Simulations Plus - Earnings Call - Q1 2019

Transcript

Speaker 0

Good afternoon, everyone. Thank you for joining us. Hosting the call today is Simulations Plus' CEO, Sean O'Connor and the company's CFO, John Kneisel. Before beginning, I'd like to remind everyone that with the exception of historical information, the matters discussed in this presentation are forward looking statements that involve a number of risks and uncertainties. The actual results of the company could differ significantly from these statements.

Factors that can cause or contribute to such differences include, but are not limited to, continued demand for the company's products competitive factors the company's ability to finance future growth the company's ability to produce and market new products in a timely fashion the company's ability to continue to attract and retain skilled personnel and the company's ability to sustain or improve the current levels of productivity. 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, I'd like to turn the call over to Sean O'Connor. Sean?

Speaker 1

Thank you, Cameron. This was a strong start to what we expect to be another record year for Simulations Plus. We continued our long tradition of profitable growth and returning capital to shareholders. We delivered a record $7,500,000 in revenue for the first quarter, up 6.6% compared to the same quarter in the prior fiscal year. Our software revenue growth was strong for the quarter at 10% versus the same period last year.

Our consulting revenues were up 3% for the quarter compared to last year, constrained by resource capacity and two key project initiatives that slipped out of the quarter. Overall, our 6.6% revenue growth in the 2019 is in line with our historical annual revenue growth in the 10% to 15% range on an annual basis. The two key projects initiations I referred to are both in our DillySum division. The first, our Rinasum project that is funded by the previously announced $1,700,000 SBIR grant completed its Phase one effort during the quarter, at which point review of the effort was required before initiating Phase two. Work effort was suspended awaiting Phase two approval, which was not received until after quarter end.

Phase two, which includes $900,000 of funding for 2019 has now been initiated and is fully staffed. The second is a new contract with a large pharmaceutical company that closed just recently. Under this agreement, Dilisim will develop a QSP model that will provide the ability to predict efficacy of drugs being developed to treat idiopathic pulmonary fibrosis. The development is funded by our large pharmaceutical company partner for up to $2,700,000 over the next two plus year time frame. Upon completion, Dilisim will retain the rights to the model to market on a software licensing or consulting service basis to the rest of the industry.

We expect this project to contribute significantly to twenty nineteen revenues. Demand for our consulting services remains strong, and these are just two examples of that demand. I spoke last quarter of the challenge of meeting the services demand with the growth of our consulting resources to deliver on these opportunities. We have grown staff 9% year over year and during the quarter brought on board new staff as well. That new staff historically have a ramp up time before they become fully billable and our margins reflected that this quarter.

And we continue to seek additional qualified staff to support this side of our business. While software related revenue grew faster than consulting revenues this quarter, our forecast anticipates that consulting revenue growth will outpace software revenues over the course of the full fiscal year, And we have sales pipeline which supports this expectation. First quarter revenue growth was strong in the context of our historical seasonality trends, and we are in line with our historical organic annual growth in the 10% to 15% range on an annual basis. Our gross margins were slightly up for software revenue at 79% compared to 78% in the year ago quarter. But our consulting margins declined to 61% compared to 72% in the year ago quarter.

This decline was due to several factors. The aforementioned ramp up to normal billability levels for new staff, increased CRO costs at DilliSum, increased training revenues at Lancaster and increased reimbursable client expenses at Cognigyte, all of which are lower than average service margin revenue components. That said, our consulting margins this quarter are consistent with consulting margins reported for the last three quarters and do not indicate any significant change in margin expectation for 2019. Our 72% service revenue margin in the first quarter of last year was the highest experienced by the company. We expect service margins for this year to remain at or improve slightly over last year's service margin on a full year basis.

During the quarter, increases in SG and A expenses were related to increased revenue from international distributors with the resulting higher commission expenses as well as increased personnel costs in general. It was a very active quarter with regard to conference attendance and workshop activity. All of these efforts are in support of future revenue growth, and I would expect SG and A expense to normalize towards historical annual rates for 2019. And finally, our investment in R and D spending, while up as a percentage of revenues from last year's first quarter, continue to trend to trend at levels consistent with the last three quarters of fiscal twenty eighteen. Bottom line, I believe the first quarter saw success at the top line, and we have initiated several endeavors which will support the full year outlook for the company.

Turning to our fiscal first quarter results consolidated and by division. Consolidated revenues for the quarter reached $7,500,000 with a growth rate of 6.6% year over year. The mix of revenues changed slightly with software revenues up 2% to 55% of total revenues and consulting services down slightly to 45 from 47% last year. Net income before taxes was $2,000,000 or 27% of revenue for the quarter, and our earnings per share was $0.09 in Q1 twenty nineteen. We anticipate these metrics will return closer to historical levels for the year as a whole.

We generated $2,600,000 in cash from operations for the quarter and continued to return capital to shareholders through a quarterly dividend. In addition, during this period, we paid out $1,600,000 in scheduled acquisition payments to Dillison. The company had cash on hand at the end of the quarter of $9,400,000 At quarter end, the company had 96 employees, representing a 9% increase from the same time last year. Our Lancaster division revenues were up 8% year over year, reflecting 7% growth in software and a 12% increase in consulting services. This division of the company represented 58% of revenues and 74% of EBITDA for the 2019.

The quarter's revenue breakdown was as follows: 69% renewal, 15% new licenses and 16% consulting. Software renewal rates followed historical strong trends at 84% of accounts and 94% of fees. We continue to enjoy excellent long term relationships with our customers and benefit from very low churn rates as a result. New license units for the quarter were two ten, up 6% year over year. We added seven new commercial companies and 20 nonprofit groups this quarter.

New customer being either a new company or a completely new geographical division of a current customer. We ended the quarter with a headcount of 40 at Lancaster. Our Buffalo division revenues were up 5% for the quarter year over year. This division of the company represented 27% of revenue and 14% of EBITDA for the 2019. We acquired three new clients during the quarter and initiated 14 new projects.

The division currently has 31 project proposals outstanding with 26 companies. We ended the quarter with a headcount of 40 in Buffalo. Our DiliSum division revenues were up 1% in the quarter. This division of the company represented 15% of revenue and 12% of EBITDA for the 2019. The quarter's revenue breakdown was as follows: 75% DeliSim software and projects 14% NAFLD SIM software and projects and 11% RinaSim grant.

We ended the quarter with a headcount of 16 at RTP. Let me now turn the call over to John to review some detailed financial results. John?

Speaker 2

Thanks, Sean. The consolidated net revenue for our first quarter of the fiscal year were up 6.6%, as Sean said. It's approximately $467,000 to $7,500,000 compared to $7,100,000 for the prior year. By division, Lancaster revenues were up 8% to $4,400,000 Buffalo revenues were up 8% to $2,100,000 And as Sean said, RTP revenues were slightly up. Consolidated software and software related revenues were up $365,000 just under 10%.

The consulting service revenues were up $102,000 or 3.1%. During this quarter, we completed our implementation of the new revenue standard ASC six zero six revenue from contracts with customers. This had minimal impact on our current revenue. We expect it may have some impact on the timing of revenue recognition and service revenue margins on certain contracts going forward, but we don't anticipate significant changes to our annual historic service margins due to the minimal number of projects for which the standard changed revenue recognition. We used the retrospective method to make the adjustment.

This method allows for an adjustment to beginning retained earnings for the effect of the implementation. The total adjustment to retained earnings was about $690,000 A portion of that adjustment will become future revenue over the life of the contract. Gross profit increased slightly, remaining a strong $5,300,000 in the 1839 for this fiscal quarter. Sorry about that. Our cost of sales increased this quarter compared to the prior year due to the growth in labor count, salaries, and benefits.

That increase accounted for about $310,000. Additional software amortization was about 54,000, and we incurred 80,000 of direct contract costs, the majority for testing on related contracts in our North Carolina division. Gross profit margin for the 2019 was 70.8% compared to 75.4% in the prior year. The decrease was primarily the result of the increased staffing to meet the demands of the modeling and simulation projects that Sean has spoken about and anticipated growth in this area of our business. SG and A expenses were $2,200,000 or 36.1% of revenue for the first quarter of the fiscal year, an increase of $311,000 up 12.9 compared to $2,400,000 or $34,100,000 of revenue in the 2018.

The increase in SG and A expenses come somewhat from increased licenses and commissions on sales in Asia, but was primarily the result of wage and salary increases from stock comp, increased costs of a new full time CEO, and increased headcount in the divisions as well as higher part percentage of G and A allocation. Scientific personnel spent a little bit more time on G and A. These increases were partially offset by decreases in some trade show expenses that we saw in the period. Research and development, during the period, we incurred 984,000 of R and D costs. Of that amount, we expensed 530,000, which represented about 7% of our revenue, an increase of $168,000 or a 46.8% increase over the prior year in the expense portion, which was 5.1% of revenue in the first quarter last year.

This increase in research and development expenses was primarily a result of costs associated with research activities in North Carolina. Income from operations for the 2019 was 2.1 down $477,000 or 18% compared to $2,600,000 in the year ago quarter. It's primarily a result of the increased labor costs as we've been building staff and investing in R and D projects. Our provision for income taxes was $486,000 It was at an effective annual or effective rate of 24% in the quarter compared to $8.00 $1 in the prior year. That rate last year was just about 32%.

That tax rate decrease is attributable to the new tax act that became effective 01/01/2018. And those lower taxes have allowed us to invest in the operations of the business. Income decreased by $180,000 or 10.5% to $1,500,000 for the recent quarter compared to 1,700,000.0 in the year ago quarter. On a per share basis, net income was $09 per diluted share this quarter compared to $0.10 a year ago, down $01 per share. EBITDA was $2,800,000 in the first quarter of 'nineteen, down $13.8 compared to 3,200,000.0 in the prior year.

Next, turning to Slide 10. This is our revenue by quarter. This slide represents our revenue on a quarterly basis that goes back to 2015 through the most recent quarter. It illustrates with you the seasonality of the business with our third quarter typically being our strongest and a drop off in the fourth quarter coinciding with the typical shutdown in our clients' purchasing and project activities during the summer months. It also illustrates an unseasonably high growth in the 2017, which was sourced from our Buffalo division as well as the first quarter, including the results of our RTP division in June 2017.

On the next Slide 11, it's a view of our income from operations by quarter. This data again represents a general track record of increases both year over year and sequentially through the first and third quarters with the fourth quarter typically the lightest of the year. Next slide on net income by quarter. We see a similar pattern with the third quarter typically being the strongest. We shaded the effect of a $1,500,000 deferred tax benefit we received last year as it tends to skew the presentation without calling out that difference.

The next Slide 13. Diluted earnings per share, as would be expected, follows and tracks with the same pattern of net income. So we look at EBITDA on Slide 14. That also does follow the same metrics as the others. Going on to Slide 15.

This represents our worldwide view of sales. The majority of our revenues in North America, And you can see that Asia and Europe are strongly represented, but we also see them as a growing source of revenues for the company. On Slide 16, we provide this chart on a quarterly view of cash and cash outflows for dividends and acquisitions and the impact of cash balances over the last four years. We've actually put out over $30,000,000 in cash over the last five years. This chart shows the period for the last four years in it.

So beginning in the first quarter on the left side of 'fifteen, the blue bars at the bottom illustrate a consistent dividend payout. And then beginning in 2018, the board increased the quarterly dividend payment to $06 per share, up from $05 per share in those other periods of time. Moving up the chart, the red bar represents cash used for acquisitions. We spent nearly $15,000,000 over the past four to five fiscal years on acquisition related projects. Most notably, this slide has been our ability to not only to return cash to our shareholders through consistent dividends, we've been able to invest in growth for the future through acquisitions while maintaining a healthy balance sheet with ample cash.

We've had zero borrowed debt and we continue to increase the value of the company. And just today, with the earnings announcement, we announced our next dividend, which the Board voted on, and we will distribute $06 a share quarterly dividend payable February 1. Now I'll turn the call back to you, Sean.

Speaker 1

Thank you, John. In summary, this was a solid quarter for Simulations Plus, with good revenue growth reflecting the typical seasonality we have historically experienced. Our revenue outlook is positive and tracking to our growth expectations for 2019. During the quarter, we initiated efforts to recruit additional staff in support of our service businesses and invested in our sales and marketing efforts. These investments impacted our expense in this quarter but will position us well in quarters ahead to achieve anticipated profitable growth.

Certain expense lines like R and D will remain higher, but expected revenue growth in coming quarters should move us back towards historic profitability levels as expenses as a percentage of revenues are more in line with historical levels. This was a good start for fiscal twenty nineteen. We'll now open the call up for any questions you might have. Cameron?

Speaker 0

Thank you, Sean. As a reminder, if you'd like to ask a question using your telephone, please use the hand raising icon on the control panel and be sure to enter your unique audio PIN. I will start off with some of the written questions submitted on the call. Our first question is for the Lancaster division, what was the revenue renewal rate and how many new licenses were sold for the quarter?

Speaker 1

That was in the prepared speech. I'm just flipping through the page. The renewal rates on accounts were 84% and on fees were 94%. New accounts for the quarter were two ten, which was up 6% from the year ago quarter.

Speaker 0

Thank you. And is the two ten number, that's the new accounts for the quarter? I believe that might be the total accounts?

Speaker 1

New license units for the quarter. Great.

Speaker 0

The second question, is the aggregate level of first quarter twenty nineteen SG and A and R and D expenses the new baseline going forward or just incremental sequential increases?

Speaker 1

I think there if I understand the question right, incremental end of the first quarter here. We've initiated some investments in our service organization and the sales and marketing effort. And as revenue steps up in the 2019, On a percentage basis of revenues, we will come back in line with historical percentages. SG and A, as an example, stepped up to about 36% in the first quarter. Historically, we've been in the 32% to 34% range, and I would anticipate that during the course of the year or for the year as a total, we'll come back to that level.

The exception there is R and D expense, which we saw step up midpoint of last year. And that expense level will continue into 2019 at this new percentage of revenue rate.

Speaker 0

Thank you. The next question. For the Kiwi offering, how is the potential customer pipeline taking shape beyond the current five year project you're currently implementing?

Speaker 1

We continue to market Kiwi in aggressive but slow pace in the marketplace as the product is developed with feature functionality that's being funded through our client funded efforts, that product becomes more functional, more useful in the marketplace. Towards at the end of it, with the addition of these features, we think it'll be more marketable. It is, in the marketplace, a very muddy marketplace. And what I mean by that is that there are, several offerings, of that nature of the Kiwi's purpose in the marketplace. But probably more importantly, the large pharma companies all have internally developed products that serve these purposes.

So the sales and marketing effort is is a two step process of not only demonstrating the prowess of our product against other competitive products, but also in terms of convincing the large pharma to displace their internally built systems with a third party piece of software. So still feel good about the direction that we're headed at this point in time, but the pace is going to be impacted by this two step process in the marketplace.

Speaker 0

Thank you. Your next question. What role should the release of Billy Sims version 8A, which was released, I believe, two days ago, into the future growth opportunities?

Speaker 1

I think our release there demonstrates our ability to on a very rapid pace to process almost annual basis, if not better, in some regards, deliver new releases out there to marketplace with new functionality across our products that enhance not only the abilities that are in the hands of our installed base, but have the potential to extend into multiple hands, new cubicles, new scientists, functionality that they will find useful and support future new sales in those products. This quarter was deletion version eight, and we expect with each quarter a schedule of release of updates to all of our products.

Speaker 0

The next question is what percentage staff growth for this year do you anticipate?

Speaker 1

I hesitate to put out a number there. We're aggressively recruiting on the consulting side. Our 9% year over year growth from and the experience here in the first quarter is something that we'll be shooting for, for the year. It will be dependent upon our success rate on the recruiting side, but it will be something of that magnitude.

Speaker 0

Thank you. The next question is, is there any additional news or updates on the MRI or missile guidance applications?

Speaker 1

I characterize it that our effort there is still exploratory in terms of utilizing our AI and machine learning technology that is already developed and searching for new applications and new extensions of it, be they in those particular areas, or, remaining within the life sciences arena. While we are investing some time and effort in that, there is nothing of note to update with this quarter other than progress that we're making in terms of identifying potential opportunities, but too early at this stage to speak to at this point.

Speaker 0

Thank you. And our final question today is big picture question. In your view, how far along is and is the acceptance of simulation software applications within the drug development process?

Speaker 1

In general and globally, the adoption is there conceptually and the implementation of model based development in the marketplace is moving rapidly forward. And while we've seen some great success across the industry over the last number of years, we're very early stages in terms of the depth of its penetration and fullness of its application. Specifically, with regard to our offerings in the marketplace, we have reported in the past evaluations that we've done in terms of the penetration of our products and those have always worked out to be a 20% or thereabout penetration in terms of the number of scientists that potentially could make use of GastroPlus as an example. So both as an industry as a whole and specifically with regard to Simulation Plus, model based drug development is accepted and the implementation process has begun. And our clients in the marketplace in general are moving rapidly to do so.

But I would say that we are still in the early stages of seeing it being fully implemented, if you will.

Speaker 0

Thank you. That concludes the Q and A session. One final note before we end, Sean O'Connor, SLP's CEO, will also be presenting at the Needham Conference next Wednesday, the sixteenth. This concludes today's conference call and webinar. If you missed any part of today's presentation, the replay will be available at our website, www.simulations+.com.

Thank you.