Simulations Plus - Earnings Call - Q2 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 numerous risks and uncertainties. The actual results of the company could differ significantly from those statements.

Factors that could 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 their 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 said, I'd like to turn the call over to CEO, Sean O'Connor. Sean?

Speaker 1

Thank you, Cameron. Simulations Plus delivered another strong quarter with double digit revenue growth at the high end of our historical annual organic growth range of 10% to 15%. The revenue growth was achieved along with good profitability and excellent cash flow. Of note for the second quarter, our consulting business accelerated its revenue growth pace after a relatively slow first quarter. Our Buffalo division delivered 23% year over year revenue growth for the second quarter, its highest growth quarter since 2017.

In addition, as we discussed in our last call, we closed on several new business opportunities at the end or right after the close of our last quarter. Specifically, we received approval for Phase two of the SBIR grant for DiliSem's build of the Rinosem platform. After the end of the first quarter, DiliSem also closed on a $2,700,000 agreement with a large pharma company for the build of an IPF mechanistic model. These two projects commenced in the second quarter and supported the achievement of 25 revenue growth in the RTP division. Demand for services remains high across all three divisions.

We're making strategic investments in our organization to drive future growth and made good progress on these initiatives in the second quarter. We added an additional business development individual to our software business and hired a senior scientific resource into our consulting practice with business development expertise. We experienced success in our consulting recruiting efforts in a very competitive market, increasing our consulting staff by 7% in the quarter and 15% year over year. Additionally, we have placed three consultants in Europe during the quarter in support of increasing our physical presence in this market. Overall, we made good progress on all key initiatives and I am encouraged with the results and the team we have in place.

With regard to our financial results for the company as a whole, our revenue increased 15% for the quarter and 11% year to date. Both metrics are in line with our historical annual growth range of 10% to 15%. The second and third quarters are typically our strongest growth quarters, so we appear to be in line with these expectations for the year. Our gross margin of 74% was an increase over last year's second quarter gross margin and this year's first quarter gross margin, which were both 71%. The gross margin improvement was contributed to by increases from both the software and consulting revenues.

Our net income and earnings per share results were up in year over year comparisons, but not to the level of our revenue growth increase even after adjusting last year's second quarter results for the one time tax benefit received in that period. John will speak to the adjustment later in the call. On an adjusted basis, net income was slightly up year over year and earnings per share increased to $0.12 from $0.11 year over year. This outcome is reflective of the investments we are making in sales and marketing resources, fees related to more aggressive consulting recruitment, the cost of initial placement of staff in Europe and the significant refactoring project in our software business that is impacting on our R and D expense. These investments are being made to position the company to support future revenue growth at or above our historical range.

That said, the impact of these investments will diminish in coming quarters and our expectation is that our year over year comparisons for the full year of fiscal year twenty nineteen will be in line with fiscal year twenty eighteen full year results. For example, our SG and A costs, which had creeped up to 36% of revenue in the first quarter, fell back to 33% in this quarter and total operating expenses stepped down from 43% in the first quarter to 42% in the second quarter. Our mix of revenues for the quarter remained consistent. Our software revenues represented 56% of total revenues. They were 57% for fiscal year 'eighteen and grew at 12% for the second quarter year over year.

Our consulting revenues were 44% of total revenues and grew at 19% for the quarter year over year. Turning to our second quarter fiscal results by division. In our Lancaster division, software revenues were up 12% year over year and consulting revenue in this division declined 8% year over year. Our Lancaster division continues to enjoy good overall revenue growth in line with seasonality with strong renewal rates. Consulting revenue was down to a, the timing of certain project milestones and b, allocation of resources to the refactoring project.

Breaking down our key software metrics for the division, 74% of revenue was from renewals, 16% from new licenses, 10% from consulting. Our renewal rates were 85% based on accounts and 93% based upon fees. Our license units of two forty six were up 8% year over year. We added 12 new commercial companies and 10 nonprofit groups. We have projects with 22 companies and four funded collaborations.

Overall, we work with 19 of the top 20 pharmaceutical companies and nearly 200 organizations worldwide. A highlight in the quarter was the expansion of licenses at both The U. S. And China FDA. As a reminder, established relationships with regulatory bodies serves as a strong business development tool for us as regulators often move on to major pharmaceutical companies and bring positive experience with our software to them.

In addition, if a regulator utilizes our software, it can encourage pharmaceutical companies to embrace modeling and simulation software as well. We also experienced an expansion of licenses with multiple domestic Asian customers. We sell in Asia through distributors and growth in this geography is in excess of our overall growth rate. Major highlight during the quarter was the release of Version six of DDD plus advancing our competitive position with this important product line. We ended the quarter in Lancaster division with 41 full time employees, up from 40 in the prior quarter and up from 37 year over year.

Buffalo achieved 23% revenue growth year over year, its highest growth quarter since 2017. This performance reflects strong client demand and increased consulting resources to deliver projects. Buffalo has built a solid pipeline of new and existing clients. As I have previously mentioned, it was a good recruiting quarter for the Buffalo division, increasing our capacity to deliver projects and strategically adding resources with business development skill sets and initiating a presence in Europe. Such presence enhances our accessibility by clients benefiting both new business development as well as project performance.

We ended the quarter with 42 full time employees in our Buffalo division, up from 40 in the prior quarter and up from 37 year over year. Our RTP division initiated key projects closed at the end of or after the first quarter, which contributed to robust 25% year over year revenue growth. The DiliSemRinAsum SBIR grant was approved for the initiation of Phase two. The 2019 portion of this $1,700,000 aggregate grant is estimated to be approximately $900,000 In addition, our IPFSAM QSP mechanistic modeling project sponsored by a pharmaceutical company for up to approximately $2,700,000 commenced during the second quarter. This platform is expected to be available for license to all pharmaceutical companies upon completion in 2021.

Significantly, these projects demonstrate progress in our ability to expand into new therapeutic areas with the mechanistic modeling skill and know how of our RTP organization. We ended the quarter with 17 full time employees at our RTP division, up from 16 in the prior quarter and up from 15 year over year. Overall, this was a good quarter for Simulations Plus with strong growth, consistent profitability and excellent progress on initiatives with future growth impact. Let me turn the call over to John to review the detailed financial results. John?

Speaker 2

Thanks, Sean. Beginning on this slide, the consolidated net revenues for our second quarter of fiscal year 'nineteen were up 15.2%, approximately $1,100,000 to $8,500,000 compared to 7,400,000.0 for the prior year. By division, Lancaster's revenues were 10%, were up 10% to $5,000,000 Buffalo's revenues were up 22.8% to $2,300,000 and RTP in North Carolina's revenues were up 24,800,000.0 to 1,200,000.0 Consolidated software related revenues were up $522,000 or 12.3% and consulting service revenues were up $593,000 or 19%. We saw a modest cost of sales increase this quarter of $92,000 compared to the prior year due to growth in year over year employees, salaries and benefits. This increase was offset by lower direct contract costs, primarily CRO expenses related to contracts in our North Carolina division.

The gross profit increased 19.5% to 6,300,000.0 representing 73.9 percent gross margin in the second quarter of fiscal year 'nineteen compared to $5,200,000 or 71.2% gross margin same quarter last year. SG and A expenses were $2,800,000 or 33.2% of revenue for the second quarter of this fiscal year, an increase of $470,000 or 20.1% compared to 5.3 sorry about that, dollars 2,300,000.0 or 31,800,000.0 of revenue in the second quarter of fiscal year 'eighteen. The increase in SG and A expenses comes from increased licenses and commissions on sales, wage and salary increases from stock compensation, increased costs of new and full time CEO and increased FTEs and their attendant insurance and related expenses, as well as higher percentage of G and A allocated from scientific personnel during the period. We also incurred higher than normal recruiting expenses during this period. Our research and development during the period, we incurred approximately 1,300,000.0 of R and D expenses of which 724,000 was expensed or 8.5 percent of revenue during the period, an increase of about $240,000 or about 49.5% compared to last year of $484,000 or 6.5% of revenue in the second quarter of last year.

The increase in R and D expenses was primarily result of costs associated with scientific research activities in Lancaster. Income from operations for the 2019 was $2,700,000 was up $313,000 or 13% compared to $2,400,000 in the year ago quarter. This was primarily a result of revenue outpacing their increases in quarterly costs. Our provision for income taxes was 596,000 with an effective tax rate of about 22.1% for the quarter compared to a benefit of 1,100,000.0 a year ago that showed a effective tax benefit rate of 45.7%. For those who followed SLP, you'll recall that last year we recorded a million and a half dollar tax benefit in our '18.

That benefit was attributable to the new federal tax act that became effective in 01/01/2018. Deferred tax liabilities on our books are recorded to reflect the that the company will in the future pay income taxes associated with transactions that took place in the past or in the current period. An estimated tax rate that will be in place at the time the taxes are paid is used to fund the tax liability account. When the federal government changed the tax rates as of 01/01/2018, the estimated rates we were using changed from 34% to 21%. That result, recalculated our deferred liability and posted that difference as a one time adjustment to income taxes, the amount of $1,500,000 last year.

That because we posted such a large credit last year, that's the reason our tax expense went up so much this year and it affected both this quarter and our six month results. It was effective about 8¢ per share on last year's and affected EPS change or the difference in EPS this year. Our 22% rate this quarter is a bit lower than anticipated on the annual basis based on tax credits and other permanent differences in the calculation. We anticipate that the rate on an annual basis will be somewhere in the 23% to 24% range. Our net income for the quarter was $2,100,000 which is a decrease of about $1,400,000 However, that included that $1,500,000 tax benefit posted last year.

Taking that into account, net income would have been up about $125,000 for the quarter. On a per share basis, net income was $0.12 per diluted share in the 2019. Last year was $0.19 per share in the quarter, but that also included about an 8% effect from the tax benefit. EBITDA was $3,400,000 in the 2019, up 10.3% compared to $3,100,000 in the quarter last year. Turning to the six month slides, we'll cover some high level areas here.

Consolidated net revenues for the year for 2019 were up 11% or approximately $1,600,000 to $16,000,000 compared to 14,400,000.0 for the prior year. By division, Lancaster revenues were up 9,100,000.0 to $9,300,000 Buffalo revenues were up 15.3 to $4,300,000 and RTP revenues were up 11% to $2,300,000 Consolidated software and software related revenues were up $780,000 or about 10% and consulting service revenues were up 1,200,000.0 or 18%. Gross profit was up a million dollars or 9.7 with margins slightly decreased by 0.8% to 72.5 from 73.3 the prior year. SG and A expenses were up 16.5% over the prior year, combination of salaries, recruiting, benefit related costs, as well as licenses and commissions as we discussed when we were talking about the quarter. SG and A as a percentage of revenues year to date is at 34.5 down from 36 in last quarter and is coming down more in line with our annual expectations.

R and D expense as a percentage for the year is at 8.5%. It's still on the higher side, but it's expected to come back a bit more toward the 7% level year to date by the end of the year. One last comment on the year to date information, it relates to the tax provision. As I mentioned with the quarter, we're expecting that rate to be somewhere in the 23.4% range. It was just under 23% on the year to date calculations.

Turning to the next slide, this is our view of revenue by quarter. On a quarterly basis, starting in 2015 through the most recent quarter, it illustrates the seasonality of our business with third quarter typically being our strongest with a drop off in the third quarter coinciding with the typical slowdown of our clients purchasing and projects during the summer months, our fiscal year being 08/31, the last quarter, Q4 is the summertime season. Revenues in our recent quarter though reached $8,500,000 which is almost our peak performance from last year at 8,600,000.0 This slide is a slide of our income from operations by quarter. Data illustrates the general track record of increases, both year over year sequentially through the first to third quarters with the fourth quarter typically being the lightest of the year. The next slide, we see a similar pattern of net income with third quarter typically being the strongest.

We've shaded the effects of that $1,500,000 deferred tax benefit, which I discussed earlier, as it tends to skew the presentation without calling out that difference. As expected on the next slide, diluted earnings per share follows the same pattern and tracks with net income. Going on to EBITDA. Again, EBITDA follows those same seasonal seasonal patterns with the third quarter being the highest of EBITDA, really shows the seasonality of it. Moving on to slide 16, this is our revenues by region of the world, North America, being our highest area, but you can see that Asia and Europe are strongly represented and we see them as growing sources of revenue for the company.

On slide 17 here, we provide this chart on a quarterly as a quarterly view of cash and cash outflows for dividends, acquisitions and other major uses of cash and the impact on our cash balances over the last four point five fiscal years. Beginning with the first quarter of fiscal 'fifteen on the far left, the blue bars on the bottom illustrate the consistent dividend payout. Beginning in fiscal year eighteen, the board increased the quarterly dividend payment to 6¢ per share, up from 5¢ per share in fiscal year 'seventeen. Moving up the chart, the red bars represent cash from used for acquisition activity. We spent nearly $15,000,000 over the past four to five fiscal years.

Most notably on this slide has been our ability to return cash to our shareholders through consistent dividends while at the same time being able to invest for growth through acquisitions. We maintain a healthy balance sheet with ample amounts of cash and zero borrowed debt as we continue to increase the value of the company. Just today, we announced with our earnings release that the board of directors has voted to distribute another 6¢ per share quarterly dividend that will be payable May 1. The next slide shows some of the ratios we've historically tracked on these calls, all stable in line with historical trends and getting better as the company continues its profitable history. Now I'll turn the call back to you, Sean.

Speaker 1

Thank you, John. In summary, this was a strong quarter for the company. Revenue growth overall, especially in our consulting business was strong and came in at a high end of our historical annual organic growth range. Profitability and positive cash flow were good and we are achieving this while making investments in sales and marketing, international presence and recruiting strategies that support future accelerated growth opportunities. We are well positioned at the midpoint of our fiscal year.

We will now open the call up to any questions that you might have. Thank you, Sean. And as a reminder, if

Speaker 0

you would like to ask a live question, please click on the hand raised icon or you can type in your questions on your GoToMeeting portal. We'll begin with a question by Howard Halpern. Please stand by. What are the sales and marketing initiatives designed to drive future growth?

Speaker 1

Well, touched on several of them during the course of the call today. Business development resources on the software side, we've added a new employee into the sales side of the organization there. On the consulting side, hiring consultants, more senior consultants that have business development skills and can interact with clients in terms of identifying and pursuing new business is an important component of the way the consulting business operates and we have had some success adding there and we are looking to add more into the future in terms of senior scientific staff, Very, very competitive market for these profiled individuals, but they are critical to supplying the demand securing the demand to fuel the growth on the consulting side of the business. We are establishing some presence in Europe. The opportunity to be face to face with clients that are located in that region is important, easing the ability to attend conferences and other networking opportunities that highlight or bring forth project opportunities and allow us to pursue them is one component of our sales and marketing initiative as well.

We have completed opening up our distributor lines in Asia to the deli sum side of our business. These are some of the examples. There is other marketing endeavors that we are trying to focus on. We are focused on presenting our combined skills, products and services to our clients and we are seeing a bit of an uptick, some examples of where some synergies are coming to reality in terms of clients that are engaging in one of our divisions services and that's leading to opening the door for another divisions services as well. So, to leverage those opportunities that have been percolating for some time there.

These are examples of our investments on the sales and marketing side.

Speaker 0

The next question is with the addition of personnel to the consulting services organization, is the structure changing or evolving?

Speaker 1

We've made no structural or organizational changes if that's question. We still operate in our three division format. Consulting services are offered out of three each of the divisions. We try to work together as best we can, look for opportunities as I just referenced in terms of leveraging in the face of the client, the opportunity as we expand geographically into Europe with more staff, as we bring on more consultants. Obviously, their organization needs to evolve with that in terms of its management structure and the way we operate.

But I would say that at this point in time, there's no major structural changes, organizational changes in that business.

Speaker 0

And I'm not 100% clear if this was the intention of the question, but maybe just talk as far as the expectation internally as far as how the structure of software versus services that you feel the company will look like in the next twelve to twenty four months?

Speaker 1

Well, I think we've organized ourselves as a result of the acquisitions into three divisions and are working to identify the synergies there. I've been a believer in my past history of looking at the business not just from its divisional structure, but looking at the business from its business line structure, its portfolio of products and services and optimizing the software business and getting the synergies that exist across the entire portfolio of those products. Similarly, on the consulting side, look at the consulting business and drive towards optimizing that. And I think that's something that's new that I brought to the table here and something that we will look to leverage as we move forward.

Speaker 0

Thank you. Next question is how has growth progressed in Korea, India and China? These are all recent areas that we've added some new basically structured growth for the software sales.

Speaker 1

Well, we sell through to the Asian markets our software products through distributors in those regions, some of them longer term than others. Korean distributor is the newest. They have been climbing the learning curve and building a pipeline and we have had some recent success there. I referenced China, the FDA success that we had in terms of licensing more units of several of our software products into the FDA organization there, which is very leverageable in that market. China is the second largest of our markets in that region.

The growth opportunity there looks very positive. Japan is the largest market. We had success during the quarter in terms of growing units in that region. That's been our strongest region historically. And on the Indian side, in the Indian market, we've had success as well.

I think Asia is going to continue to grow maybe at a pace greater than our overall growth and contribute to the success of the organization going forward. One of the things we'll have to look for in the future is in terms of the consulting side

Speaker 0

of

Speaker 1

the business there, that's a little bit more challenging. Historically, companies of our profile have required presence there in terms of consultants that are used locally more so than reaching out to The U. S. Market and that will be a challenge on the consulting side. But certainly, the software growth in the market is moving very well.

Speaker 0

Thank you. The next question, is the Buffalo Cognition division poised to sustain double digit revenue growth for the 2019?

Speaker 1

Well, we certainly took a great step up here in this quarter getting to the 23% revenue growth level. The division has typically performed in the double digit growth range, but hasn't for a couple of quarters, the first quarter of this year and the last quarter of the last fiscal year. And I think we are challenged in terms of the capacity. Our recruiting pickup here over the last six months really has contributed to providing them the resource to support growth. As I have said before, the market is very robust out there and the demand for these types of services exists if you can go, a, secure them, be in the right sales and marketing position to secure that business and to have the staff to deliver the projects.

And I think we are impacting both of those variables here in a positive way. Can it grow double digits going forward? I would certainly hope that, that will be the case. Going forward, it certainly has been their history in the past and I think we've addressed at least partially some of the issues that have constrained them here in the last six months and allow them to return to a double digit growth going forward.

Speaker 0

Thank you, Sean. The next question is for the Lancaster division, what does the consulting service pipeline look like compared to the first half of 'nineteen? I think that may be okay, for the second half compared to the first half.

Speaker 1

Pipeline The is the opportunities in terms of the consultants to work in that area exists and we are looking for more resources like in our Buffalo division to add to the team there to increase our capacity. The other dynamic that exists there is that we are utilizing some of those resources on the internal project called refactoring, which is a major project we've undertaken to rewrite the GastroPlus platform. And so we're balancing the two demands there. The pipeline exists. I believe that their growth in the back half of the year will be positive unlike the step down that we took in the second quarter, third and fourth quarter pipeline should support positive year over year growth in the second half of the year.

And that's where we stand.

Speaker 0

Thank you. Next question is, are you looking to improve the consulting services gross margin in Cognigygen over the next year?

Speaker 1

Well, they improved here in the second quarter and stepped up quite nicely. I think the margin in the consulting businesses, all as are I'm sure aware, is going to be less than the software revenue margins that we enjoy. But consulting margins can typically be run-in the 60% gross margin level and that would be our target going forward. When you are accelerating your recruiting, you encounter some additional costs as those new recruits come on board, A, have a ramp up period in which they integrate themselves into the practice and become or achieve the billability targets that you are looking for in the long run. There is a ramp up timeframe there.

Two, it's a marketplace in which the resources are scarce and so we have got the added expense of not just some recruiting expense, but also the fact that it's a dynamic market in terms of compensation. So there is a number of pressures there that make the margin pressures on the margin in the consulting side of the business. But once you've climbed up and are recruiting at a steady state on an ongoing basis, those tend to be very manageable and allow you to achieve that 60% gross margin level. I'd expect that in the long run we will be able to achieve that.

Speaker 0

Thank you. The next question is what is the status of software applications in the missile guidance in the MRI and other opportunities that we have discussed in the past?

Speaker 1

Yes, not a primary focus for the company right now. We are still looking for ways in which to apply our data mining, our AI capabilities going forward. But in this past quarter, I would say that our progress in that regard has been minimal. We are still looking for an opportunity to leverage our capabilities, but no progress to report at this point.

Speaker 0

I guess in conjunction with that question, there's a question as far as could you please elaborate a bit on the AI machine learning capabilities developed by SLP?

Speaker 1

Well, we've developed these techniques and capabilities and they are embedded in our ADME predictor capabilities and elsewhere in the software products. AI and data mining is a hot buzzword today, but it's been something that has been technically worked for many, many years before it gained these labels and the excitements. In many regards, we are one of the more realistic leaders in that field in the pharmaceutical industry. There is a lot of focus, a lot of investment, a lot of effort underway in that space. And we are looking for the right opportunity to leverage what we do in a commercial way that can lead to real business revenues and margin and profit going forward.

And I expect that we will at some point identify and move forward on that, but we are being cautious in terms of where we place our investment dollars right now. Thank you.

Speaker 0

Next question, could you comment on the competitive environment and any changes that you are seeing there?

Speaker 1

No new news to report there in terms of any new players. We certainly on the software side have the field of small niche players that are competitors out there. The competition that's provided from the larger players, Certara, in terms of their SIM sub application, nothing new to report there. On the consulting side, it's a very dynamic market and come from a competitive point of view. Certainly, there are multiple bidders in terms of each opportunity that exists out there, but it's a market that there is plenty of opportunity for all of us to play in.

And I think we really stand We need to leverage it and do a better job of leveraging it going forward. We stand out in the context of the breadth of our capabilities that run from PKPD modeling through to mechanistic modeling and PBPK modeling capabilities out there. And so from a competitive point of view, we feel very confident in terms of our ability to line up against any potential competitor in this space.

Speaker 0

Thank you. The next question is what is the status of PK plus at this point?

Speaker 1

PK plus is still growing. We are adding licenses on a quarterly basis at a I think a good quarter in comparison to our previous quarters, but it's growing off of a very small base. And so it will find its footprint out there and it's slowly growing, not a significant or material contributor to revenue at this point, but we should continue to see it grow.

Speaker 0

Thank you, Sean. At this point, it looks like there is no further questions.

Speaker 1

Very good. Well, I appreciate everyone's attention. It's been a great quarter for Simulations Plus. Look forward to reporting progress at the end of the next quarter. Thanks everyone.

Speaker 0

And just as a final comment, before we close, the company will be presenting at the Investor Conference of B. Riley on May 2223 in Beverly Hills. And 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, simulations+.com. Thank you for joining us today.