stock price increased 4x to 5x post announcement. The investment company has already approached us for additional projects in other therapeutic areas where they’d like to invest. The experts at Simulations Plus supported a small biotech company in their pursuit of a therapy to treat inflammatory bowel disease.

The first-in-human simulations projecting local concentrations within the gut were included in the Company’s pre-IND briefing book and will be provided to regulatory agencies to support dose selection for the upcoming first-in-human studies. These highlights demonstrate the numerous means in which we assist our clients in optimizing their drug development strategies, utilizing model-informed drug development approaches and the ever expanding use cases for the application of modeling and simulation techniques across the drug development cycle. Moving to our software business. Revenues were down 17% in the quarter due to our change in renewal strategy. As we said last quarter, we took deliberate actions to align software renewal timing for our customers, which we expected to impact our first quarter revenue seasonality while boosting our second through fourth quarter results.

Also, as expected, we’re seeing some new sales push into our second quarter to align with customers’ new calendar year budgets. The renewal patterns are progressing as expected, and we added 15 new customers across the portfolio during the quarter and saw continued strength in our cross-selling strategy with 15 upsells. While GastroPlus was hit hardest in the quarter by the renewal alignment with revenue down 24%, we still added one new customer, made eight upsells to existing customers and saw 14 peer-reviewed published journal articles. These are all encouraging data points given the shifts in customer budgetary timing for new sales and renewals. MonolixSuite revenue declined 1% in the quarter due to the renewal alignments and foreign exchange impact.

However, we added two new customers and made two upsells to existing customers during the quarter. ADMET Predictor revenue declined 25% in the first quarter reflecting timing adjustments in our renewal strategy. Despite this, we added four new commercial customers and made five upsells to existing customers in the quarter. Our University+ program continued to grow and now represents 266 licenses in 54 countries. This program integrates our software into educational facilities and makes it part of advanced curriculum while seeding the market of next-generation modeling and simulation professionals to drive future demand. Positive growth momentum in our service business continued in the first quarter with 17% revenue growth and backlog growth to $15.8 million.

Operationally, we added five consultants to our team, which we expect will help convert backlog to revenue in the coming quarters. Finally, we enjoyed a successful fall conference season and continued to expand our virtual workshop programs. PKPD revenue increased 23% this quarter. We experienced a shift to higher-margin time and materials contracts from fixed-price projects, which contributed to expanding our service and profit margins. QSP/QST revenue decreased 28% for the quarter due to the more volatile nature of these high-dollar value longer lifestyle projects. PBPK revenue increased 74% for the quarter, reflecting the deeper implementation of PBPK modeling, including an overall expansion of use cases and higher perceived value and impact.

As you saw in our press release, we have an evolving capital allocation strategy that I would like to briefly outline. We have three areas of focus: corporate development, which drives inorganic growth; internal investment, which drives organic growth; and finally, returning capital to shareholders. Internal investment remains a top priority as it drives our expected 10% to 15% CAGR for organic growth over the next several years. Most important is our investment in R&D to expand our product functionality and new offerings that maintain our technological leadership in modeling and simulation and support organic growth. In addition to revenue growth, our goal is to increase efficiencies and drive operating leverage in our cost structure. While operating leverage is expected to decline in fiscal 2023, longer term, we expect scientific employee retention programs and strategic hires we made, combined with selective headcount growth in sales and marketing will continue to drive revenue growth and operating leverage as experienced historically.

Internal technology is also part of the equation as we enhance our systems to drive further efficiencies across the Company. Next, we have evolved our inorganic growth strategy beyond M&A to a broader corporate development focus. In August 2020, we sold 2.1 million shares at $55 per share for net proceeds of $108 million for M&A purposes. Since this offering, we identified more than 60 potential candidates that initially met the Board’s M&A criteria, which includes strategic and cultural fit, immediate EPS accretion, revenue synergies and attractive valuations. We engaged in various levels of discussion with all of these candidates, but we have not as yet closed any deals. This does not mean we’ve exhausted all options. We expect many of these discussions to continue, but we have nothing to disclose at this time.

While acquisitions will remain a top priority for inorganic growth in light of the evolving market conditions, we will expand our corporate development strategy to allow for strategic investments and building strategic partnerships with companies that could lead to potential future financial upside. This change will enable Simulations Plus to cast a wider net of relevant companies previously screened out or allow us to gain access to leading-edge trends and technology in biosimulation or adjacent markets. Finally, with regard to returning capital to our shareholders, the Board approved a $50 million buyback program. Given our current cash position and free cash flow accumulated since the offering in 2022, we believe we can still execute corporate development initiatives while offsetting a portion of the dilution from the 2020 capital raise.

We believe that this evolving strategy optimizes the combination of organic growth, operating leverage, inorganic growth and return on investment to our shareholders. Looking to the remainder of fiscal 2023, we remain confident in achieving the guidance we provided last quarter. As a reminder, our full year revenue target is 10% to 15% organic growth, which translates to $59.3 million to $62 million. As we said last quarter, we will continue investing in our people while selectively adding headcount in certain areas to support our long-term growth targets. This means fiscal 2023 will be a transition year for our cost structure leading to lower margins and restraining EPS and EBITDA growth. We believe these actions are prudent and will benefit our longer-term revenue growth while returning to a model with strong operating leverage.

We expect to achieve diluted earnings per share of $0.63 to $0.67, which translates to 5% to 10% growth. Let me now turn the call to Will to discuss the financial results.

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Will Frederick: Thank you, Shawn. Total revenue declined 4% in the quarter, comprised of a 17% decline in software and 17% services growth. Total revenue decline was approximately 1% on a constant currency basis. Software represented 51% of revenue during the quarter. Gross margin was flat year-over-year at 78%, reflecting the lower software mix, offset by higher services margins. Software gross margin decreased to 85% due to the lower revenue and foreign exchange rate headwinds. Services margin increased to 70% due to a higher bill rate this quarter. For the first quarter, GastroPlus represented 50% of software revenue, MonolixSuite was 26%, ADMET Predictor was 18% and other software was 6%. For the quarter, our customer renewal rate was 82% based on accounts and 90% based on fees.

These lower rates reflect the renewal timing changes Shawn mentioned, the impact of FX rates for our EMEA and Asia Pac customers as well as some of our smaller biotech customers not renewing their licenses. Generally, the smaller customer non-renewals are offset with our price increases for larger customers as reflected in the higher fee-based renewal rates. The decline in average revenue per customer is reflective of the new smaller biotech companies that we’re adding as new customers as well as the seasonality of our software business. We expect quarterly comparisons to prior periods to fluctuate throughout the fiscal year with our new seasonal expectations. Shifting to our services business. Our first quarter services revenue breakdown was 49% from PKPD services, 18% from QSP/QST services, 25% from PBPK services and 8% from other services.

Other services consist primarily of regulatory services we provide our customers to help them meet global regulatory compliance and quality requirements. We also provide comprehensive learning services focused on modeling and simulation training with a variety of options to help our customers succeed. Regarding key services metrics, total services projects worked on during the quarter increased 14% this quarter compared to last year and backlog increased by approximately $1 million from last year to nearly $16 million. Now turning to our consolidated income statement for the quarter. Total R&D costs for the quarter were $2.1 million or 17% of revenue compared to $1.7 million or 14% of revenue last fiscal year. R&D expenses for the quarter were $1.2 million or 10% of revenue compared to $0.9 million or 7% of revenue last year.

Capitalized R&D for the quarter was $0.9 million or 7% of revenue compared to $0.8 million, also 7% of revenue in the same period last year. SG&A expense for the quarter was $7.2 million or 61% of revenue compared to $5 million or 40% of revenue last year. Scientific headcount and compensation increases were the most significant driver of this increase. Income from operations was $0.9 million, while operating margin was 7%. Q1 revenue is now our lowest revenue quarter for the fiscal year, which impacts our profitability with relatively fixed payroll expenses. As quarterly revenue increases through the end of the fiscal year, the corresponding profitability will improve each quarter toward the level provided in our fiscal year guidance. Interest and other income was $0.7 million this quarter versus $0.1 million last year.

This reflects stronger returns from higher interest rates on our investment portfolio balance. Income tax expense was $0.4 million compared to $0.8 million last year, reflecting an effective tax rate this year of 23% compared to 22% last year. The first quarter typically has the highest effective tax rate since the annual tax expense for our France division is included. We still expect our effective tax rate for fiscal 2023 to be closer to 20%. Q1 net income was $1.2 million and diluted earnings per share was $0.06. The revenue impact for the quarter from foreign currency exchange was $290,000 and expenses related to M&A during the quarter were $345,000 for a total of $635,000 or about $0.03 diluted earnings per share. Adjusted EBITDA for the quarter was $3 million, and adjusted EBITDA margin was 25% compared to adjusted EBITDA of $5.3 million or 42% margin last year.

As a reminder, we calculate adjusted EBITDA by adding back stock-based compensation expenses and expenses related to M&A or other noncash non-operating expenses. We provide a reconciliation of this non-GAAP metric to net income, the relevant GAAP metric in our earnings release and on our website. We ended the quarter with cash and short-term investments of $132 million and no debt. We believe we are well capitalized with sufficient cash to support our capital allocation initiatives. Accordingly, the Board has authorized a share repurchase program to repurchase up to $50 million of outstanding common shares as part of our ongoing commitment to drive shareholder value. We intend to enter into an accelerated share repurchase transaction during the second quarter for the repurchase of $20 million of our outstanding common shares.

We believe the remaining funds on hand plus our free cash flow will be sufficient to continue our pursuit of strategic acquisitions and investments. Now I’d like to provide some further commentary on our fiscal 2023 guidance with the expected changes in quarterly seasonality this fiscal year. First, we expect our second quarter revenue growth rate to be between 7% to 11% compared to last fiscal year. As we mentioned before, Q2 through Q4 revenue should be more evenly distributed for the remainder of the fiscal year compared to prior years. This should result in the largest quarterly growth rate occurring in Q4 compared to last fiscal year. Second, I’d like to reemphasize the generally fixed nature of our cost and expenses, primarily related to employee compensation and total rewards.

Total costs and expenses are calculated by adding cost to revenue plus R&D expense plus SG&A expense. While the allocation of costs and expenses amongst these three categories is largely driven by the type of work our employees perform each quarter, the total amount is expected to increase as we add headcount or increase employee-related costs, offset by the amount of capitalized R&D performed each quarter. Third, even though our total costs may result in fluctuations each quarter as a percentage of revenue, we still expect to see the same annual trends we mentioned in our last earnings call for fiscal ’23. Specifically, increasing software and services gross margins for the fiscal year compared to last year, R&D expense as a percentage of revenue for the fiscal year in the range of 6% to 8%, operating expense as a percentage of revenue for the fiscal year in the mid-50s and an effective tax rate for the fiscal year of approximately 20% plus any additional impact from the new excise tax on stock buybacks, depending on the actual timing of the repurchases.

Fourth, we saw an increase in interest income this quarter compared to last year as interest rates have gone up substantially since then. We expect interest income for the remainder of the fiscal year will be impacted by four things. One, interest rate changes during the rest of the year; two, the $20 million accelerated share repurchase we expect to fund this quarter; three, the actual timing of share repurchases during the fiscal year for the remaining $30 million of the repurchase program; and four, the timing and amount of any strategic acquisitions or investments that we make during the fiscal year. Finally, we expect diluted earnings per share for the second quarter to be between $0.17 to $0.19. Accordingly, diluted earnings per share for the second half of the year is anticipated to be between $0.40 to $0.42 to achieve our fiscal year guidance target of $0.63 to $0.67.

We hope this additional commentary helps communicate our expectations for quarterly year-over-year trend comparisons with the shift changes this fiscal year. As previously mentioned, we do not expect these quarterly shifts to have an impact on our fiscal year performance and annual trends. I’ll now turn the call back to you, Shawn.

Shawn O’Connor: Thank you, Will. This quarter unfolded as we expected. The adjustments we are making to our business, including hiring scientists, and expanding our sales and marketing organization, while adjusting renewal timing to facilitate cross-selling are driving the intended results. While these changes impacted our consolidated results in the first quarter, we’re confident we will achieve our full year outlook. I’m proud that we continue to deliver on our commitment to science, driving greater adoption of in silico tools to accelerate innovation and reduce costs. We are investing in internal R&D efforts to maintain and grow our leadership position and our increased scale enables us to expand our industry collaborations.

We continue expanding our strong global regulatory relationships and now have multiple FDA technology development collaborations. Thank you for your time and attention. And I will now turn the call over to the operator for the question-and-answer session.

Q&A Session

Operator: Thank you. Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. Our first question comes from the line of Matt Hewitt with Craig-Hallum. Please proceed with your question.

Matt Hewitt: Maybe a couple. First, on the renewal side, last quarter, when you talked about the shift in strategy as far as allowing your customers to kind of line up the renewals across suites and products and then there was also the piece that was tied to budgets and the shift to the January budgets for your customers. Is there any way to kind of break out or look at that second piece as far as the budgetary aspect of it? And maybe talk a little bit about what you’re seeing so far here through this quarter — through Q2, which includes January and what you’re seeing? I realize it’s very early days, but what are you hearing from customers from the budgetary standpoint?

Shawn O’Connor: A fair question, Matt, I don’t know that we can quantify the split between the two, but there’s always been a phenomenon in the industry in terms of spend budget for this year as we get to November, December where we lose it and then waiting for new budgets, new dollars to be available after the first of the year and the new budget year. I think what we experienced or saw is a handful of deals that were potential deals that might have occurred before the end of the calendar year, that in these situations, we’ve not lost those opportunities. Those opportunities were earmarked for spending by our clients in the new calendar budgets after the first of the year. I’ll check with the team. I’m not sure by January 4, we’ve cut some closed this yet, but we anticipate that they will now come through this year.

And on the other side, we saw a lot more conservativeness on the part of our clients in terms of not spending out excess dollars in their budget ahead of time before the end of the year, like we’ve seen sometimes in the past. So a handful of deals in that side of the ledger that got pushed off or delayed into the second quarter. And then on the other side, on the renewal side, pretty good visibility out to the renewal activity of our clients and the changes that we’re making to line them up, and that was pretty anticipated. Expectations for the quarter came in exactly where we thought they would.

Matt Hewitt: That’s great. And then shifting gears a little bit, the $50 million share repurchase program that makes complete sense. But you’re also implementing a little bit of a shift in your strategy as far as looking for more or the possibility for some strategic investments or partnerships. Help us, what are you thinking along those lines? I mean is this a $10 million investment into a software company? Or what could that look like? And more importantly, I guess, from a shareholder perspective, how would that investment flow back to your shareholders?

Shawn O’Connor: Sure. Fair question. First, I’d highlight that the acquisition effort is still number one focused here. And while we’ve all been a little frustrated in terms of the speed to closure, there are a number of good candidates that are still in discussions, and we hope that those will continue and come to fruition at some point in the future. The strategic investment opportunity sort of expands with the same objective, same objective of finding good technology fits that open up TAM, open up market for us in an inorganic way going forward, same objective with the strategic investments. So we find a lot of technology players out there and the marketplace aren’t really entities that are ready for acquisition amongst the criteria that we listed off, be it accretion or valuation expectations for some, not start-up, but early-stage companies.

And our opportunity there is to partner with them. The company has a rich history of collaboration, those collaborations that we do time and time again with our large pharma clients, collaborations that we do with the FDA whereby we work with a partner. And that effort results in technological advancement that finds its way into our product suite. And with some of the opportunities out there that might not be today ripe for acquisition, there’s opportunity to, in a lesser dollar point to make a strategic investment in a partnership that allows for some technology sharing and some development of our products or it could be go-to-market strategies, along with that entity that open up opportunities for us. The payback in the end is the same payback from an acquisition, an opening up of a market and enhancements of our existing products that delivers a larger TAM and larger opportunity for us in the long run.