SLP - NASDAQ

Greetings. And welcome to the Simulations Plus Second Quarter Fiscal 2024 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. [Operator Instructions]. As a reminder, this conference call is being recorded. It is now my pleasure to introduce Lisa Fortuna from Financial Profiles. Ms. Fortuna, you may now begin.

Good afternoon, everyone. Welcome to the Simulations Plus second quarter fiscal 2024 financial results conference call. With me today are Shawn O'Connor, Chief Executive Officer, and Will Frederick, Chief Financial Officer and Chief Operating Officer of Simulations Plus. Please note that we updated our quarterly earnings presentation, which will serve as a supplement to today's prepared remarks. You can access the presentation on our Investor Relations website at www.simulations-plus.com. After management's commentary, we will open the call for questions. As a reminder, the information discussed today may include forward-looking statements that involve risks and uncertainties. Words like believe, expect, and anticipate refer to our best estimates as of this call. There can be no assurances 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 Securities and Exchange Commission. With that said, I'll now turn the call over to Shawn O'Connor. Shawn?

Thank you, Lisa. Good afternoon, everyone, and thank you for joining our second quarter fiscal 2024 conference call. Results for the second quarter of fiscal 2024 played out as expected. Our team delivered solid revenue growth of 16%, with strong performance in both our software and services segments and reported diluted earnings per share of $0.20. Given our strong first half results, we are confident we will meet our full year guidance. Our market continues to show encouraging signs of strength. In the first calendar quarter of 2024, biotech funding has been strong, especially for companies that have drug candidates in the clinic. Biotech companies of this profile can benefit from our full portfolio of modeling and simulation capabilities. For large pharmaceutical companies, funding continues to vary depending on their near term direction, drug program stability, and business outlook, but the overall market is healthier compared to a year ago. For the balance of 2024, we remain cautiously optimistic that demand for our comprehensive suite of modeling and simulation software products and services will continue to gain momentum as market conditions improve. Before turning to our segment performance, I want to spend a few minutes on our topic of artificial intelligence as it relates to drug discovery and development. As I've noted previously, Simulations Plus was an early developer of AI technology and tools to optimize our predictive technologies. As AI technologies continue to develop, we keep pace by improving our use of AI technology to enhance our modeling and simulation solutions. Additionally, AI accuracy is only as good as the data sets used for training and our access to accurate public and private data is a true competitive edge and a barrier to entry in our business. Our longstanding partnerships and collaborations with both industry leaders and regulatory agencies have granted us significant access to both private and public data, essential for perfecting and refining predictive algorithms. This access to key data is critical to advancing our capabilities in AI-enabled biosimulation well into the future. When you look broadly at the digital economy, our business, rooted in science and data, stands to meaningfully benefit from evolving AI applications. Moving on to our software segment, software revenues increased 11% in the second quarter and were up 16% for the six-month period with good renewals, upsells and new logo activity. Overall, we are seeing solid demand in our key markets except for Asia, which continued to lag overall market growth. Our Cheminformatics business unit delivered 14% revenue growth in the second quarter and 10% for the fiscal year-to-date. This quarter's growth was due to higher revenues from ADMET Predictor, which continued to gain adoption and added another new AI biotech customer. Additionally, there were eight new customers and 18 upsells during the quarter. Our Physiologically Based Pharmacokinetics, or PBPK, business unit had a modest 2% revenue increase in the second quarter and 11% for the fiscal year-to-date. The PBPK business unit added six new customers and booked nine upsells for existing customers. Momentum is strong for GastroPlus and our expectations for full year growth are strong. Our Clinical Pharmacology & Pharmacometrics, or CPP, business unit delivered the strongest performance with revenue growth of 38% for the quarter and 21% for the fiscal year-to-date. Monolix continues to take market share from its primary competitor and saw another large pharma client commit to transition to the platform. During the quarter, we added 7 new customers and had 10 customer upsells. Revenue in our Quantitative Systems Pharmacology, or QSP, business unit decreased 6% for the quarter and increased 77% for the fiscal year-to-date. As a reminder, quarterly results can be lumpy for QSP based on the high price per license and a small pool of end users. Turning to our services segment, revenues increased 27% during the second quarter and 22% for the six-month period, with solid bookings and a healthy pipeline of active opportunities. Clients are being cautious about spending, but we're seeing a pickup in RFPs, which is a positive sign. There's still lingering volatility associated with start and stop decisions on drug programs and data delivery disruptions related to the completion of clinical trials. So we are managing through this volatility quite well to maintain a steady flow of projects, activities, and utilization of our scientific staff. Total backlog at the end of the second quarter was $18 million, which is strong as we enter the second half of our fiscal year. Services revenue in our CPP business unit were solid, up 10% in the second quarter and 11% for the full fiscal year despite the impact of volatility. In our QSP business unit, service revenues grew 78% in the second quarter and 89% for the full fiscal year, benefiting from immunology and cancer model projects. Services revenue in our PBPK business unit increased 39% for the second quarter and 11% for the full fiscal year, delivering strong growth after a sluggish first quarter performance. And with that, I'll turn the call over to Will.

Thank you, Shawn. To recap our strong second quarter performance, total revenue increased 16% to $18.3 million. Software revenue increased 11%, representing 63% of total revenue, and services revenue increased 27%. On a trailing 12-month basis, software revenue increased 22% and services revenue increased 14%. As we communicated last quarter, the business unit reorganization we implemented in the first quarter to improve our focus on customers also allowed us to evaluate our departmental structure with a focus on continuing to improve operational performance and profitability, while providing our investors improved visibility to our progress. As a result, we moved all services personnel into cost of revenue departments. This has no impact on our total costs or net income, but does impact the services gross margin trend compared to prior periods. Accordingly, Q2 total gross margin was 72% compared to 83% last year, with software gross margin at 88% versus 92%, and services margin at 44% versus 66%. Approximately $1.3 million of the increase in cost of revenues corresponds to a $1.3 million decrease in G&A expenses. Turning to software revenue contribution by business unit for the quarter, PBPK was 54%, CPP was 24%, Cheminformatics was 18%, and QSP was 4%. For the trailing 12 months, PBPK contribution was 55%, CPP was 20%, Cheminformatics was 19%, and QSP was 6%. For the trailing 12 months, our customer renewal rate increased to 93% based on fees and increased to 84% based on accounts. For the trailing 12 months, average revenue per customer increased to $95,000. Shifting to our services revenue contribution by business unit for the quarter, CPP was 43%, QSP was 27%, PBPK was 25%, and REG was 5%. For the trailing 12 months, CPP contribution was 43%, QSP was 30%, PBPK was 22%, and REG was 5%. Total services projects worked on during the quarter was 176, a slight decrease from 183 last year, and quarter-end backlog increased to $18 million compared to $15.4 million last year. Anticipated revenue from backlog within 12 months increased to approximately 90%. Turning to our consolidated income statement for the quarter, R&D expense was 7% of revenue compared to 8% last year, sales and marketing expense was 11% of revenue, same as last year, and G&A expense was 30% of revenue compared to 38% last year. Total operating expenses were 48% of revenue compared to 58% last year. Income from operations was 24% of revenue compared to 26% last year. And income before income taxes was 29% of revenue compared to 32% last year. Year-over-year increases were primarily due to the acquisition of Immunetrics, compensation-related increases due to headcount additions, increases in stock compensation, and general annual salary adjustments for existing employees. Other income was $0.8 million this quarter compared to $1 million last year, primarily due to an increase in interest income of $0.4 million, partially offset by an increase in the fair value adjustment of the Immunetrics earn-out liability of $0.4 million. Net income for the second quarter was $4 million or 22% of revenue compared to $4.2 million or 27% of revenue last year. Diluted earnings per share was the same as last year at $0.20, reflecting a decrease in diluted shares outstanding as a result of last year's share repurchase. Second quarter adjusted EBITDA increased to $7.1 million compared to $6.2 million last year, and both were 39% of revenue. We calculated adjusted EBITDA by adding back interest, taxes, depreciation, and amortization, stock-based compensation, gain or loss on currency exchange, any acquisition or financial transaction related expenses, any asset impairment charges, and any tax provisions or benefits related to these items. The reconciliation of this non-GAAP metric to net income, the relevant GAAP metric, is in our earnings release and on our website. Income tax expense for the second quarter was $1.2 million compared to $0.9 million last year, and our effective tax rate increased to 23% from 18% last year. The increased tax rate was primarily the result of changes in prior-year estimated taxes and foreign tax-related differences we benefited from last year. Now that we're halfway through our fiscal year, our current effective tax rate estimate for the full fiscal year is 20% to 23%. Finally turning to our balance sheet. We ended the quarter with $117.5 million in cash and investments. We remain committed to our capital allocation strategy and corporate development initiative as we continue to seek opportunities for strategic acquisitions, investments, and partnerships. I'll now turn the call back to Shawn.

Thank you, Will. Our second quarter results reflected strong performance in both our software and services segments. Market conditions have improved, but these changes require time before they translate into actual bookings and revenue. We remain cautiously optimistic. With our strong first half performance, combined with market improvement, we're well positioned to meet our stated fiscal 2024 guidance targets, which include total revenue between $66 million and $69 million, year-over-year revenue growth in the range of 10% to 15%, software mix between 55% and 60%, services mix between 40% and 45%, diluted earnings per share of $0.66 to $0.68, year-over-year diluted earnings per share growth of 35% to 39%. Before turning to the Q&A, I'd like to take the opportunity to reinforce key differentiators of our story. We're a clear leader in software and consulting services in a large and growing biosimulation market. Simulations Plus is a leader in biosimulation technology, leveraging AI tools since the company's inception to optimize drug discovery and clinical development through to and beyond regulatory approval. We have a compelling customer value proposition and strong competitive position with high barriers to entry. We have an attractive financial profile with a strong balance sheet and no debt. And finally, we have a seasoned management team with scientific leadership and significant expertise in modeling and simulation. Thank you for your time today. And with that, I'll turn the call over to the operator for questions.

[Operator Instructions]. Our first question comes from the line of Matt Hewitt with Craig-Hallum.

Congratulations on the second good quarter here in a row. Maybe first up, to follow up a little bit on the macroenvironment, obviously, you're starting to see some improvement on the biotech side. You commented on that. I'm wondering, on the large pharma side, how much of that is the funding versus some of the reprioritization and some of the other items that have hit that market over the past few quarters? Is it more just that or is there maybe some funding on the large pharma side as well?

During the last couple of years, the environment, biotech versus pharma, has been a little different. Certainly a funding issue on the biotech side. On pharma side, it's been less funding as it has been circumstances related to the individual company, their outlook in terms of patent exposure, on revenue streams, resorting their drug programs and investments there, their access – or acquisition, I should say, of new programs have created a turn there. You've got a wide range of scenarios from Novo Nordisk at one extreme and other companies. Pfizer is an example that's announced significant cutbacks this year. So most everyone is obviously in between those two extremes, but there's still a lot of churn and consciousness and sorting out of drug programs that are going to be invested in or not invested in. Catch all funding of those companies has been less of an issue in terms of their situation.

Regarding the biotech funding, obviously, it has been – I think everyone's kind of seen the strong start to the year, but how quickly do you start to see that from a bookings perspective? Is it pretty quickly or is there a little bit of a lag? So when we're seeing the IPOs and the secondaries hit, is there a quarter or two lag historically or does that show up in your revenues right away?

Yeah, we'll see. It's anecdotal depending on where their drug candidates are when they get the funding, where are those candidates in terms of the cycle of drug development. Typical sales cycles in our industry can range to I need a new seat and I need it tomorrow, I just hired somebody to prolong the budgetary activities. So I know I'm dancing around in answer to your question because I can't give you a it's a two month, it's a three month sort of lag. It runs across the spectrum in terms of timing. But, certainly, within the first quarter or thereabouts of funding activity, you're not going to see a quick turn in terms of market volume. But in the six to nine month range, I would anticipate many of these companies that are getting funded are going to be advancing their candidates, especially those that are getting funding with drugs in the clinic looking to go to the next level, close their protocol on the next clinical trial. Those are decision points that drive purchasing decisions.

Maybe one more for me and I'll hop back in the queue. But, obviously, a big pop in ADMET. I think you quadrupled the number of customers versus last quarter, the new wins, I should say. Your upsells were up 3X versus last quarter. Maybe a little bit more color in what drove the strong pop there.

The technology is getting more acceptance in the marketplace in terms of what we're doing. The questions and the companies we're focused on, new generative AI solutions, the recognition that that which is in ADMET Predictor and the contributions we make there are not displaced by many of the new technologies that are being brought to the market. I'm extremely pleased yet another AI startup, biotech company, licensed our ADMET Predictor tool to supplement what they are building separately. I think that endorses that we're not being displaced or replaced in terms of many of these technology builds, AI technology builds, and the value of what we've built and brought to the market for many years here and continue to enhance and improve has its place and value in the lead optimization process.

Well, congratulations again on the strong quarter.

Our next question comes from the line of David Larsen with BTIG.

Hey, congrats on the very good quarter. Can you talk a little bit about the sequential increase in GastroPlus revenue? It looked very good to me, especially given that you had the harmonization process last year. Is there any more color or thoughts around that would be great?

Growth in the specific quarter here, year-over-year comparison was not tremendous, but this was our step up quarter as the harmonization process that completed last year set in motion a little bit different seasonality pattern to the year. First quarter to second quarter jump was an even larger jump sequentially for us and GastroPlus performed quite well. The harmonization process complete doesn't mean that there aren't licenses that slip from one quarter to another quarter based upon their closure at the end of any given quarter and whatnot. So, we had some impact from that. I referenced in the prepared comments with regard to softness in the Asian market where we're seeing, especially in China, some pullback in terms of spending related to well0known issues taking place there. So momentum is very good on GastroPlus. We're performing to our expectations for the year and look for that to continue to grow at a steady pace and continue to drive overall revenues.

IQVIA, in their research business, they showed tremendous growth. It was, I think, one of their best quarters they've ever printed. I think it was second or maybe third best for IQVIA. I'm seeing a very good increase year-over-year in Monolix. Is there any correlation to that? How tied is MonolixSuite to clinical trial activity? Can't it create virtual clinical trials? I guess what's all that huge increase there over 30% year-over-year or 38% year-over-year growth?

Monolix is doing quite well. Made it through its harmonization process last year. It, since our acquisition of that product line in 2020, has been a fast grower, our fastest growing software platform these last few years and continues to perform nice in the marketplace, displacing the incumbent, the leading market share product there. This past quarter, we had yet another large pharma company that made the commitment to displace entirely the competitive product and go 100% to a use of Monolix for their needs there. So its momentum and progress continues quite strong into the future. It's tied to clinical trial activity? Yes, not quite so direct, but, hey, we've got 10 clinical trials this quarter. We need an extra copy of Monolix. But generally, there's a strong indirect correlation between development programs, clinical trials and the amount of modeling and simulation work that is being performed and therefore leads to growing staff and our clients that need Monolix on their desktop. But it's not quite so immediate quarter-to-quarter.

And then the pricing, the average revenue per customer, I think it came in at like $113,000. That's up from $79,000 in 1Q. That looked very good to me. The fee retention, though, 94%. I mean, you had a great quarter, but it was down from 100% in 1Q. Anything going on there? What's sort of driving that?

We've more typically operated at a mid-90s level, 95%, 96% in terms of fees. Our performance last quarter was quite extraordinary. Not that I'm complaining about it, but it created a peak for which we'll always be compared to [indiscernible]. So the revenue renewal rate, I should say, this quarter was kind of the norm, , even though, as I mentioned, there were a couple of renewals that slipped out of Q2. So I think we're in good shape there. The components of the renewal, the number of accounts that are renewing, the stickiness of our price increase as implemented, all of those seem to be performing well at this point.

You recently announced a new corporate development effort. Can you maybe just talk a little bit about what that is? Have you actually made any investments yet? And it's my understanding that this may enable you to capture some of the upside. If you work with a pharma client and you help them launch a successful drug, you could potentially capture some of that very significant revenue stream long term. Is that how it works? Is there any color there, would be great?

They've announced the program this year and certainly looking at a number of opportunities, as we speak here. It was really borne out of our acquisition strategy, which remains, first and foremost, number one priority in terms of the use of our capital in terms of identifying additional acquisitions to add to the Simulations Plus product and service portfolio. But in that effort, we encounter a number of situations with companies that have good technology capabilities, but for a whole host of reasons may not be acquisition candidates at this stage of the game. And yet, their technology that they've built might have some very positive go-to-market strategies, technological linkage, integration into our existing technology, all things that we could get benefit from more quickly as to waiting for them to mature and become an acquisition target down the road. So a number of those opportunities are being assessed, as we speak, and hope to find some candidates to make our first investments of this nature. One profile of investment in these companies may be companies that their use of our technology, their charge mission maybe include drug development processes by which our investment in them would allow us to play in the success of their drug programs as well. Our first and foremost sort of filter, though, will be their technology and its value in terms of our business model, which would be software license revenue and/or service revenue, but it does present an interesting scenario where we might be able to benefit from their drug development program success in the long term.

Yeah, we certainly have impact in terms of a more efficient spend on the funding that takes place, more efficient spend of that. But the drug program, depending on the circumstances of that entity, may or may not require – even efficient spend may lead to more funding for further development.

Our next question is a follow-up question from the line of David Larsen.

I wanted to ask, Will, a question about his new sort of expanded role, I think, of chief operating officer. Just, Will, what are you seeing from that perspective? Maybe can you talk a little bit about the reclassification of some G&A costs up into COGS? Why did you do that? Just any color would be very helpful.

I think one of the things it definitely allowed us to do as a company is look across the entire organization at the way that we're running our operations, both services operations and software operations. So, as we've progressed since we've done the acquisitions, we've always tried to have a one-company focus, I'll call it, that drives further synergies, leverages best practices throughout the organization. And this was one more step in addition to the most recent ones were sales and marketing consolidation. Certainly, the reclass that we did this year, as I mentioned, no impact on our total costs in the way that we've reported them. But given a little bit more clarity, and we've tried to incorporate that into the script on our cost as a percentage of revenue and really looking at what's our services organization costing us, where can we improve in utilization rates or allocations of effort to development, sales and marketing, what's our sales and marketing spend as a percentage of revenue, what's our G&A spend? So really helping the company focus on areas that we can drive future profitability, get the leverage out of the business. And most importantly, we continue to have a focus on future M&A, so having this infrastructure in place that allows us to bring in new companies and keep layering on that infrastructure should hopefully allow us to see some nice synergies in the future.

What I just heard you say was you had a better look at the earnings per individual in each department in the organization, and that's exactly what I like to hear, quite frankly. And then just last one, can you just talk a little bit about your sales organization? How many FTEs do you have in sales? How many are quota carrying? And then, you mentioned integration of sales force. Who was integrated into what? Was it Immunetrics or were there other integrations that happened recently? Just any sort of color there will be helpful. Sales is obviously very important.

Certainly, with the Immunetrics acquisition, we do have an earn-out, so there are certain constraints within where we can fully integrate it, but we've made strides in the direction to leverage our existing sales force. You've heard us talk about the cross-selling, where can we leverage customers that we have to sell services, software from the different business units, continue to work up that value chain within the organization, hire decision makers. We still got about the same amount of sales and marketing folks. So there's, I want to say, about 12 sales people, quota carrying, about 6 or 7 folks that are in marketing. And, certainly, a great addition, just recently, this last quarter with Dan Szot as our chief revenue officer. Shawn, anything I missed?

That sounds good. The consolidation process really started a couple of years ago. And at that time, before Immunetrics was pulling the resources from the divisions at the time, the previous acquisitions and consolidating them together into one sales and marketing organization that internally creates some efficiencies, but, more importantly, it was a focus in terms of our go-to-market presentation to our clients as one company. All of that leads to support to upsells and cross selling across platforms and across services to our existing customers. And I think that's been accruing benefits here for a while.

There are no further questions in the queue. I'd like to hand it back to Mr. O'Connor for closing remarks.

Very good. Well, I appreciate everyone's attention today and hope all was well on your side and look forward to speaking again soon. Take care all.