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. [Operator Instructions] 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..

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?.

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..

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..

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..

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

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?.

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..

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?.

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..

Got it. And maybe one last one, and then I'll hop back in the queue and maybe touches on that a little bit. So there's been a step-up in R&D investment here the past couple of quarters, a little bit more pronounced here in Q1.

Is there anything tied to that? Obviously, you called out that you've got six different federal or FDA partnerships, if you are -- or contracts that you're working on, but typically, those dollars kind of offset R&D.

So is this some internal investment? Is there something that you're investing there? Or is something else that's sitting in that line?.

Yes, Matt, I think yes, some incremental spend there as the scientific resources are allocated during the quarter into development work there. I think the percentage there probably exaggerated a little bit because of the lowest quarter top line revenue causing that percentage to go up a bit as well. We'll give guidance for the year.

I don't know that the R&D for the year will come out any different than our historical payout in there in the long run..

Our next question comes from the line of Dane Leone with Raymond James. Please proceed with your question..

Maybe you could just talk a little bit more of where you're seeing some of the investment by therapeutic area or drug development area. You'd mentioned NASH, I was just curious on that area, given -- I remember a year ago, you had seen some pullback in spending on NASH-related projects.

And anything you'd say on some of the oncology products as well, that would be great..

Sure, Dave. Yes. No, we've not pulled back. There's an ebb and flow in terms of the client activity in the therapeutic areas, and NASH has been one that the NAFLDsym product and our QSP/QST group supports clients in that area on an ongoing basis, we just had a significant project this last quarter there. It ebbs and flows.

Oncology area, one of the stronger areas in terms of drug development today, an area that we support as well. Neurological therapeutic endeavors is a larger area for us as well. But the service group performs across the board, the full spectrum of therapeutic areas..

Our next question comes from the line of François Brisebois with Oppenheimer. Please proceed with your question..

Just a couple here. You talked about TAM expansion. The example you gave with the investment company that used the software to gauge probably success of a clinical trial outcome.

I was just wondering if you disclose how you would charge an investment company and is it related to maybe the profit that they can make off a correct decision? Or is this a project that you think that could significantly actually expand the TAM that you're currently looking at? Or is it kind of a one-off?.

Hopefully, it's not a one-off, Frank. It's an area that knocked on a lot of doors over the years with modeling and simulation support to either capital entities or investment companies and sporadic success in that regard. It was a highlight during the quarter. Very successful project performed.

I would say that our model there has been similar to the work we do for our more traditional clients and that we do work for fee, whether it's timing materials or fixed rate.

We don't do our service engagements with any future drug success royalty stream or in this case, they return on investment opportunity as part of the proceeds of our work effort there. But it's priced accordingly as best we can.

And it doesn't really have an indirect impact in terms of the strategic investment opportunities that we're looking at in terms of expanding our TAM. If that market opens up and we can do more work like that, it will be incremental to our business but not a large TAM..

Okay. Great.

And then in terms of the strategic partnership angle, is this -- is it fair to assume that this was just not part of the plan in terms of corporate development in the past outright acquisitions and now this expands it? Or was it also somewhat part of the plan in the past?.

I would say that it really wasn't a focus on our part.

We were very focused in terms of the -- continuing the success of prior acquisitions, which were always very focused on stand-alone entities with the criteria that we listed off with an acquisition orientation and not really an open eye to opportunities that might not be right for acquisition at this point in time, but a strategic investment would link the two organizations, could lead ultimately to an acquisition down the road but most importantly, would open up some technology sharing or market capability sharing the will enhance obviously both companies in the shorter run..

Okay. Great. And in terms of the business model, is it fair to assume this would be some sort of a biotech kind of upfront and milestones in royalties with the partnership or too early to disclose..

Each deal can take its own form based upon circumstances.

Our focus is primarily in terms of, again, like our acquisition strategy, we'll be focused on software opportunities, service opportunities as well, but software opportunities that can build the technology either within our products or in some linkage to other capabilities in third party's hands.

And those terms of those strategic investments can take many, many forms. But I wouldn't limit it to a sort of drug oriented -- drug development oriented milestone royalty type of arrangement..

Okay. Great. And just lastly here. I'm sorry if I missed this. But in terms of the stickiness of the business, obviously, the change in seasonality, but the stickiness had already been there on the 95%. And I think you had mentioned some of the 5% that's not necessarily sticky. It is either maybe a company getting out of business or just due to M&A.

Is that stickiness still there around the 95%?.

Absolutely. The renewal rate is anticipated as certain renewals that previously would have been in the first quarter because of the change in the renewal pattern here will happen during the course of the year. It's reflected by our guidance of 10% to 15% for the year. Underlying metric there is that 95% -- 93% to 95% renewal rate, and that will occur.

But as we indicated last quarter, first quarter would be impacted by the push out of renewals into the second, third and fourth quarter, and hence, on a year-over-year basis, you see a little dip in the for free renewal metric..

Our next question comes from the line of Mitra Ramgopal with Sidoti. Please proceed with your question..

Just a couple.

First, if you could just provide some more color on the headcount additions in terms of -- is it ahead of where you expect it to be as you head into the second quarter and the remainder of the year? And are you seeing any change in easing in terms of availability of candidates and even compensation?.

Mitra, as we've indicated, it's a very competitive market out there for scientists and computational biology, and therefore, we were extremely pleased with the success we had this past quarter in both regards in terms of the additions, the recruiting and new hires that we're able to bring on board as well as our retention profile for the quarter, very successful quarter on the people front for the Company.

Are we done? No, we're continuing through the course of the year to look for new talent to bring on board. And successful first quarter gives me high expectations for our ability to continue to operate the plan..

Okay. And just coming back on the M&A side. I know you mentioned since August 2020, you identified more than 60 candidates that sort of met your criteria, but you haven't announced any closure, so to speak.

And I'm just curious, what has sort of been like maybe the biggest sticking point or maybe a few things that you think might have just led to not being able to get a deal done?.

Yes. It's a range of scenarios, not the smallest of which, probably top of the stack is companies are not always in a position where they're looking to be acquired.

And so that is a scenario that's often encountered in those instances where there is interest, the accretive nature of their business, it being at the stage that would allow us to fulfill the criteria which that we're not interested in non-accretive acquisitions, that would be a stumbling block in cases.

And then finally, attractive valuation, the dynamics of which have changed over the course of the last couple of years as health care multiples have risen and fallen and over time, those valuation discussions have changed and evolved. But in the end, valuation is always a key criteria to come to agreement on that..

Okay. And then finally, obviously, you have a lot on your plate in terms of the domestic market. But I know you've always talked about exploring opportunities in Europe and even in Asia.

Just wondering, if you're having any traction on that front?.

Good traction. We service Europe directly. We service Asia and Latin American markets through distributors. And we're seeing a pickup in terms of the distributor geographies.

They were, in some cases, more impacted by COVID, more impacted for a longer window of time, and those seem to be improving, probably the exception to which is obviously the Chinese market.

But there's some promise of that opening back up here of late and the Latin America market, which we initiated a new distributor agreement late in the last fiscal year. It looks to be contributing very well to us as we move into the new fiscal year here. European marketplace is pretty robust.

We bank on the service side to see more boots on the ground for scientists local in that territory and working to that end have increased the employee count in Europe, pretty well over the last couple of years, but there's more work to be done there.

So I think as we've grown, the European component of our revenues, I think, has that split of round numbers, 60%, 65% revenue in North America with the remainder split pretty evenly between Asia and Europe has stayed pretty consistent. So it's growing, growing as our businesses as a whole.

And I think there is opportunity for us to accelerate in some geographies there..

[Operator Instructions] There are no further questions in the queue. I'd like to hand the call back to Mr. O'Connor for closing remarks..

Very good. Well, I appreciate everyone's time and attention here. It's been a very good quarter for us, very active and look forward to continuing that through the next couple of quarters and look forward to talking to you again at the end of our second quarter. Take care, everyone..

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day..