Simulations Plus, Inc. (NASDAQ:SLP) Q2 2023 Earnings Call Transcript

Simulations Plus, Inc. (NASDAQ:SLP) Q2 2023 Earnings Call Transcript April 5, 2023

Operator: Greetings, and welcome to the Simulations Plus Second 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 Brian Siegel from Hayden IR. Thank you. Mr. Siegel, you may begin.

Brian Siegel: Good afternoon, everyone. Welcome to our second quarter fiscal 2023 financial results conference call. With me today is our CEO, Shawn O’Connor; and our 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 risks and uncertainties. Words like believe, expect and anticipate refer to our best estimates as of this call, and there can be no assurances that we will — that these will actually take place. So our actual future results could differ significantly from these statements. Further information on the company’s risk factors is contained in the company’s quarterly and annual reports and filed with the U.S. SEC. With that said, I would like to turn the call over to Shawn O’Connor. Shawn?

Shawn O’Connor: Thank you, Brian, and thank you all for joining us on our second quarter conference call. This was a solid quarter for Simulations Plus. Second quarter revenue grew 6% year-over-year. Our software business grew 7%, generally in line with expectations reflecting the changes we proactively made in our renewal program and the service business grew by 4% year-over-year, highlighted by the PKPD and PBPK offerings. From a profitability perspective, we maintained solid margins and saw improvement over the first quarter as revenues grew, leading to $4.2 million of net income, or $0.20 per diluted share. This result exceeded our guidance for the quarter. We continue to successfully navigate a challenging economy and its impact on our sales cycle.

Drug developers are delaying purchases and elongating the sales cycle. For the most part, we have not lost opportunities, but this did impact our growth in the second quarter. I reiterate that we’ve taken this into account when preparing our 2023 full year outlook. Second quarter was highlighted by significant collaborative work with both partners and in support of our clients. To begin with, we have in the last month announced two collaborations involving our artificial intelligence machine learning technologies. Both the Institute of Medical Biology of the Polish Academy of Sciences and Sino-American Cancer Foundation partnerships will leverage our expertise in AI machine learning technologies to help with the discovery of novel molecules against two different emerging cancer targets.

The computational and medicinal chemists in our early drug discovery services team will work with them to utilize the cutting edge AIDD technology in our ADMET Predictor software platform to accelerate the design and optimization of novel lead molecules. Our primary objective in these collaborations is to demonstrate the value of our AI machine learning technology and the capabilities of our drug discovery team in support of our software licensing and consulting service practice and in our market growth in these two areas. In addition, both collaborations do provide for incremental benefits of joint compound ownership, or milestone payments if successful. We’re very excited about these opportunities — the opportunities these two collaborations represent.

We entered into a new pKa collaboration with a large agrochemical company extending machine learning models into a new and different space and broadening our addressable market. Our team will use the partner company’s proprietary measurements drawn from its vast internal databases to build and refine a predictive model that can accurately predict the pKa values of various chemical compounds. Additionally, we will create and evaluate new algorithms and techniques to further enhance the predictive capabilities of the model. We also submitted four FDA grant applications, one for ocular PBPK, another for lipid-based formulations, and finally PBPK precision dosing and virtual BE workflows. Our relationship in collaborations with the FDA to extend modeling functionalities have always been a strength for Simulations Plus.

A global biopharmaceutical company strategically partnered with us to apply GastroPlus PBPK modeling for their biosimilars project. Preclinical and clinical PBPK models are developed for the reference antibody injectable formulation and applied to predict bioequivalence for the prototype test formulations in development. The simulation results help the company decide on the final formulation to advance into the pivotal study and minimize the risk of a failed outcome. Applications of GastroPlus in the biologics and biosimilars market is an emerging opportunity for us. A clinical stage precision medicine company outsourced GastroPlus PBPK modeling support to our experts for the lead and backup compounds with the simulation results in forming their clinical candidate selection, and the upcoming first in human study designs for their IND filing.

The confidence our partner obtained from these activities helped convince them to onboard the software for use internally across their entire pipeline. This quarter Simulation Plus’s service team provided pharmacometric modeling in simulation support for multiple high profile regulatory submissions, including one compound offering novel treatment for a rare genetic disease and two other compounds considered to be among the most anticipated drug launches in 2023. Finally, we expanded our growing opportunity as a consultant for investors, successfully selling our services for another even larger QSP project to provide insight to an investment group looking to invest in public private companies. This follows the successful NAFLDsym project last quarter.

Our ability to utilize public data and information to help investors make an informed decision is creating a new opportunity for us. These highlights demonstrate the numerous ways we assist our clients utilizing model informed drug development approaches. Moving to our software business. Revenues were up 7% in the quarter. As we had previously stated, we’re taking deliberate actions with our software customers to align software renewal timing, which we expect to impact our first quarter revenue seasonality, with our second through fourth quarter revenues being more evenly dispersed in absolute dollars. This trend line and new seasonality pattern was evident in the second fiscal quarter. We believe the renewal harmonization initiative is having the expected results of efficiency for ourselves and our customers and should be completed during the fiscal year.

Quarterly software revenue growth rates are being impacted by this change in seasonality, we anticipate its impact on year-over-year software revenue growth to be minimal, and it’s contemplated in our guidance. Our sales cycle is being impacted by economic concerns, as sales to several potential new clients were pushed out but not lost. We also had several smaller biotechs not renewed due to cost containment measures, implemented more dramatically in this market segment and the economic headwinds that are impacting funding for that part of the market. At the same time, we are achieving success in rolling out price increases reflective of our increased costs, which somewhat offset slower new sales cycle and contribute to higher gross margins and higher average revenue per account.

Photo by Hans Reniers on Unsplash

GastroPlus was hit hardest in the first quarter by renewal alignment. But as expected, it rebounded nicely with 18% growth in the second quarter. We added six new customers, including business sourced in China. Of note, we brought a brand new distributor on in Brazil, which booked its first sale during the quarter. We also made six upsells to existing customers and saw 25 peer reviewed published journal articles. These are all positive data points. MonolixSuite revenue declined 8% in the quarter due mostly to the software harmonization process, and foreign exchange impact. However, we added five new customers and made six upsells to existing customers during the quarter and feel good about returning to growth over the next few quarters. ADMET Predictor which received the largest impact from the loss of the small biotech customers saw revenue decline of 2% in the second quarter.

Despite this, we added one new commercial customer and made eight upsells to existing customers in the core. Our University+ program continued to grow and now represents 278 licenses in 54 countries. The program integrates our software and educational facilities and makes it part of advanced curriculum while exceeding the market of next generation modeling and simulation professionals to drive future growth. Momentum in our services business continued in the second quarter with 4% revenue growth and backlog growth to $15.4 million. Operationally, we hired two consultants adding to the five we hired in the first quarter. And we believe these professionals will help convert backlog to revenue in the coming quarters. We performed 188 projects during the quarter.

PKPD revenue increased 19% this quarter. We continue to experience a shift to higher margin time and material contracts from fixed price projects, which contributed to expanding our services gross margins. QSP/QST decreased 32% for the quarter, due to the more volatile nature of these high dollar value — excuse me, longer life cycle projects. As a reminder, in the second quarter last year, we had significant CRO pass through revenue, creating a challenging comparison for this business. PBPK revenue increased 29% for the quarter, reflecting the deeper implementation of PBPK modeling, including an overall expansion of use cases and higher perceived value impact. As we discussed last quarter, we evolved our capital allocation strategy, including the implementation of an accelerated share repurchase program, which began in January, and an ongoing cash dividends.

As a reminder, we have three areas of focus: first, internal investment, which drives organic growth. Second is corporate development, which drives in organic growth and finally returns capital to shareholders. With regard to return of capital to shareholders, the Board approved a $50 million buyback program. Given our current cash position and free cash flow, we believe we can still execute the corporate development initiatives, while offsetting a portion of the dilution from the 2020 capital raise. We initiated the share repurchase program with a $20 million ASR, which is currently being affected with an anticipated conclusion in the third quarter. Looking to the remainder of fiscal 2023, we maintain the guidance we provided at the beginning of our fiscal year.

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 proven and will benefit our long-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 turn to Will to discuss the financial result.

Will Frederick: Thank you, Shawn. Total revenue increased 6% for the quarter comprised of 7% software growth and 4% services growth. Software represented 67% of revenue during the quarter. Total revenue increased 2% year-to-date comprised of a 3% decrease in software revenue and 11% services growth. Software represented 60% of revenue during the year. Gross margin for the quarter improved year-over-year to 83% reflecting the higher software mix and improved services margins. Software gross margin remained flat at 92% and services margin increased to 66% compared to last year, due to increased pricing and improved utilization. Gross margin year-to-date improved year-over-year to 81%, reflecting improved services margins. Software gross margin decreased slightly to 90%.

And services margin increased to 68%. For the quarter GastroPlus represented 55% of software revenue, MonolixSuite X suite was 20%. ADMET Predictor was 18% and other software was 7%. Year-to-date, GastroPlus represented 53% of software revenue. MonolixSuite was 22%, ADMET Predictor was 18% and other software was 7%. For the quarter, our customer renewal rate was 94% based on fees and 80% based on accounts. These lower rates reflect the renewal timing changes Shawn mentioned, as well as the impact from smaller biotech customer non-renewals. Generally, the smaller customer non-renewals were offset with our price increases as reflected in the higher fee based renewal rates. The increase in average revenue per customer is reflective of the higher prices combined with the loss of smaller biotech companies, 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. Year-to-date, our customer renewal rate was 93% based on fees and 81% based on accounts. Average revenue per customer increased to $103,000. Shipped into our services business, the services revenue breakdown for the quarter was 50% from PKPD services, 20% from QSP/QST services, 23% from PBPK services, and 7% from other services. The services revenue breakdown year-to-date was 49%, from PKPD services, 19% from QSP/QST services, 24% 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. Total services projects worked on during the quarter decreased 6% compared to last year, and backlog decreased by approximately $2 million from last year to approximately $15 million. The decreases are primarily due to the QSP/QST services business. Turning to our consolidated income statement for the quarter. Total R&D costs were $2.1 million, or 14% of revenue compared to $1.6 million, or 11% of revenue last year. R&D expenses were $1.3 million or 8% of revenue compared $0.9 million or 6% of revenue last year. Capitalized R&D was $0.8 million or 5% of revenue compared to $0.7 million, also 5% of revenue last year.

SG&A expense was $7.8 million, or 49% of revenue, compared to $5.6 million, or 38% of revenue last year. Scientific headcount and compensation increases were the most significant driver of this increase. Income from operations decreased 26% to $4 million, while operating margin was 26 compared — 26% compared to 37% last year. Interest in other income was $1 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 $0.9 million compared to $1.1 million last year, reflecting an effective tax rate of 18% this year, compared to 20% last year. Net income decreased 5% to $4.2 million, and diluted earnings per share decreased to $0.20. The revenue impact for the quarter from foreign currency exchange was $0.2 million and expenses related to M&A during the quarter were $0.1 million.

For a total of $0.3 million or about $0.01 in diluted earnings per share. Adjusted EBITDA was $6.2 million and adjusted EBITDA margin was 40% compared to adjusted EBITDA of $7.2 million or 48% 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 non cash 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. Turning to our consolidated income statement. Year-to-date, total R&D costs were $4.2 million, or 15% of revenue compared to $3.3 million or 12% of revenue last year. R&D expenses were $2.5 million, or 9% of revenue compared to $1.8 million or 7% of revenue last year.

Capitalized R&D was $1.7 million or 6% of revenue compared to $1.5 million also 6% of revenue last year. SG&A expense was $15 million, or 54% of revenue, compared to $10.6 million, or 39% of revenue last year. Income from operations decreased 47% to $4.9 million, while operating margin was 18% compared to 34% last year. Interest and other income was $1.8 million versus $0.1 million last year. Income tax expense was $1.3 million compared to $2 million last year, reflecting an effective tax rate of 19% this year, compared to 21% last year. We expect our effective tax rate for the fiscal year to be in the range of 19% to 20%. Net income decreased 27% to $5.4 million and diluted earnings per share decreased to $0.26. The revenue impact year-to-date from foreign currency exchange was $0.5 million.

And expenses related to M&A during the year were $0.4 million for a total of $0.9 million or about $0.04 in diluted earnings per share. Adjusted EBITDA was $9.2 million and adjusted EBITDA margin was 33% compared to adjusted EBITDA of $12.4 million, or 46% margin last year. We ended the quarter with cash and short-term investments of $115 million and no debt. During the quarter, we paid Morgan Stanley $20 million under our accelerated stock repurchase agreement and received an initial delivery of 408,685 shares of our common stock. These shares were retired and are treated as authorized and issued shares. The final number of shares to be repurchased will be based on the volume weighted average price of our common stock during the term of the ASR agreement, less than discount and subject to adjustments.

The final settlement is expected to be completed during third quarter, and we currently estimate the final share delivery to be approximately 85,000 to 95,000 shares. We continue to be well capitalized and combined with our free cash flow, we believe we have sufficient resources to support our capital allocation initiatives, and continued pursuit of strategic acquisitions investments. I’ll now turn the call back to you, Shawn.

Shawn O’Connor: Thank you, Well, the quarter generally unfolded as we expected, and the adjustments to our renewal strategy are progressing well, putting us on track to achieve our full year goals. Foreign exchange rates continue to create headwinds in the general economy as a pack impacting our sales cycle, particularly for smaller biotech companies. But we are navigating these challenges driving profitable growth, generating cash and returning capital to shareholders. 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. In conclusion, we are confident in our ability to execute against our plan and achieve our guidance for fiscal 2023. Thank you for your time and attention. And I’ll now turn the call over to the operator for the question-and-answer session.

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Q&A Session

Operator: Our first question comes from the line of François Brisebois with Oppenheimer. Please proceed with your question.

François Brisebois: Hi. Thanks for taking the question. Just a first one for me is just in terms of the revenue growth and the confidence and hitting the end of the year guidance, can you just maybe help us just clarify what metrics are maybe qualitatively what it is just based on the quarter here that keeps you confidence — confident and achieving the year-end revenue goal.

Shawn O’Connor: Yes, Frank, the renewable harmonization program really has jumbled the renewal dates through the course of the year and impacting our quarter delivery of the software revenue. The activity through the first couple of quarters in that regard has gone as anticipated, and still believe pretty strongly that the renewal rates will be complete that harmonization process will be complete by the end of the year. And so on a year-over-year basis, we should see normalized revenue growth in terms of the software business that inevitably meant that with a seasonality pattern last year, low first and fourth quarter, and this year with a low first quarter, you can lower first quarter and more comparable second, third and fourth quarter delivery of revenue, that the growth rates in terms of the first half of the year, we’re going to be depressed and the growth rates in the third quarter and especially the fourth quarter, where last year was a very low revenue quarter would be exaggerated in the fourth quarter evening out as we get to the end of the year.

So the qualitative indicators that were on that path or the harmonization program, slotting in pretty much as anticipated going into the year.

François Brisebois: Okay, great. Great. So that extension in sales cycle that we expected a new seasonality. It’s not you wouldn’t say this quarter it kind of shows that look, it was a little bit worse than expected. It’s still fairly in line and we’re dealing with it.

Shawn O’Connor: Yes, no it’s fairly in line in terms of harmonization program. Now certainly receiving your elongation of some sales cycle sphere, independent of the harmonization program as we see the macroeconomic environment slowdown purchasing departments and in our clients industries, and especially in that segment in biotech, so we’re managing our way through that. And on the other side, price increase that we put in place at the beginning of the year, before the beginning of the year is yielding a pretty good contribution to offset those economic challenges that we’re running into. So a number of variables coming into play, all of which come down and net out to reconfirmation of guidance as provided at the beginning of the year.

François Brisebois: Okay, great. And then on the side, given the economic backdrop and what’s been going on, that part of the prepared remarks just discussing the new hires that you’re making, these are very specialized hires. Can you maybe comment? Is it only new hires? Or has there been a loss of personnel as well on the other side, or if there is a loss is a kind of normal weight of loss and just trying to get a feel for whether or not there’s more people net-net, or pretty much the same kind of sales force, I guess, consultant force.