Earnings Call Transcript - SLP Q2 2026

Operator, Operator

Greetings, and welcome to the Simulations Plus Incorporated Second Quarter Fiscal Year 2026 Financial Results Conference Call. Please note that this conference is being recorded. It is now my pleasure to turn the conference over to Lisa Fortuna. Thank you. You may begin.

Lisa Fortuna, Investor Relations

Good afternoon, everyone. Welcome to the Simulations Plus Second Quarter Fiscal Year 2026 Financial Results Conference Call. With me today are Shawn O'Connor, Chief Executive Officer; and Will Frederick, Chief Financial Officer of Simulations Plus. Please note that we updated our quarterly earnings presentation, which will serve as a supplement to today's prepared remarks. You can access the presentation on our Investor Relations website at simulation-plus.com. After management's commentary, we will open the call for questions. As a reminder, the information discussed today may include forward-looking statements that involve risks and uncertainties. Words like believe, expect and anticipate refer to our best estimates as of this call, and actual future results could differ significantly from these statements. Further information on the company's risk factors is contained in the company's quarterly and annual reports filed with the Securities and Exchange Commission. In the remarks or responses to questions, management may mention some non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures are available in the most recent earnings release available on the company's website. Please refer to the reconciliation tables and the accompanying materials for additional information. With that, I'll turn the call over to Shawn O'Connor. Please go ahead.

Shawn O'Connor, CEO

Thank you, and welcome, everyone. We exceeded the top line guidance that we communicated to you last quarter and delivered $24.3 million in revenue during the second quarter with growth in both our Software and Service segments. Adjusted EBITDA was $8.7 million, reflecting a 36% margin and adjusted diluted EPS was $0.35, in line with our internal expectations. Turning to the macro environment. We continue to see encouraging market conditions globally, supported by ongoing most favored nation pricing agreements, easing tariff concerns and a more supportive funding environment for our customers. On the regulatory front, the new approaches methodologies or NAMS guidance issued late last year was further clarified with an additional update last month. Against this backdrop, we're seeing a pickup in client spending reflected in solid software renewal rates, increased new logo activity and strengthened service bookings. Overall, we're pleased with our first half fiscal 2026 performance and encouraged by the momentum that is building across the business. Next, I want to address the broader discussion around artificial intelligence and its impact on software companies, including our own. Over the past quarter, AI-related competitive concerns have weighed on valuations across most software-based business models, and biosimulation has not been entirely immune to that sentiment. That said, we believe it's important to separate short-term market perception from long-term fundamentals. From our perspective, ongoing advances in AI are a net positive for biosimulation. AI is accelerating the industry's transition to data-driven drug development workflows and, importantly, enhancing the value of trusted and validated scientific engines rather than replacing them. We have been an early adopter of AI for decades, beginning with the introduction of ADMET Predictor in the late 1990s, and we continue to lead in its practical application today. Beyond using machine learning for property prediction or to improve software development efficiency, we are embedding AI across our product roadmap, improving compute performance, interoperability between scientific engines, data management and automation, and making our tools more accessible across organizations. While certain software models may face disruption from AI, we believe the core value of our scientific engines, including property predictions, PBPK, PK/PD and QSP modeling functionality and science remains strong and durable. These capabilities are built on decades of scientific investment, deep domain expertise, validated methodologies and integration into customer workflows and regulated environments. In contrast to black box approaches, our solutions are trusted, auditable and difficult to replicate. That is why we have long been the preferred choice for commercial drug developers even during a period of significant investment in AI-driven discovery companies and numerous open-source applications. At our Investor Day in January, we outlined the roadmap focused on further leveraging AI across our ecosystem and we continue to make solid progress executing against that plan. Just a few weeks ago, we announced strategic collaboration programs with three large pharmaceutical companies to advance AI workflows across the drug development life cycle. The close collaboration between Simulations Plus and leading pharmaceutical organizations will provide direct insight into how AI will be integrated into real-world environments, informing product direction, workflow standardization and future commercial models. The programs will utilize Simulations Plus' major software platforms, including GastroPlus, MonolixSuite, ADMET Predictor and Thales. Participating companies will integrate our internally developed AI agents directly into model-informed development workflows, enabling natural language interaction, automation of data processing, coordination of simulations across multiple modeling engines and the generation of interoperable outputs from complex multistep pipelines. These programs represent an important step in moving us and our partners beyond experimentation and into practical implementation as we advance our software and services into a unified modeling ecosystem. Finally, it's important to emphasize that our customers are not looking to replace biosimulation engines. Instead, they are looking to enhance their value using AI to improve efficiency, broaden deployment and accelerate drug discovery and development. Furthermore, cost benefits accrue at any point that Simulations Plus can help us simplify and shorten the drug development process or mitigate costly miscalculations. This approach aligns closely with our strategy to be a key partner in our clients' AI journey and supports our long-term growth plans. With that, I'll turn the call over to Will.

William Frederick, CFO

Thank you, Shawn. To recap our second quarter performance, total revenue increased 8% to $24.3 million. Software revenue increased 9%, representing 60% of total revenue, and Services revenue increased 8%, representing 40% of total revenue. Turning to software highlights for the quarter. Discovery revenue, primarily from ADMET Predictor, increased 19% for the quarter and 6% for the trailing 12-month period. The contribution as a percentage of total software revenue was 19% during the quarter and 18% for the trailing 12 months. Development revenue, primarily from GastroPlus and MonolixSuite, increased 12% for the quarter and 3% for the trailing 12-month period. The contribution was 78% of total software revenue for both the quarter and the trailing 12 months. Clinical operations revenue, primarily from proficiency, declined 54% for the quarter and 58% for the trailing 12-month period. The contribution during the quarter was 3% of total software revenue and 3% for the trailing 12 months. We ended the quarter with 297 commercial clients, achieving an average revenue per client of $124,000 and a 91% renewal rate for the quarter. On a trailing 12-month basis, we achieved an average revenue per client of $148,000 and our renewal rate was 87%. While we've seen a decline in software renewal rates, it's worth diving a bit deeper into the patterns we've seen. For top 20 pharma clients, we've historically had 100% logo retention. For $1 billion-plus pharma, defined as companies generating over $1 billion in global revenue, we've seen 90% logo retention. Churn has predominantly been with other commercial pharma defined as biopharma companies with at least one approved product and less than $1 billion in revenue and pre-commercial biotech defined as biotech companies without an approved therapy. This is consistent with historically more episodic versus recurring demand as pipelines progress with the challenging early-stage biopharma market backdrop over the last few years. Our top 25 customers represent about 46% of overall software revenue and these customers are highly stable with 100% logo retention and 90% plus gross revenue retention. As we continue to assess software renewal rates and advance our sales team reorganization from product-focused selling to a regional account-based model centered on deepening client relationships, we plan to provide increased visibility into software retention and cross-sell expansion opportunities. For example, in fiscal 2025, we saw the following from clients with software revenue greater than $100,000: 50% purchased 2 software products, 23% purchased 3 software products and 15% purchased 4 or more products. We believe this creates meaningful cross-sell and upside opportunities as reflected in the continued growth of average software revenue per client. We look forward to providing additional insight into these performance metrics over time. Turning to services highlights for the quarter. Development services, which includes our biosimulation services, increased 12% for the quarter and declined 3% for the trailing 12-month period. The contribution during the quarter was 77% of total services revenue and 75% for the trailing 12 months. Commercialization Services, which includes our MedChem services, declined 1% for the quarter and increased 66% for the trailing 12-month period. The contribution during the quarter was 23% of total services revenue and 25% for the trailing 12 months. Total services projects worked on during the quarter were 199 and ending backlog increased 18% to $24 million from $20.4 million last year. Overall, we have a healthy pipeline of services projects. Total gross margin for the second quarter was 66%, with Software gross margin of 89% and Services gross margin of 33%. On a comparative basis, total gross margin for the prior period was 59% with Software gross margin of 81% and Services gross margin of 25%. The increase in Software gross margin was primarily driven by increased software-related revenue, particularly from Development and Discovery Solutions and lower software-related costs largely reflecting reduced amortization expense following the impairment charge in the third quarter of fiscal 2025. Other income was $0.3 million for the quarter compared to $0.8 million last year. The prior year amount included the gain on the change in fair value of contingent consideration related to the Immunetrics holdback liability. Income tax expense was $1.4 million compared to $0.4 million last year; our effective tax rate was 23% compared to 12% last year. The increase in the tax rate is primarily due to the result of a favorable discrete item in the prior year that did not recur in the current year, a less favorable jurisdictional mix of earnings between the U.S. and France, increased unfavorable global intangible low-taxed income, or GILTI, impacts driven by higher French taxable income, and a lower foreign-derived intangible income or FITI benefit. In addition, certain items affecting the current year effective tax rate relate to accelerated deductions elected under the One Big Beautiful Bill Act. These deductions are expected to be favorable to cash flows as they accelerate the timing of tax benefits and reduce near-term cash tax payments. As a result, we now expect our effective tax rate for fiscal 2026 to be between 23% to 25% as compared to our previous expectation of 12% to 14%. Moving to our balance sheet. We ended the quarter with $41.8 million in cash and short-term investments. We remain well capitalized with no debt and strong free cash flow as we continue to execute our growth and innovation strategy. Our guidance for fiscal 2026 remains relatively unchanged from what we previously provided. Total revenue between $79 million to $82 million, year-over-year revenue growth between 0% to 4%, software mix between 57% to 62%, adjusted EBITDA margin between 26% to 30%. Adjusted diluted earnings per share is now expected to range between $0.75 to $0.85, which reflects the change in our effective tax rate we just discussed. For the third quarter of 2026, we anticipate revenue to be between $20 million to $22 million, adjusted EBITDA margin of 27% to 33% and adjusted diluted EPS between $0.20 to $0.27. I will now turn the call back to Shawn.

Shawn O'Connor, CEO

Thank you, Will. As I mentioned before, we're pleased with our first half performance and remain excited about the opportunities ahead. Simulations Plus is transitioning from a set of innovative modeling tools into an integrated AI-driven biosimulation ecosystem, supporting the full drug development life cycle, from discovery through commercialization. Our core purpose remains unchanged: empowering our clients to deliver safer, more effective therapies through science-driven innovation. What's accelerating is how we execute against that mission. By combining our validated scientific engines with enhanced cloud capabilities, AI-powered workflows, and a coordinated roadmap, we're delivering greater speed, consistency and interoperability to our clients. Thank you for joining the call today. And with that, we'll open the call for questions.

Operator, Operator

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

Matthew Hewitt, Analyst

Obviously, it's nice to hear we're starting to see some positive impact from the changes that we started to see last fall. Maybe first up, I was hoping we could dig in a little bit on the three large pharma customers that you announced here a couple of weeks ago kind of coming in and adopting the four major platforms. Could you walk through exactly how that's going to work? What do those contracts look like? Is it cross-selling that's already occurring? Just any more color there, I think, would be helpful.

Shawn O'Connor, CEO

Sure, Matt. Yes, we announced a few weeks ago the collaborations with three large pharma accounts. Those collaborations have been underway for a longer period of time. These are not new relationships beginning. They've been involved in our product roadmap development for some time, prior to our unveiling of that to the Investor Day meeting in January. Each of the collaborations has a little bit different focus across the scientific engines, but collectively, they all involve working together to ensure that we've got good visibility to their needs and workflows internal to their organizations so that we can match the development of the AI capabilities to meet their needs and fit into their environments. It's good to have two or three of these relationships so that every company is unique in how they're deploying their efforts on the AI side. So it allows us to develop our solutions in a way that can be tailored to different needs across the pharma companies. We are engaging with them on a product development basis. There has been some financial component to at least one of the relationships already. The financial relationship moving forward with each of the parties is currently under discussion regarding what the long-term terms across the technology platform will be and what the financial circumstances will be around that. These are very important relationships for us. It's similar to what we've done throughout our lifetime as a company. Our scientific engines have been developed in a series of collaborations with our clients and regulatory bodies. It's what's made them effective in terms of the needs of drug development, and it's good to see that that's continuing through our AI developments today.

Matthew Hewitt, Analyst

That's super helpful. And then maybe a follow-up question. You noted you're having some success with cross-selling already. And you also mentioned that during the quarter, you won some new logos. I'm just curious, are those new logo customers that maybe hadn't adopted your software services before? Or are these competitive conversions, like you're winning business or taking share? Just any other color there would be helpful as well.

Shawn O'Connor, CEO

Yes, as new logos, they are non-existing customers that are taking down solutions for the first time. So they're new to us in terms of the competitive situation in their selection of our product, we have to assess each and every one. As Will described, the stability of our client base, certainly with the large top 20 and the billion-dollar pharma companies, is quite strong. New logo opportunities are going to be at the lower end of the environment or size of the clients. These customers can be clients that are just initially starting up their internal capabilities for biosimulation. But in some cases, they may be moving from competitive scenarios.

Operator, Operator

And our next question comes from the line of Constantine Davides with Citizens.

Constantine Davides, Analyst

Just a couple of questions here. First, I noticed a large sequential uptick in the commercial portion of the services backlog. And I just wanted to get a sense for maybe the proficiency pipeline in both software and services, size of deals that you're seeing, and then any seasonality we should consider as we think about that business over the back half of the year?

Shawn O'Connor, CEO

Sure. The backlog highlights that it is completely based on service revenue. Seventy-five percent of our service business is in the development area, while twenty-five percent comes from the proficiency communications sector, which we gained through the acquisition of proficiency. We began to notice strong pipeline activity and closures as we finished the first quarter, and service revenue delivery has continued well into the second quarter. That part of our business is currently performing quite well. Regarding proficiency, the backward leverage off the service Med Communications business through the middle of the year has scaled nicely. They achieved a very good first quarter, and while the second quarter growth wasn't as high percentage-wise, it still made a solid contribution, and overall, they are doing quite well for the year so far. On the software side, the performance has met our expectations. To remind you, after the acquisition of proficiency at the start of FY25, their first few quarters produced good revenue. The slowdown in clinical trials in the latter part of FY25 did reduce that software revenue contribution. This trend has carried into the first half of the year, but it has stabilized at a solid starting point, and we anticipate reasonable growth moving forward from here.

Constantine Davides, Analyst

Great. I appreciate the additional insights on some of the product updates. You mentioned that 50% of your customers have two or more products, along with some other related metrics. When considering upsell opportunities, Shawn, where do you see the biggest potential? Is it converting single product customers to two products, or is it moving some of the two product customers to three? How should we approach tracking progress in that metric over time, and what do you think is feasible?

Shawn O'Connor, CEO

Yes, opportunities exist at all levels, taking a client from one to two and two to three and beyond. We historically have seen good linkage between ADMET Predictor and GastroPlus; often our two-product customers might start with those two. Obviously, the Monolix product that came to us through acquisition one and a half years ago now is a nice complement in the PK/PD space for our clients to adopt. We've seen strong growth from the Monolix PK/PD platform over the last several years. The opportunities exist across all those levels, and I think the opportunity here is for that to accelerate driven by our reorganization of our business development organization from product-focused selling to a regional account-based model centered on deepening client relationships. I think that focus will enhance our cross-selling efforts. Secondly, the development and delivery of our ecosystem, as we've described, tremendously enhances the interoperability across the scientific engines. Additionally, putting it into the cloud opens more opportunities for smaller and medium-sized entities out there taking access. So that may create new logo opportunities, but those new logo opportunities then roll into cross-selling opportunities. From both an organizational perspective and our sales approach, as well as our product roadmap, we are very focused on our cross-selling efforts going forward, and the opportunity is certainly quite large.

Operator, Operator

And our next question comes from the line of Max Smock with William Blair.

Max Smock, Analyst

Wondering if you can discuss where you're at right now halfway through the year relative to your expectations when you gave your initial guidance at the end of last year? Just trying to get a sense for the level of conservatism that's embedded in the guide in light of your bullish macro commentary and the growing interest in NAMs. Just looking at the numbers, revenue up 3% in 1H, but I think guidance implies basically flat revenue in the second half off of what looks like easier comps. So if you can just level set and help us understand the thought process behind not taking up the guidance on the back of the really strong results we saw here in the second quarter?

Shawn O'Connor, CEO

Sure, Max. Not a surprising question. We evaluate guidance opportunities each quarter as warranted. I'd say we're still operating in an environment that might be termed fragile. We see a lot of momentum and good spending from our clients. But we've got macro issues regarding global politics and more specific pharma-related scenarios that could pose risks. A cautious approach to forecasting based on our experience over the last 24 months drives our decision-making here. That being said, yes, the momentum seems to be building and we delivered well in the first couple of quarters, which certainly positions us moving into the back half of the year with greater confidence. However, a relatively cautious approach is warranted, so we’re not taking a one or two quarter trend and driving it into a longer-term trajectory just yet.

Max Smock, Analyst

That's really helpful. And maybe just following up on that, particularly your comment around the fragile environment. I know it's probably hard to tell, but just wondering if you can bifurcate a little bit between the momentum you're seeing, how much of that is coming from an overall recovery in the macro environment and biopharma spend versus how much of that recovery is more a function of just increasing interest and growing adoption of NAM specifically?

Shawn O'Connor, CEO

I'd say broadly, when we mention NAMs, some may jump to the conclusion about animal testing announcements; however, the momentum built here is certainly on the horizon, but it remains a few years out. In general, the support for biosimulation and in silico methodologies for AI is strong from the regulatory perspective. I believe our clients shifted in FY25 to an AI investment strategy, forming partnerships with other AI discovery companies. This shift is now prompting them to consider internal AI implementation. There is considerable momentum building within the large pharma environment. Overall, I think the momentum is fairly broad, but we operate in an industry that can be somewhat sensitive to external announcements and macro issues.

Operator, Operator

And our next question comes from the line of Jeff Garro with Stephens.

Jeffrey Garro, Analyst

I want to ask a little bit more on cross-selling. You just kind of hit the macro versus micro part of that topic. But I was hoping you could dive a little bit further on evaluating your progress to reach multiple buyers within your clients' organizations, getting beyond the modeling department with these clients?

Shawn O'Connor, CEO

That's a good question, Jeff. Maximizing your targeted budget is important, but also looking for additional budget sources within our clients is always a priority. Our efforts related to the proficiency acquisition opened up our reach into clinical trial operation projects. This provides a wider Total Addressable Market (TAM) at a macro level and specifically allows us to tap into different pockets of budget within our clients. The most significant opportunity is likely in the AI budget areas within our client organizations. The collaborations we've announced have enhanced our ability to leverage existing strong modeling and simulation relationships, building connections with leaders within those collaborative clients. This relationship strengthens the opportunity for the funding of our ecosystem and AI functionalities to be sourced from outside of traditional modeling and simulation budgets. I believe this puts us in a good position for future growth. When assessing budget growth in modeling and simulation, one must recognize the additional momentum coming from AI budgets as they can be quite substantial.

Operator, Operator

And our next question comes from the line of David Larsen with BTIG.

David Larsen, Analyst

Are any of the large AI companies clients of yours, like Google DeepMind comes to mind or any of these other organizations?

Shawn O'Connor, CEO

Yes. Many of the historical drug discovery AI entities, including Recursion, DeepMind, and other relevant AIs, are licensing some portion of our software. While it's not full coverage, a good percentage of these companies are indeed our clients, utilizing our platforms.

Operator, Operator

And our next question comes from the line of Brendan Smith with TD Cowen.

Brendan Smith, Analyst

Maybe first, just on some of the services metrics that you show, I think it's on Slide 13, if I'm not mistaken. I just want to make sure I'm understanding correctly. I guess how should we think about the relative decline, albeit minimal in total projects year-over-year kind of versus the increase in backlog there specifically? Is that kind of a function more of the types of projects you're moving into, the customers themselves? Or are there any other dynamics at play there?

Shawn O'Connor, CEO

Yes. The number of projects can evolve over time; some projects can consume a significant percentage of our staff in a particular quarter, while other quarters may focus on smaller or medium-sized projects. Therefore, project counts can ebb and flow significantly. The backlog growth is encouraging and shows great progress in terms of our pipeline as it closes ahead of actual project performance.

Brendan Smith, Analyst

Okay. Got it. Helpful. And then maybe a second one, just looking at kind of Slide 9, I think you referenced the comparison of Q2 versus trailing 12 months and just looking at the breakdown of software solutions as a percent of software revenue. I mean, it looks pretty stable over the last year. But I guess I'm just wondering if you expect any meaningful shift in that segment breakdown over the next 12 months as some of these new rollouts and broader sector interest starts to evolve? And if not, what are you assuming underlining some of those assumptions, presumably based on your recent conversations?

Shawn O'Connor, CEO

Yes. Our development solutions of Monolix and GastroPlus are the key drivers in terms of our software revenue, with ADMET Predictor contributing as well. The proficiency training platform provides the smallest percentage of that pie. The cross-selling opportunities will be significant in both ADMET Predictor and GastroPlus, but especially with Monolix, as we are seeing more large $1 billion-plus pharma clients adopting Monolix as their preferred platform in the PK/PD space. That contribution could grow. It has been growing at a faster rate than the other solutions over the past couple of years. Therefore, seeing this grow would not surprise me. When pursuing new logos, the starting point will often be GastroPlus or Monolix for developing pre-product biotech companies, while ADMET Predictor might be the choice for discovery clients. I anticipate stability in our contributions from these software solutions moving forward, with perhaps Monolix taking a slightly larger piece of the pie.

Operator, Operator

And with that, there are no further questions at this time. I'd like to turn the call back over to Shawn O'Connor for any closing remarks.

Shawn O'Connor, CEO

Very good. Okay. Over the next few months, we've got a number of investor conferences, including the RBC Global Healthcare Conference, Craig-Hallum Conference, TD Life Science Tools and Diagnostic Revolution, and the Citizens Medical Devices and Health Care Services Forum. Hopefully, we can see many of you there. Otherwise, I appreciate the opportunity to deliver this quarter's results to you and look forward to speaking again next quarter. Take care, everyone.

Operator, Operator

And with that, ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation, and you may now disconnect your lines, and have a wonderful day.