Simulations Plus, Inc. (SLP) Q2 2022 Earnings Call Transcript

Simulations Plus, Inc. (NASDAQ: SLP) Q2 2022 earnings call dated Apr. 06, 2022

Corporate Participants:

Brian Siegel — Investor Relations

Shawn O’Connor — Chief Executive Officer

Will Fredrick — Chief Financial Officer

Analysts:

Francois Brisebois — Oppenheimer — Analyst

Lucas Baranowski — Craig-Hallum Capital Group — Analyst

Presentation:

Operator

Greetings, and welcome to the Simulations Plus Second Quarter Fiscal 2022 Financial Results Conference Call. [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 now begin.

Brian Siegel — Investor Relations

Good afternoon, everyone. Welcome to our second quarter fiscal 2022 financial results conference call. Hosting the call today are Simulation Plus’ CEO, Shawn O’Connor; and CFO, Will Frederick. An opportunity to ask questions will follow today’s presentation.

Before beginning, 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 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, and a sustainable market. Further information on the company’s risk factors is contained in the company’s 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?

Shawn O’Connor — Chief Executive Officer

Thank you, Brian. Second quarter was another successful period for Simulations Plus. Revenue growth of 13% was in the upper half of our guidance range, and we continued to make strategic and operational progress across both segments of our business. We are well positioned to achieve our full year goals. The 13% revenue growth was purely organic and surpassed the 11% organic growth rate in the last year’s second quarter. The primary growth driver remains our software business, which grew 25% year-over-year organically versus organic growth of 16% last year, excluding the contribution of Lixoft. This 9% improvement demonstrates how powerful the Lixoft acquisition has been for the company.

Revenue from our service business declined 5%, in line with expectations. The total backlog of our service business increased 50%, suggesting that service revenue will return to growth in the second half of fiscal 2022. Strong operating leverage and the mix shift towards software drove 40% diluted EPS growth to $0.21 and an adjusted EBITDA margin of 48%.

Moving to our software highlights. GastroPlus revenue increased 22% compared to 16% in the second quarter last year. We signed three new commercial clients and had eight upsells in the quarter. China, a relatively new market for us, grew 34% off a small base, validating our decision to engage additional distribution to this growth market. I’d also note that GastroPlus was referenced in 18 peer-reviewed journals during this quarter, supporting our progress in making simulations and modeling mainstream in drug development.

We also released MembranePlus 3.0 to drive advances for in vitro, in vivo, extrapolation for permeability, skin penetration and release assay systems.

Once again, MonolixSuite revenue continues to set the pace for our software segment. Revenue increased 43%, more than double the 20% growth rate last year, driven by strong renewals and upsells. We signed eight new commercial clients and had 11 upsells during the quarter. Additionally, our efforts to expand the addressable market geographically for MonolixSuite, include the distribution in China and Japan starting to pay off.

MonolixSuite provides users with a fast, uncomplicated and powerful suite of applications for pharmacometrics analysis. In January, we released an update that added a new module and a new model editor among other enhancements. The overall result is improved performance for data, libraries and algorithms, and we are confident in our ability to innovate and grow our technological advantages leading to further share gains.

ADMET Predictor delivered 13% revenue growth in the quarter compared to 20% in the year ago period. We added seven new commercial customers and had eight upsells in the quarter. We continued to advance our AIDD collaboration.

Turning to our services highlights. PK/PD services revenue declined 14% while the backlog increased 18% in the quarter. Year-to-date revenue declined 6%. The relatively high number of project disruptions that impacted the business during the second half of fiscal 2021 continues to normalize. We booked eight new projects from four new customers and from for continuing customers, demonstrating our strong demand and bolstering our confidence in a normalization of services revenue.

Given the cadence and moving from bookings to revenue, we view bookings during the first part of the fiscal year as a key leading indicator of positive revenue growth in the second half of the fiscal year. With improved bookings and a higher backlog, we’re optimistic about the prospects for our PK/PD services business overall.

QSP/QST revenue declined 12% for the quarter while backlog increased 78%. Year-to-date revenue increased 4%. This service segment is returning to pre-COVID-19 [Technical Issues] with a good mix of both efficacy and toxicology business and collaborations.

Last week, we announced that we secured a Phase 2 SBIR NIH grant to develop further and validate our BIOLOGXsym platform. This platform is the quantitative systems toxicology software focused on complex macromolecule liver safety. The grant provides approximately $1.7 million for internal software development and wet lab work over two years through our partnership with the University of Pittsburgh Drug Discovery Institute. The institute will utilize a next-generation organ on a chip system that compares liver toxicity in liver cells collected from healthy donors versus those with liver disease. This allows for the screening for signals related to liver safety mechanisms and provides this data for BIOLOGXsym simulations.

In addition, we booked other important QSP projects during the quarter. GOUTsym will be a QSP model of uric acid and the propensity for therapeutic candidates to prevent crystal formation in joints, which leads to pain and inflammation. COMPLEMENTsym will be a QSP model of the complement pathway to support evaluation of therapeutic targets and candidate compounds for diseases impacted by the complement pathway, which includes many inflammatory and nervous system disorders. Our PBPK revenue was flat this quarter and backlog increased 113%. Year-to-date revenue increased 15%. We are seeing increasing demand for PBPK services as the use cases for PBPK expand and exceed industry capacity leading to more outsourcing.

In January, we announced two new funded collaborations. We are partnering with a large pharmaceutical company to modify the GastroPlus advanced compartmental absorption and transit model, or ACAT, in support of ongoing research programs for the treatment of gastrointestinal diseases. The second is with a large animal health company to both validate current animal PBPK models and to add critical new species to the GastroPlus platform.

As a reminder, funded collaborations is strategically important to us. First, it further solidifies our relationship with an existing customer. Second, it helps us reduce our R&D costs and ensure that our innovation is aligned with the customers’ immediate needs. Finally, we own the IP that comes from these collaborations and can use it with other customers as well. This proven strategy is an important tool for ensuring GastroPlus retains its industry leadership.

Overall, our services backlog increased 50% during the quarter, further evidence that the challenges and disruptions in the second half of last year are behind us. As a result, we expect this business to return to growth in the second half of this fiscal year.

Our fiscal year-to-date performance gives us confidence in our guidance. Our software business continues to deliver accelerated growth rates that are driving strong profitability. In addition, our services business is recovering and should contribute to consolidated growth in the second half of the fiscal year. Accordingly, we should exit fiscal 2022 at a pace that supports our longer-term expectations for 15% or better organic growth with any acquisitions incremental to this number.

With respect to M&A, we continue to look for strategic opportunities to increase our total addressable market and accelerate our growth rates.

Let me now turn the call over to our CFO, Will Frederick, to discuss the financial results.

Will Fredrick — Chief Financial Officer

Thank you, Shawn. Our total revenue growth rate was 13% in the quarter. The strong growth of 25% in our software business positively impacted our mix, and software was 66% of total revenue this quarter. Our services business declined 5%, and it contributed 34% of total revenue.

Our total revenue growth rate was 14% year-to-date. Software revenue growth was 23%, and services revenue growth was 2%. Software accounted for 63% of total revenue, and services contributed 37%. Our software gross margin was 92% for the quarter, up from 89% last fiscal year due to increased revenue and slightly lower cost of revenue. Our services margin was 59%, down from 61% last fiscal year due to lower revenue and an increase in lower-margin QSP/QST services projects.

Our total gross margin increased year-over-year to 81% as a result of the improving software revenue mix. Our software gross margin was 91% year-to-date, up from 88% last fiscal year due to increased revenue and slightly lower cost of revenue. Our services margin was 60%, down from 63% last fiscal year due to increased salaries and an increase in lower margin services projects, including training and workshops. Our total gross margin increased slightly to 79% as a result of the improving software revenue mix.

We continue to enjoy a diverse mix of software revenue in the quarter with solid growth across our entire product portfolio. For the quarter, GastroPlus was 56% of our software revenue. MonolixSuite was 23%. ADMET Predictor was 14%, and other software was 7%. Year-to-date, GastroPlus was 55% of our software revenue. MonolixSuite was 22%. ADMET Predictor was 17%, and other software was 6%.

For the quarter, our software renewal rate for the commercial customers was 96% based on fees and 87% based on accounts. As a reminder, our renewal rates fluctuate quarter-to-quarter due to customers who either renew early in a quarter before their license term ends or late in the following quarter. We saw an increase in our average revenue per customer this quarter compared to the prior year quarter. This change reflects our normal price increases and ongoing upselling efforts, offset by changes to our discount structure for multiyear deals.

Year-to-date, our software renewal rate for commercial customers was 96% based on fees and 90% based on accounts. Renewal rates for commercial customers, on average, continued to be in line with historical rates in the mid-90s based on fees. Average revenue per customer year-to-date was the same as the prior year period. And we now have 124 University+ customers in 39 countries. We believe this program, which offers free use of our software for students and educators, will 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 second quarter services revenue breakdown was as follows: 44% from PK/PD services, 30% from QSP/QST services, 19% from PBPK services and 7% from other services. Our year-to-date services revenue breakdown was as follows: 45% from PK/PD services, 30% from QSP/QST services, 18% from PBPK services and 7% from other services.

Regarding key service metrics, total services projects increased 45% this quarter compared to the prior year quarter, and we ended the quarter with $17 million in backlog, up $6 million from the prior year quarter.

Now turning to our consolidated income statement for the quarter. Total R&D costs for the quarter were $1.6 million or 11% of revenue compared to $2 million or 16% of revenue last fiscal year. R&D expenses were $0.9 million or 6% of revenue compared to $1.3 million or 10% of revenue in the same period last year. Capitalized R&D was $0.7 million or 5% of revenue compared to $7 million or 6% of revenue in the same period last year.

SG&A expense for the quarter was $5.6 million or 38% of revenue compared to $5.4 million or 42% of revenue last year. The slight increase in expense was primarily due to increases in selling and marketing costs, software license and maintenance costs and higher insurance costs, partially offset by decreases in compensation costs and lower state and local taxes.

Income from operations was $5.5 million, an increase of 57%. And operating margin expanded to 37% from 27% last year. Income tax expense was $1.1 million for an effective tax rate of 20% compared to income tax expense of $0.2 million and an effective tax rate of 6% last year. Last year, we saw a lower effective tax rate, primarily driven by the tax benefit associated with disqualifying dispositions.

Net income increased 37% to $4.4 million compared to $3.2 million last year, and diluted earnings per share increased 40% to $0.21 compared to $0.15. Adjusted EBITDA and adjusted EBITDA margin was $7.2 million or 48% compared to $5 million or 38% last year. As a reminder, adjusted EBITDA is calculated by adding back stock-based compensation expense and when applicable, any expenses related to M&A or other noncash nonoperating expenses.

We provide a reconciliation of this non-GAAP metric to net income, the relevant GAAP metric, in our earnings release as well as on our website. For our year-to-date income statement, total R&D costs year-to-date were $3.3 million or 12% of revenue compared to $3.5 million or 15% of revenue last fiscal year. R&D expenses were $1.8 million or 7% of revenue compared to $2.1 million or 9% of revenue in the same period last year. Capitalized R&D was $1.5 million or 6% of revenue compared to $1.4 million, also 6% of revenue in the same period last year.

SG&A expense year-to-date was $10.6 million or 39% of revenue compared to $9.9 million or 41% of revenue last year. The expense increase was primarily due to increases in selling and marketing costs, software license and maintenance costs and higher insurance costs, offset by decreases in compensation costs and lower state and local taxes. Income from operations was $9.3 million, an increase of 42%, and operating margin expanded to 34% from 27% last year.

Income tax expense was $2 million for an effective tax rate of 21% compared to income tax expense of $0.7 million and an effective tax rate of 11% last year. As mentioned, last year, we saw a lower effective tax rate, primarily driven by the tax benefit associated with disqualifying dispositions.

Net income increased 31% to $7.4 million compared to $5.7 million last year. And diluted earnings per share increased 33% to $0.36 compared to $0.27. Adjusted EBITDA and adjusted EBITDA margin was $12.4 million or 46% compared to $9.3 million or 39% last year.

This quarter, we continued to strengthen our balance sheet with cash and short-term investments of $124.6 million and no debt. As a result, we are well capitalized with sufficient cash to support our continued expansion through internal investment and potential M&A activity.

I’ll now turn the call back to you, Shawn.

Shawn O’Connor — Chief Executive Officer

Thank you, Will. In conclusion, the first half of fiscal 2022 gives us confidence that our business remains on a positive trajectory and that we are well positioned to achieve our full year outlook. Overall, we are targeting continued organic growth with a balance sheet that supports M&A when we fund the right candidates.

With that, I’ll be happy to take your questions. Operator?

Questions and Answers:

Operator

[Operator Instructions] And our first question comes from the line of Francois Brisebois with Oppenheimer. Please proceed with your question.

Francois Brisebois — Oppenheimer — Analyst

Hi. Thanks for taking the questions and congrats on the quarter. Just my first question here. This quarter-ended February, so I was just wondering, I think a lot of people were wondering about the pandemic impact. The last quarter you had ended November, so Omicron hadn’t really hit yet. So if you could just maybe characterize — it seems like there hasn’t been much. But do you think maybe some of the downturn, which seems to go in the right way on the services side, could have anything to do or just any impact at all from Omicron?

Shawn O’Connor — Chief Executive Officer

Yes, Frank, thanks for the question. The impact, if anything, was not very dramatic in total compared to where we were in the latter part of last fiscal year. The number of delays and cancellations has come back to kind of the normal level of a couple, three of those happening every quarter that we need to respond to versus where we were six months, half a year ago at nine in the third quarter of last year.

So relatively speaking, the impact of Omicron versus previous variants was much less. And certainly, at the level of business activity with our clients, the uptick in terms of the bookings in the quarter that led to the significant increase in terms of the backlog that we finished the quarter with, business operations of our clients and ourselves, obviously, were not as impacted dramatically at all. Maybe there’s still some churn in terms of clinical trials and some impact in terms of data flow, ability to commence projects, but nothing of a very dramatic nature.

Francois Brisebois — Oppenheimer — Analyst

Okay. Great. And on the software side, a strong quarter. The addition of the 18 new customers, can you just — I think you’ve touched on it a little bit, I think there’s three GastroPlus, eight MonolixSuite, but is this something that surprised you? Was this expected? Or where did those customers come from?

Shawn O’Connor — Chief Executive Officer

Well, they come from a really stepped-up process in terms of our business development activities, both internal and through our distributor network. The industry is coming back to work. Employees are moving. They are adding new scientists into their organization, all of which drives a new license opportunity for us. And so our activities in terms of investment in business development are continuing to pay off and dramatically as well in terms of upsells. The new customers’ activity is good. The upsell with our larger portfolio of products with the introduction of Lixoft is really kicking in. 40% growth with the Monolix product is something that we’re very proud of. I can’t say that we necessarily targeted at 40%, and we’re just seeing the benefit of that product displacing its competitor in the marketplace and taking both new customers, bringing on new customers and as well taking business away from the installed base of the competitive product.

The upsell program for Monolix, the typical sales process there as a customer takes a small set of license in its first bite and gets familiar with the product and the fact that when they come back to renew, they are almost every time taking more licenses to spread them through and displace the competitive product in their organizations speaks well. And that’s — that new customer this quarter for Monolix, a year from now will likely be a great upsell lead for us to work in terms of increasing the revenue for that client specifically.

So yes, software is certainly performing very well here across the board, across our three most significant platforms. The other category is growing as well. That other category primarily being the license of our QSP/QST models, which operate at a lower level simply because there aren’t that many clients that have the in-house capability of operating those models. So we’re seeing contribution from that other segment of our software as well.

Francois Brisebois — Oppenheimer — Analyst

Okay. Great. And just maybe lastly, a small decline, but that 5% decline with the increase in backlog and everything kind of normalizing. Can you just help us understand where — why the 5% decline here?

Shawn O’Connor — Chief Executive Officer

Yes. Frank, the biggest impact there is that a booking and new contract that we get typically is timed for work effort, project performance maybe three to six months out, sometimes longer. Yes, we occasionally get a deal that is a response — immediate response to an FDA inquiry to a client that we will sign and get started on very quickly. But more often than not, it is for work that’s going to be performed three to six months or more out there. And so while we picked up bookings in the last two quarters here, the first two quarters of the year, most of that work is out towards the back half of the year.

And our trough in the third and fourth quarter of last year, where bookings were low, that kind of translates to now six months later or at least the last three to six months where that gap in terms of new business and backlog was declining. That affects revenue three to six months later, and we’re in that period. So our 5% decline wasn’t dramatically different than our expectation. And we expect that the benefit of our uptick in terms of bookings and backlog to impact us in the back of the year — back half of the fiscal year.

Operator

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

Lucas Baranowski — Craig-Hallum Capital Group — Analyst

This is Lucas [Phonetic] on for Matt Hewitt. I guess, our first question is you’ve received some government grants recently. Can you give us a sense what the cadence of the revenue from those will look like?

Shawn O’Connor — Chief Executive Officer

Yes. Several grants, collaborations with some commercial clients as well. The biggest one, the one we just announced recently the grants in support of the QSP platform — should I say, QST platform BIOLOGXsym, $1.7 million grants.

It will be performed over about a two-year window of time. It is not perfectly linear. It’s as work is performed and milestones are achieved. But more or less over the next two years, that will contribute to revenue.

The other ones that’s an unusually longer-term one — actually normal for an NIH grant, but the collaborations with commercial clients, the FDA grants or FDA collaborations that we’ve engaged in of recent. Those can more typically be periods of two to three, maybe four quarters.

Lucas Baranowski — Craig-Hallum Capital Group — Analyst

Thank you. That’s helpful. And then geographically, are there any markets where you had been selling through a distributor, but you’re now going direct?

Shawn O’Connor — Chief Executive Officer

No changes of that nature, Lucas. Over the last six months or so, we’ve added a distributor in China in support of the MonolixSuite product line. We’ve added a new distributor in South America for GastroPlus ADMET Predictor. So we’ve added a couple of new distributors.

We are in the process of reviewing those relationships, not that we have any underperformers, but we believe that we can improve the revenue flow from those geographies by supporting those distributors in a little different way. So it’s an area of focus for us, but no issue, just an opportunity we think that sits there that we can go after.

Lucas Baranowski — Craig-Hallum Capital Group — Analyst

Thank you very much. That’s all I had.

Operator

And there are no further questions. At this time, I’d like to turn the floor back over to Mr. Shawn O’Connor for closing remarks.

Shawn O’Connor — Chief Executive Officer

Very good. Well, I appreciate everyone’s attention on our announcement today. I feel very confident in terms of the position we’re in to fulfill our expectations, the guidance and our business expectations for the back half of the fiscal year. Thanks for attending and look forward to updating you again soon. Take care.

Operator

[Operator Closing Remarks]