Simulations Plus, Inc. (NASDAQ:SLP) Q3 2023 Earnings Call Transcript
Simulations Plus, Inc. (NASDAQ:SLP) Q3 2023 Earnings Call Transcript July 6, 2023
Simulations Plus, Inc. reports earnings inline with expectations. Reported EPS is $0.2 EPS, expectations were $0.2.
Operator: Greetings, and welcome to the Simulations Plus Third Quarter Fiscal 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A 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, John Wilfong from Financial Profiles. Thank you. Mr. Wilfong, you may begin.
John Wilfong: Good afternoon, everyone. Welcome to the Simulations Plus third quarter fiscal 2023 financial results conference call. With me today are Shawn O'Connor, Chief Executive Officer, and Will Frederick, our Chief Financial Officer of Simulations Plus. Please note that we have -- 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 page at www.simulations-plus.com. After management's commentary, we will open the call for questions. As a reminder, 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 are no -- 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 will turn over the call to Shawn O'Connor. Shawn?
Shawn O'Connor: Thank you, John. Good afternoon, everyone, and thank you for joining us today to discuss our third quarter 2023 results. To start off, I am pleased with our team's successful acquisition of Immunetrics, a well-respected modeling and simulation company. This acquisition is highly complementary to our core strength and expertise in quantitative systems pharmacology, or QSP. With Immunetrics, we can rapidly expand into the fast-growing therapeutic areas of oncology, immunology and autoimmune diseases. We are very excited to welcome the Immunetrics team that brings proven QSP technology, a strong reputation in the market and incredible scientific talent to Simulations Plus. By joining forces, we believe we can establish a leading position in these rapidly growing therapeutic areas.
Moving on to current market conditions, as you know, we operate in an innovative and fast-growing market that is being driven by the vital need to achieve higher ROIs from the costly and time consuming drug development process. The compelling value proposition that biosimulation delivers continues to grow, especially with new advancements in technology, and expanding impactful use cases. However, as I've mentioned in previous calls, our industry is not immune to macroeconomic pressures and the current environment is challenging. We anticipated these challenges this past October when we provided our fiscal '23 guidance of 10% to 15% revenue growth after delivering 16% revenue growth in fiscal year '22. During the third quarter, small biotech, large pharmaceutical and CRO customers remained more cautious and we did see several non-renewals from smaller biotechs.
Even so, we continue to perform within the guidance we provided. We believe this near-term hesitancy around investment will eventually reverse. The healthcare needs are so great and the stakes are too high for pharma to ignore faster, more efficacious ways to bring drugs to market. On a positive note, there has been good uptake of our price increases throughout the fiscal 2023, which we think demonstrate the value of our products and services. The adoption and growth of biosimulation software and services continues to grow despite current market conditions. In this context, third quarter results were in line with our expectations. We delivered 9% top-line growth year-over-year, driven primarily by strong revenue in our software segment, which was up 10%, while service revenue increased 5% over last year.
From a profitability standpoint, we delivered strong gross margins of 82%, which reflected a favorable mix of higher margin software sales as well as the ability to pass on price increases. While carefully managing expenses is a top priority, this quarter, we incurred M&A expenses related to the Immunetrics acquisition of $0.4 million or $0.02 per share. Despite this, we delivered net income in the third quarter of $4 million or $0.20 per diluted share, in line with our guidance. Adjusted EBITDA was $6.5 million, representing 40% of total revenue. Will will cover our third quarter results in more detail. Now I'll take a few moments to discuss how our software segment performed during the third quarter. Overall, we're pleased with our performance.
As previously mentioned, large pharma spending constraints and small biotech funding challenges have impacted some renewals and upsell opportunities. That said, our software revenue grew 10% in the quarter, benefiting from strong uptake of our price increases, good renewal rates and upsells and the addition of 17 new customers. Our top-line growth reaped some benefits from our renewal harmonization initiative, which we implemented at the beginning of this year, and is proceeding as planned. The goal of this initiative is to smooth out renewal contracts to create greater predictability and minimize seasonality. Largely due to more favorable renewal harmonization, we saw robust software revenues for MonolixSuite, which grew 84% year-over-year.
While we expect to see ongoing benefits from our renewal harmonization initiative, in the short run, it can temporarily dislocate some revenues in certain product categories. For example, this quarter's GastroPlus revenues declined 2% year-over-year due to the timing and harmonization of the renewal contracts. Once we cycle through this harmonization, we expect to recapture these dislocated revenues. During the quarter, we saw 9% revenue growth in ADMET Predictor, our AI-powered software solution with six customer upsells and three new customers. In Q3, ADMET also achieved an important milestone with the successful integration of data provided by several large pharmaceutical and agrochemical companies to retrain our machine learning models to predict ionization constraints -- constants, I'm sorry.
This has significantly expanded our library of experimental pKa data to over 70,000 measurements, which gives our industry-leading models unprecedented accuracy of their predictions. As such, all users will be able to benefit from this major advancement in the new ADMET Predictor Version 11 release that is expected in the fourth quarter. Other notable software highlights include significant collaborative work between our modeling experts from the pharmacometrics software and services team. They are working together to develop a PKPD platform model framework that will quantitatively support our clients go/no-go decision making for oncology compounds based on linking early biomarker data to predict late clinical endpoints. We're very focused on driving synergies like this example across all of our acquisitions.
On the international front, China was a strong performer with 29% revenue growth, mostly from GastroPlus and ADMET Predictor products. This is a massive market that is under penetrated and we anticipate continued growth here. Moving on to our services segment. Revenues grew 5% year-over-year, representing 35% of total revenues. Services backlog declined 6% to $16 million and our services team performed 212 projects during the quarter, 16 more than this time last year. PKPD services revenues grew 2%, reflecting the shift to higher margin time and material contracts, which represented 42% of projects this quarter and contributed to expanding our services gross margin. Furthermore, our pharmacometric consultants performed PKPD modeling to support a highly-anticipated novel therapy being investigated to treat a rare childhood disease.
Our team of experts subsequently assisted this drug sponsor in preparing for an advisory committee meeting that resulted in attaining an accelerated approval granted by the FDA. In our business, these victories are personally meaningful to everyone involved. In QSP/QST, service revenues were up 6% for the quarter, primarily due to the market conditions previously discussed. Of note, we conducted a quantitative systems pharmacology project for a financial services firm that focused on predicting efficacy-related clinical trial outcomes in the pulmonary space. This was an interesting project because the goal was to use modeling and simulation to predict the best future outcomes that would warrant investment considerations by the firm. This is a great example of how industries outside of pharma are beginning to use predictive analytics and modeling to reach informed business decisions.
We see some solid opportunity to expand the use of our applications in this space and others. We also conducted a DILIsym liver safety project for a pharma company focused on evaluating an early development drug candidate. DILIsym is a quantitative systems toxicology software platform capable of predicting and explaining drug-induced liver injury. This assignment identified liver safety issues with the compound and helped to inform the company's decision to abandon the candidate and avoid a multimillion dollar failure in future clinical trials. As you can imagine, predictive outcomes like this go a long way in strengthening relationships with our clients. PBPK revenues increased 5% in the quarter. We have made substantial progress on the five FDA funded grants, which advanced the mechanistic modeling and simulation science of drugs delivered through non-oral pathways.
Additionally, we provided PBPK consulting support on seven projects in the quarter, which assisted pharmaceutical and generic companies in the design and development of pulmonary, ocular, intraoral, dermal and long-acting injectable drug products. The launch of our Consult and Coach program in early '23 has garnered significant interest in adoption from our clients. This innovative program provides clients with access to our cutting-edge software and valuable learning opportunities. We believe that over time our Consult and Coach program will gain meaningful traction by training and expanding in-house client expertise with the end goal of driving incremental software licensing revenues. Additionally, our team of PBPK consulting and regulatory experts successfully delivered a model-informed drug development strategy to support a top 50 pharmaceutical company.
A mechanistic GastroPlus model was developed and applied to define the dissolution acceptance criteria for the company's commercial formulation of a new drug product and the simulation results submitted to a global regulatory agency to support the waiver of bioequivalents. The growing acceptance of these applications of PBPK analysis versus costly trials are driving growth in this service segment. We have made some significant strides in the third quarter and I'm very proud of our teams collaborating with one another and with our clients to deliver exceptional work. Going forward, we will continue to execute our strategy that combines organic growth, operating leverage and inorganic growth to create long-term value for our shareholders. Our renewal harmonization strategy is providing significant benefits to smoothing out our contract renewal timing and seasonality impacts.
As anticipated, we should complete this shift of seasonality as we conclude fiscal year '23. With that, I'll turn the call to Will to review our third quarter financial results in detail.
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Will Frederick: Thank you, Shawn. We had another solid quarter with total revenue increasing 9%, with software up 10% and services up 5%. Software represented 65% of revenue during the quarter. For the nine months, total revenue increased 4%, comprised of a 2% increase in software and services growing 9%. Software represented 62% of revenue during the year. Gross margin for the quarter declined slightly to 82%, reflecting softer margins in our services segment. Software gross margin was down slightly to 91% from 92% last year and services margins came in at 63%, primarily due to lower margin work on grants. Gross margin for the nine months was flat at 81%, with software gross margin at 90% and services margin at 66%. Now turning to software for the quarter.
GastroPlus represented 57% software revenue, MonolixSuite was 18%, ADMET Predictor was 19% and other software was 6%. For the nine months, GastroPlus represented 55% of software revenue, MonolixSuite was 20%, ADMET Predictor was 18% and other software was 7%. During the quarter, our customer renewal rate was 96% based on fees and 87% based on accounts. These rates reflect the positive impact of our ongoing revenue harmonization program, offset slightly by non-renewals with smaller biotech customers. Generally, the smaller customer non-renewals were offset with price increases as reflected in the higher fee-based renewal rates. Average revenue per customer increased to $97,000, mainly due to higher prices and some seasonality in our software business.
We expect quarterly comparisons to prior periods to fluctuate through Q4 with our new seasonal expectations based on our revenue harmonization program. For the nine months, our customer renewal rate was 94% based on fees and 83% based on accounts. Average revenue per customer increased to $118,000, up from $108,000 last fiscal year. Shifting to our services business. The services revenue breakdown for the quarter was 45% from PKPD services, 23% from QSP/QST services, 25% from PBPK services and 7% from other services. The services revenue breakdown for the nine months was 48% from PKPD services, 20% from QSP/QST services, 25% from PBPK services, and 7% from other services. Other services consist primarily of the regulatory services we provide 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 increased 8% compared to last year and backlog decreased by approximately $1 million from last year to $16 million. The backlog decrease was primarily due to the QSP/QST services business. Turning to our consolidated income statement for the quarter. We saw an increase in total R&D costs primarily due to the development of the newest version of GastroPlus version 10, or GPX, and from an increase in personnel costs from market compensation adjustments. Total R&D costs in the quarter increased to $1.8 million compared to $1.4 million last year.
R&D expenses were $0.9 million compared to $0.7 million, and capitalized R&D was $0.9 million compared to $0.8 million. SG&A expense increased by $1.4 million or 21% to $8.2 million compared to $6.8 million last year. This increase was driven by an 11% increase in total headcount to meet our growing demand for our services business along with market compensation adjustments to attract and retain talent in this area. Additionally, we incurred $0.4 million in merger and acquisition costs. Income from operations decreased 17% to $4.1 million in the quarter, while operating margin was 25% compared to 33% last year. Interest and other income was $0.8 million this quarter versus an expense of $0.1 million last year due to returns from higher interest rates on our investment portfolio balance.
For the quarter, income tax expense was $0.9 million compared to $0.7 million, reflecting an effective tax rate of 19% this quarter compared to 15% last year. Net income decreased 2% to $4 million and diluted earnings per share remained at $0.20. The revenue impact for the quarter from foreign currency exchange was $0.1 million. Expenses related to M&A during the quarter were about $0.02 in diluted earnings per share. Adjusted EBITDA was $6.5 million and adjusted EBITDA margin was 40% compared to adjusted EBITDA of $6.5 million or 43% 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 operating expenses. We provide a reconciliation of this non-GAAP metric to net income to relevant GAAP metric in our earnings release and on our website.
Turning to our consolidated income statement for the nine months. Our total R&D costs were $6 million or 14% of revenue compared to $4.7 million or 11% of revenue last year. The increase was primarily due to the development of the newest version of both MonolixSuite version 2023 R1 and GPX, along with an increase in personnel costs from market compensation adjustments. R&D expenses were $3.4 million compared to $2.4 million last year. Capitalized R&D was $2.6 million compared to $2.3 million last year. For the nine months, SG&A expense increased by 34% to $23.3 million or 53% of revenue compared to $17.4 million or 41% of revenue last year. This increase was primarily due to a $4.3 million increase in employee and labor-related expenses. Additionally, we incurred merger and acquisition costs of $0.8 million.
Income from operations decreased 37% to $9 million, while operating margin was 20% compared to 34% last year. Interest and other income was $2.6 million versus a nominal amount last year due to interest income of $2.6 million, driven by the increase of interest rates. Income tax expense was $2.2 million compared to $2.7 million last year, reflecting an effective tax rate of 19% this year, similar to last year. We expect our effective tax rate for the fiscal year to be in the range of 19% to 21%. Net income decreased 18% to $9.4 million and diluted earnings per share decreased to $0.46. The revenue impact for the nine months from foreign currency exchange was $0.6 million. Expenses related to M&A during the year were about $0.04 in diluted earnings per share.
Adjusted EBITDA was $15.7 million and adjusted EBITDA margin was 36% compared to adjusted EBITDA of $18.7 million or 44% margin last year. Now turning to our balance sheet. We ended the quarter with $122.4 million in cash and short-term investments. The change from last year was primarily driven by the addition of $15.5 million in free cash flow, less $3.6 million in dividend payments and $20 million for our accelerated share repurchase. We concluded the ASR with Morgan Stanley during the quarter and received a total of 492,041 shares at an average cost per share of $40.65. The repurchased shares were retired and treated as authorized unissued shares. As Shawn discussed earlier, we recently acquired Immunetrics. And under the terms of the agreement, we agreed to pay the shareholders of Immunetrics cash consideration at closing in the amount of $15.5 million, including a $1.8 million hold-back plus two future earnout payments in the aggregate amount of up to $8 million based on the revenue performance of Immunetrics through December 31, 2024.
We continue to be well capitalized, have strong free cash flow and seek opportunities for strategic acquisitions, investments, and partnerships. I will now turn the call back to you, Shawn.
Shawn O'Connor: Thank you, Will. Our team delivered solid results this quarter despite a challenging operating environment. We have been executing on our strategic priorities and, as a result, are delivering profitable growth, generating cash and strong returns for our shareholders. As such, we remain well positioned to meet our stated goals for fiscal 2023, which include: year-over-year revenue growth in the range of 10% to 15%; total revenue between $59.3 million to $62.0 million; software revenue mix between 60% and 65%; services revenue mix 35% to 40%; diluted EPS of $0.63 to $0.67. We announced this range in October not including any impact from M&A activity. Through the end of the third quarter, we have incurred M&A expenses of $0.04 and anticipate an additional M&A expense of $0.05 in the fourth quarter.
Regarding the Immunetrics acquisition, based upon the timing of the acquisition close and its historical seasonality, Immunetrics' fourth quarter revenue contribution will be positive, but limited. This revenue contribution is contemplated in our 10% to 15% overall revenue growth guidance. Q4 Immunetrics' operating results will be accretive to earnings. We will provide fiscal year '24 guidance for Immunetrics in conjunction with our guidance for the entire business at the end of our fiscal year '23. In conclusion, our ability to create value for our customers by using innovative solutions is transforming drug development R&D, optimizing treatment options and improving patient lives. As a result, we continue to see greater adoption of our solutions to reduce costs and save time across the industry.
Thank you for your time and attention. With that, I'll turn the call over to the operator for the question-and-answer session.
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