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. [Operator Instructions] 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..

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?.

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..

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..

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..

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

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..

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..

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..

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..

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..

Primarily focused on scientific consulting group. It's a net-net plus for the organization here today to through two quarters. Good recruiting, good hiring, success on that side and on retention. Very positive. I can't say that we haven't lost anyone but certainly compared to last year, the retention side is shored up.

We invested quite a bit at the end of last year.

In terms of our review of all aspects of working for Simulations Plus, a big component of which is compensation but other factors and implemented some programs that we thought would do - contribute to a tapering off in terms of any retention challenges that we had with the demand that was on the marketplace for skilled people that we really have on board and support our recruiting efforts into fiscal year '23.

And quite pleased with the results of that investment today..

Okay, great. That's it for me. Thank you and congrats on the progress..

Take care Fran..

Our next question comes from the line of Matt Hewitt with Craig-Hallum. Please proceed with your question..

Good afternoon and thank you for taking the questions. Maybe first up regarding the synchronization process, it sounds like you're pretty much complete on the GastroPlus side. It sounds like you've got a little bit more work to do on the MonolixSuite side of the equation.

Is that something you expect to wrap up here in the third quarter? Or is that maybe a 1 or 2 quarter process to complete that?.

Yes, Matt, it's by the end of the year process. I wouldn't characterize that the process is done even for GastroPlus. While we did see that growth rate bounce back up to 18% in the second quarter, there is still a combination of movement on the renewal side there with that project that still has to play out.

So I think we are certainly halfway through it, if you will, halfway through the year, making progress but still some hard work to do by the team..

Okay. And then I think, Will, you provided a little bit of color on the renewal rates that dipped a little bit here in the second quarter.

Is that pretty much a function of the synchronization process? Or is there maybe something else? Does that speak to a little bit on the delays on signing new contracts that I think you spoke to, Shawn?.

Yes, it's a combination of some of the smaller biotechs that aren't renewing just with the environment out there for them to get financing. And then the rest of it is tied to the synchronization process and the timing for those renewals..

Got it. And then regarding the new collaborations, obviously, congratulations on both of those.

And I'm just curious, how should we be thinking about the size of those potential milestones? Will there be -- is there the potential for royalties if those molecules are ultimately approved by regulatory agencies? Who will own the molecule? Any additional color on the -- maybe the structure of the contracts would be helpful..

Sure.

Very excited about the two partnerships that we put in place and want to emphasize that our focus here is in terms of demonstrating the value and capabilities of our AI machine learning technology, working with two organizations that will supply the data, in many cases, the knowledge of the target and the candidates are -- our services support team will provide the support along with our technology to apply our AI/ML technology to lead generation process there, very hopeful that it produces success with a focus on it being a driver in terms of our software licensing business and our consulting business in this area.

Having those case studies and success stories is what will drive that. And as you know, our focus has been in terms of being a tool provider to our clients as opposed to a drug developer. Now you enter into these relationships. And one of the benefits of them is that it's very common for some shared success triggers to be involved.

And in one case, it is a joint ownership of compounds that may come out of the program. And in the other case, it's a defined royalty stream associated with them. So while that's not our primary focus, it is a nice icing-on-the-cake opportunity. Understand that these programs do take some time to come to fruition.

So I don't see any impact from those two opportunities in the near-term future for us, but certainly a nice opportunity in the long run..

That's great. And obviously, we'll -- hopefully you'll keep us apprised as those progress. And then maybe one last one, and I'm not sure if you're going to have this handy, but I'll throw it out there anyway. You did mention you're basically moving into a couple of new markets.

And I'm just curious, one being outside of therapeutics, it sounded like -- are there TAMs associated with those market opportunities? Or is it -- were these more very early stage one-off situations if, depending upon how things go, then maybe it becomes a new market for you? Thank you..

Yes, Matt, the agrochemical partnership with collaboration that we've been working there certainly opens up more business opportunity for our support in that industry segment, which has a very small footprint. And today, 5% of our business is done outside of the pharma world in support of the cosmetics industry and other adjacencies.

This would go into that bucket and certainly would add some TAM to our opportunity on a go-forward basis. The other one I think you might be referring to is the biologics collaboration. And that certainly is not a brand new market for us.

We do participate in that market already, but increasing our functionality footprint and experience in that area gives us more opportunity to take market share in that segment..

Got it. All right. Thank you so much..

Take care, Matt..

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

Yes, good afternoon. Thanks for taking the questions.

First, just curious on the churn you're seeing in small biotech accounts, if that's continuing now into the third quarter? And is it stabilizing? Or is it even moving on to maybe medium-sized companies?.

It continues into the third quarter as it's evolving in terms of growing up scale. I mean large pharma and larger medium-sized biotech companies have experienced slowdown as well.

So it's not virgin territory in those other categories, but it's been more dramatic in the small biotech space where funding is a little bit more critical, mid-term funding is critical, smaller pipeline of candidates, so on and so forth. So certainly, the challenges that they face continue into this quarter.

I know at the market level, we're playing some more activity in terms of potential funding, opening up a funding in the biotech space. It takes a while for that to trickle back down into the marketplace, cash in the hands with this small biotech and opening up of purchasing plans.

So while macro, there might be some positive signs at -- on the ground level, it's still about equipment..

Okay. Thanks. And also just coming back to the recent hires.

If that's included in the guidance in terms of expected contribution? Or is that more a fiscal '24?.

We've seen new hires come up and running and contributing billable time quite quickly in terms of our most recent experience. So we will be waiting for them to contribute until the next fiscal year. But no, we are not changing our guidance to raise it because of the success we've had on the recruiting side at this point..

Okay. And then -- thanks. And then finally, on inorganic opportunities. I know you've mentioned in the past you have a lot -- you've been evaluating but nothing close, so to speak.

And just wondering your level of optimism given the current environment and your strong cash position, et cetera, if we should be expecting something on that front over the next 12 months?.

Yes. Mitra, it's hard to ever put any time constraints around those things. But certainly, it is a very active area for us, a number of discussions and efforts and investment in that space.

And I'm sure that we will find ourselves happily making an announcement at some point here down the road, but I can't really put brackets around the timing of that..

That’s great. Well, thanks again for taking the questions..

Very good. Take care, Matt..

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

Thanks very much. Two questions for me.

One, could you just give us an estimate in terms of the expected EPS impact from the buyback this year? And then secondly, are there any particular therapeutic verticals that you saw in the quarter that had more strength in terms of projects or were particularly weak driving some of the drop in service revenue? Thank you..

I'll go backwards in terms of the service revenue and the therapeutic areas. No real change in the dynamic that we've seen as to spending on the oncology front, neuroscience front. Those areas are quite active across multiple therapeutic areas.

The service revenue drop this quarter really focused in terms of our QSP/QST consulting business where that business with its sort of typical $1 million, sometimes $2 million projects that its performance can be relatively lumpy and not really therapeutic driven in terms of its cadence of projects.

So it's not really a therapeutic area challenge there. It's just the timing of the large projects. And last year, we had a significant revenue quarter in the second quarter for that group, so they're comparable was a bit of a tailwind.

Will, you want to help out on the EPS side in terms of the impact of the stock buyback?.

Sure. With the ASR that we've got underway netted against the cash that we used and the interest we could earn, it's about a -- I'll call it, about a $0.01 improvement to EPS, which is included in our guidance..

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

Very good. Well, I appreciate everyone's attention today and support of Simulations Plus. We look forward to speaking again in a few months with our third quarter results. 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..