Simulations Plus, Inc.
Q3 2022 Earnings Call Transcript

Published: 6 Jul 2022

[Operator:]

Greetings, and welcome to the Simulations Plus Third Quarter Fiscal 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce Brian Siegel from Hayden IR. Thank you, Mr. Siegel, you may now begin.

[Brian Siegel:]

Good afternoon, everyone. Welcome to our third quarter fiscal 2022 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 would like 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 recording, 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 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 in the sustainable markets. Further information on the Company’s risk factors is contained in the Company’s quarterly and annual reports and filed with the United States SEC. With that said, I would like to turn the call over to Shawn O’Connor. Shawn?

[Shawn O’Connor:]

Thank you, Brian. We had another strong quarter with growth across both our software and service businesses and encouraging underlying data supporting our long-term view for sustainable top and bottom line growth. The 17% revenue growth was purely organic. Our software business grew 16% year-over-year and accelerated growth rate compared to last year. We experienced growth across all our client segments, but saw improving penetration into smaller customer accounts. This is an indicator of deeper adoption of modeling and simulation throughout the industry. In addition, initiatives to grow our geographic presence and expand cross-selling are benefiting our software business. As I said last quarter, we expected our services backlog to support increased revenue growth during the second half of our fiscal year. In this quarter, we experienced this with service revenue increasing 19% in the quarter. We maintained strong operating leverage during the quarter, generating significant profitability and free cash flow. EPS grew to $0.20 per share, and our adjusted EBITDA margin was 42%. Moving to our third quarter software highlights. GastroPlus revenue increased 19%. We signed 6 new commercial clients and made 14 upsells. Additionally, we saw good growth from Asia despite significant foreign currency exchange rate impacts. I’d also note that GastroPlus was referenced in 16 peer-reviewed journals during the quarter, supporting our progress in making simulation and modeling mainstream in drug development. In April, we announced a new funded collaboration with a large pharmaceutical company to expand and validate the mechanistic in vitro dissolution models using DDDPlus software. Recent enhancements to the tool are focused on improvements to in vitro analysis. Through this new collaboration, we will expand into the injectable product space and apply our novel approaches to capture dissolution kinetics within in vitro systems designed by our industry partner. This funded collaboration is specific to DDDPlus, but the results will benefit users and developers of GastroPlus. MonolixSuite revenue increased 8% for the quarter and is up 31% year-to-date. Growth rates declined in the quarter due to the timing of renewals. We signed 10 new commercial clients, and the pattern of significant upsell upon renewal of existing customers continued. We continue to believe that MonolixSuite is taking market share in established markets and expanding its addressable market geographically in China and Japan. ADMET Predictor delivered 7% revenue growth in the quarter, but is still up 14% year-to-date. We added 6 new commercial customers and had 9 upsells in this quarter. We released version 10.4 of ADMET in the quarter, allowing users to create 3D chemical structures within the software to access property prediction models derived from our cutting-edge 3D descriptors. Turning to services. PK/PD revenue increased 29%, reversing trends -- recent trends and increasing our year-to-date growth in this area to 4%. Our good bookings result in the first half of the year contributed to a 69% year-over-year increase in the number of projects worked in the third quarter. Encouraging trends include increased consultant utilization, normal volume of project disruptions and higher project pricing yields, which contributed to margin expansion. With improved bookings and a higher backlog, we are optimistic about the prospects for our PK/PD services business overall. During the quarter, Lixoft and Cognigen completed a newly funded project from the U.S. Food and Drug Administration and the Center for Research on Complex Generics to establish the suitability of model-integrated evidence to demonstrate bioequivalence for long-acting injectable and implantable drug products. We proposed a novel delivery design to alleviate bioequivalence trial’s lower power or long duration for long-acting injectables. The results were presented at an FDA-sponsored workshop. This project was a great opportunity to leverage our scientists and developers across the organization to show the need and relevance of the population modeling approach for LAI products and bioequivalence calculations. QSP/QST revenue increased 1% for the quarter and has grown 4% year-to-date. As you recall, this segment saw significant bookings acceleration in Q2 that allows the QSP and QST team to commence planning and initiate many of these projects in Q3. Revenue from these projects will more fully impact future quarters. PBPK revenue increased 83% this quarter and is now up 37% for the year, and the number of projects is up 152%. The performance reflects the deeper implementation of PBPK modeling into new use cases and an increase in the perceived value of these projects and the impact on drug development cycles. Overall, our services backlog continued to grow, increasing 34% during the quarter, providing further evidence that the challenges and disruptions in the second half of last year are behind us. On the heels of our robust performance year-to-date, heading into the fourth quarter, we are currently at the high end of our 10% to 15% revenue guidance for the full year. Given that we are nearly halfway through the quarter, we’re comfortable narrowing our guidance range to $52 million to $53 million or 12% to 15% growth. Within these ranges, we expect software to be approximately 60% of total revenue. Note that the fourth quarter is typically our seasonally slowest quarter. On the software side, the seasonal impact is especially prominent for Lixoft, where buying decisions are typically made early in our fiscal year, driving higher revenue growth rates in the first half of the year. On the services side, it is common for projects to be pulled forward into our third quarter or pushed out of our fourth quarter into our fiscal first quarter. This is due to our customers taking vacation time during the summer months especially in Europe. Concerning M&A, we continue to evaluate opportunities, and we are seeing some levels of valuation rationalization. We will update you when there is something to announce. Let me now turn the call to Will to discuss the financial results.

[Will Frederick:]

Thank you, Shawn. Total revenue growth rate was 17% in the quarter, comprised of 16% software growth and 19% services growth. Software represented 64% of revenue during the quarter, which continues to be above our 55% to 60% fiscal year guidance. Our total revenue growth rate was 15% year-to-date, with software growing 20% and services growing 8%. Software accounted for 63% of total revenue and services contributed 37%. Software gross margin was 92% for the quarter, up from 90% last fiscal year due to higher revenue and leverage from the cost of revenue line. Service margin was 66%, up from 63% last fiscal year due to improved consultant utilization and an increase in higher-margin services projects. Total gross margin increased year-over-year to 83% due to the higher software mix. Software gross margin was 92% year-to-date, up from 89% last fiscal year. Services margin was 62%, essentially flat to last year. Total gross margin increased slightly to 81% due to the higher software revenue mix. For the quarter, GastroPlus represented 67% of software revenue, MonolixSuite was 11%, ADMET Predictor was 17% and other software was 6%. Year-to-date, GastroPlus represented 59% of our software revenue, MonolixSuite was 18%, ADMET Predictor was 17% and other software was 6%. For the quarter, our renewal rate for commercial customers was 92% based on fees and 87% based on accounts. As a reminder, our quarterly renewal rates fluctuate year-to-year when customers renew before their license term ends in the following quarter or the following quarter after their license terms ends in the current quarter. The decrease in the renewal rate based on fees this quarter was also impacted by foreign currency exchange rates. Average revenue per customer dipped slightly this quarter, but remains relatively in line with historical trends. This reflects our normal price increases and ongoing upselling efforts, offset by changes to our discount structure for multiyear deals. Year-to-date, our renewal rate for commercial customers was 96% based on fees and 89% based on accounts, which continue to be in line with historical rates. Average revenue per customer is down slightly year-to-date, but remains relatively in line with historical trends. We also now have 190 University+ customers in 49 countries. As previously mentioned, this program offers free use of our software for students and educators to help prepare the next generation of scientists and contribute to the rapid development of safer, lower-cost treatments for patients worldwide. Shifting to our services business. Our third quarter services revenue breakdown was as follows

[Shawn O’Connor:]

Thank you, Will. Through three quarters, the year is unfolding as expected with continued strength in our software business and a noteworthy rebound for our service business. New versions of our software, expansion into new geographies and improved cross-selling give us confidence in our software revenue growth, while an increasing backlog with significant increases in the number of projects in our service business give us confidence that we are well positioned headed into fiscal ‘23. Longer term, the use of modeling and simulation solutions as a way to bring in silico-based efficiency to the drug development market continues to expand. Increasingly, our solutions are core parts of a robust drug development program and the use of our solution by regulators and our University+ program validate our place in this ecosystem. In addition, the increased use of our software by smaller biotechs is a positive leading indicator demonstrating that a growing number of clients are adopting our modeling and simulation solutions. In February, we conducted our second annual Model-Informed Drug Development, or MIDD conference, featuring speakers from the FDA; the Brazilian regulatory agency, Anvisa; Health Canada; and MHRA UK. This event provided attendees with case studies, global regulatory perspectives on the development and validation of MIDD. We also had sessions covering the building and validating and machine learning models and using population PK/PD approaches to support late-phase dose selection. I’m particularly proud of the Women in Science roundtable, led by Cognigen’s Divisional President, Jill Fiedler-Kelly. This event highlighted meaningful topics for women within the scientific pharmaceutical industry, including the power of mentorships, closing the STEM gap and bringing your authentic self to the workplace. All talks are available for replay in the Simulations Plus resource center and on our YouTube channel. With that, I’ll be happy to take your questions. Operator?

[Operator:]

Our first question comes from the line of Matt Hewitt with Craig-Hallum.

[Matt Hewitt:]

Good afternoon, and congratulations on the strong quarter. Maybe just a few questions. First one, high level, Shawn, what are you seeing in the market? Obviously, there’s been a lot of concern over the past quarter or so regarding pharma, biotech, funding, given what’s happened in those markets. Anything that you’re seeing, I think, would be helpful.

[Shawn O’Connor:]

Yes, Matt, thanks. Our visibility is actually quite positive in terms of both, small pharma and small biotech. Their investments in modeling and simulation, which has historically lagged the larger players in the industry has really picked up, not just in the sense of consulting acquisition, but also in movement of modeling people into their organization, hiring earlier. I think that’s reflective of the recognition of modeling and simulation, the impact it can have and commitment to it from top to bottom in the industry. Certainly, the funding challenges are out there, especially in the biotech segment. And we’re cautious in terms of counting on that business in the long haul. But we’ve seen a pickup in terms of number of customers there, albeit small footprints in terms of small projects, single seat licenses and whatnot. And so, I see the positive in terms of it being endorsement in terms of modeling and simulation and its penetration of adoption, and yet cautious in terms of those organizations that are on a tighter budget today because of the funding situation.

[Matt Hewitt:]

That’s helpful. Thank you. Maybe a question regarding the income statement. How should we be thinking about gross margins here in the fourth quarter? You provided some revenue guidance. Should we anticipate that maybe the software gross margins kind of stay in that low-90s range? But, I’m not quite sure what we should anticipate from a service margin as you kind of see a slowdown here as you typically do in the fourth quarter.

[Shawn O’Connor:]

I think our service margin has been relatively flat through the last number of quarters. I think we’ve been seeing some efficiencies brought into play there. But we also see a lot of pressure in terms of the compensation side of the scientific staff side. So, the biggest impact in terms of our blended gross margin is going to come from that net of software revenues and consulting purchase -- consulting revenues. And we’ve been running ahead of that 60-40 split that we’ve typically been at with software being a little bit higher than 60% and that’s helped our overall margins here during the year. That should continue. We’re seeing in the fourth quarter, it is our slower quarter for both sides of our business, both on the software side, not a lot of software decisions made in the summer months in the middle of our clients’ fiscal years and the natural slowdown that occurs from vacation season coming into play in terms of the consulting side of the business.

[Matt Hewitt:]

Got it. One last one, and then I’ll hop back into Q&A. And maybe, Will, if you could help me with this. I’m just -- just out of a curiosity, did you run a constant currency renewal rate for the software business that you mentioned that the currency or FX was part of the decline that you saw there? I’m -- just out of curiosity, what was the constant currency renewal rate?

[Will Frederick:]

Yes. It would have upticked a couple of percent. I mean, we had about a $200,000 impact on currency exchange this quarter.

[Operator:]

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

[François Brisebois:]

Hi. Congrats on the quarter. Just a couple of questions here. In terms of guidance for next year, can you just remind us maybe historically what gives you the confidence to start looking at that kind of guidance?

[Shawn O’Connor:]

Yes. Thanks, Frank. I mean, we’ll get to guidance time in terms of next year at the end of the quarter. We came out this year with a 10% to 15% guidance reflected certainly a lot of momentum on the software side of the business as we came into the quarter, but service business that ramped out the fiscal year ‘21 into fiscal year ‘22. As we look forward into ‘23, we’ll be coming off of a continued strong performance on the software side across our 3 -- each of our 3 main product areas, GastroPlus, Monolix and ADMET Predictor. And on the service side, we’ve certainly, in the first half of this year, built back up our backlog that drives that business. And we’re starting to see a return to good profit or good growth in the second half of the year. So, going into next year, certainly have both sides of our business operating much more out of strength as opposed to where we started this year. So, I would anticipate -- in a few months when we close the year out and issue guidance for next year, I would hope that we continue to see robustness of the business into next year.

[François Brisebois:]

Great. And then, if you expect software to be greater than 60%, should we see that as -- with a similar revenue guide, should we see a little trim on the services side versus what you had expected the bookings -- the service bookings, were they a little softer than expected? Just any color there?

[Shawn O’Connor:]

In terms of the fourth quarter specifically, Frank, or longer term?

[François Brisebois:]

Yes. Well, the 60% growth on the final year, right? So, maybe so far what you’ve seen in service bookings, and if you’re expecting on the year greater -- going from 55% to 60% to greater than 60%, should that imply that with similar revenue range, should that imply that maybe there’s a little softness on the services side versus prior expectations or no?

[Shawn O’Connor:]

Yes. Historically, the fourth quarter is relatively soft on the services side. So, that’s what that mix between the two businesses, also on both sides of our business, it’s more dramatic on the service side. Yes.

[François Brisebois:]

Okay, great. And then, on -- I know that you mentioned that you’ll talk about it when it’s time to actually kind of when there’s something to say. But when you talk about the valuations making a little more sense from the M&A front, is that from discussions? Is that people starting to realize maybe their valuation used to be a little high? Or just any color at all there you can give would be helpful.

[Shawn O’Connor:]

Yes. I mean it’s multiple discussions ongoing and some new discussions out there. Clearly, the market impact in terms of the people view their alternatives are perhaps going public, getting private funding or partnership through acquisition. Certainly, the opportunity that is presented to them from either of the other two directions in terms of IPO or funding is a little bit more challenging now. And therefore, the in which the acquisition alternative is being looked at on the part of potential partners out there is certainly picked up of late. So, valuation is always a negotiated item, not something that is simple, but certainly compared to 1.5-year ago, when both factors were a little different, funding alternatives existed with a little bit more opportunity and the IPO opportunity was also a little stronger. Discussions today are certainly much better in terms of valuation.

[François Brisebois:]

Okay. That’s helpful. Thank you very much, and congrats again on the quarter.

[Shawn O’Connor:]

Yes. Take care.

[Operator:]

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

[Dane Leone:]

Hi. Thanks for taking the questions, and congratulations on the progress. Maybe one more specific on the services side. I guess, just looking at the comps, right, there may have been more of an expectation for growth on the services side this quarter. And I think the absolute number is still below the comp for 2020 Q3. Granted, it’s kind of a marginal Q-on-Q decline in the backlog to $16.7 million versus $17 million last quarter. Just curious so for maybe more expectations around the fourth quarter and something you’re seeing in the fourth quarter right now is a trend that suggests there might be a little softness in the fourth quarter on services versus what you had been expecting. The reason -- obviously, the reason for this line of questioning is for all the biotech companies that I cover and work with, there is clearly more of a funding issue and more rationalization in terms of the spending as we’ve gone into the middle part of this year. Thank you.

[Shawn O’Connor:]

Yes. Fair enough, Dane. Our softness, if anything, in the service side of the business is -- comes back to vacation. One of my observations is that after a couple of high COVID-impacted years and finding -- people are taking vacations that they didn’t normally take in the last couple of years as they were maybe homebound and whatnot. So, if anything, we’re just seeing an exaggeration of that seasonality. It’s not driven in any way by a cancellation on projects or slow bookings at all. We continued to grow service backlog 30-plus-percent during this past third quarter. So, the business is being put there. The small biotechs out there, we’re a small segment of our customer base and therefore, not as impactful in terms of the shifts of their success funding and increases in spending or decreases in spending. And while we’ve seen an increase in the number of customers in that segment, that still is a small portion of our overall service business or software business as a whole. So, a little softness, service business continued to step up on its performance off of where we were at the beginning of the year, will continue to improve, but will reflect the seasonality of our summertime quarter.

[Dane Leone:]

And maybe one follow-up, if I could. In terms of conducting potential business development deals or right acquisitions, are you getting more positive on the ability to execute transactions on the services side or on the software side? Thank you.

[Shawn O’Connor:]

I wouldn’t say my view is shifting there at all. Opportunities exist on both sides of the ledger there. Software in terms of products that would be good tuck-ins and extensions of our portfolio of data analytical tools. On the service side, we’re always looking for opportunities, a, to bring in a good skill set of scientific consultants and the book of business, expand our service offerings there, and especially looking to extend our geographical coverage, which is primarily focused in the North America region. So, has there been any change in terms of either our target population out there or our preference? The answer would be no. And in terms of valuation discussions, I would say, the change in evolution in terms of valuation discussions are very similar on both sides of the ledger there.

[Dane Leone:]

Thanks. And maybe a final question for me. Could you just update us in terms of the business strategy in Asia to get exposure? And any hiring you’ve done over there or just kind of plans for the remainder of the year? Thanks.

[Shawn O’Connor:]

Yes, certainly. We -- Asia is a distributor-covered marketplace for us. We have distributors too in China, North Korea -- excuse me, South Korea, Japan, and India. Asia market in Japan has been our highest performer historically. We’re seeing good growth and good opportunity in each of those regions, and we’re starting. This last quarter, we hired a direct employee in the India market to assist our distributor there a little bit more timely and approximate geographically as well as take on some consulting service opportunities that we saw in that marketplace. So, I think that will continue to evolve in terms of our looking to place more resources to supplement our distributors on a go-forward basis in that region of the world.

[Operator:]

And it looks like there are no further questions at this time. I would now like to turn the floor back over to Mr. Shawn O’Connor for closing comments.

[Shawn O’Connor:]

Thanks, operator, and thanks, everyone, for your interest in the Company and joining the call today. I look forward to reporting again in a short interval of time next quarter at the end of our fiscal year. Take care.

[Operator:]

And this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.