Item 2.
Management's Discussion and Analysis or Plan of Operations
Forward-Looking Statements
This document and the documents incorporated
in this document by reference contain forward-looking statements that are subject to risks and uncertainties. All statements other
than statements of historical fact contained in this document and the materials accompanying this document are forward-looking
statements.
The forward-looking statements are based
on the beliefs of our management, as well as assumptions made by and information currently available to our management. Frequently,
but not always, forward-looking statements are identified by the use of the future tense and by words such as “believes,”
expects,” “anticipates,” “intends,” “will,” “may,” “could,” “would,”
“projects,” “continues,” “estimates” or similar expressions. Forward-looking statements are
not guarantees of future performance and actual results could differ materially from those indicated by the forward-looking statements.
Forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause our or our industry’s
actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of
activity, performance, or achievements expressed or implied by the forward-looking statements.
The forward-looking statements contained
or incorporated by reference in this document are forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended (“Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended
(“Exchange Act”) and are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995.
These statements include declarations regarding our plans, intentions, beliefs, or current expectations.
Among the important factors that could
cause actual results to differ materially from those indicated by forward-looking statements are the risks and uncertainties described
under “Risk Factors” in our Annual Report and elsewhere in this document and in our other filings with the SEC.
Forward-looking statements are expressly
qualified in their entirety by this cautionary statement. The forward-looking statements included in this document are made as
of the date of this document and we do not undertake any obligation to update forward-looking statements to reflect new information,
subsequent events, or otherwise.
General
BUSINESS
OVERVIEW
Simulations Plus, Inc., incorporated in
1996, is a premier developer of groundbreaking drug discovery and development software for mechanistic modeling and simulation,
and for machine-learning-based prediction of properties of molecules solely from their structure, and is exploring the application
of its machine-learning technologies in other industries, including aerospace/military and general healthcare. Our pharmaceutical/chemistry
software is licensed to major pharmaceutical, biotechnology, agrochemical, and food industry companies and to regulatory agencies
worldwide for use in the conduct of industry-based research. We also provide consulting services ranging from early drug discovery
through preclinical and clinical trial data analysis and for submissions to regulatory agencies. Simulations Plus is headquartered
in Southern California, with offices in Buffalo, New York, and its common stock trades on the NASDAQ Capital Market under the symbol
“SLP.”
In September 2014, Simulations Plus acquired
Cognigen Corporation (Cognigen) as a wholly owned subsidiary pursuant to that certain Agreement and Plan of Merger, dated as of
July 23, 2014, by and between Simulations Plus and Cognigen (the “Merger Agreement”). Cognigen was originally incorporated
in 1992. Through the integration of Cognigen into Simulations Plus, Simulations Plus is now also a leading provider of population
modeling and simulation contract research services for the pharmaceutical and biotechnology industries. Our clinical-pharmacology-based
consulting services include pharmacokinetic and pharmacodynamic modeling, clinical trial simulations, data programming, and technical
writing services in support of regulatory submissions. We have also developed software for harnessing cloud-based computing in
support of modeling and simulation activities and secure data archiving, and we provide consulting services to improve interdisciplinary
collaborations and research and development productivity.
We are a global leader focused on improving
the ways scientists use knowledge and data to predict the properties and outcomes of pharmaceutical and biotechnology agents, and
are one of only two global companies who provide a wide range of preclinical and clinical consulting services and software. Our
innovations in integrating new and existing science in medicinal chemistry, computational chemistry, pharmaceutical science, biology,
physiology, and machine learning into our software have made us the leading software provider for physiologically based pharmacokinetics
(PBPK) modeling and simulation and for prediction of molecular properties from structure.
We generate revenue by delivering relevant,
cost-effective software and creative and insightful consulting services. Pharmaceutical and biotechnology companies use our software
programs and scientific knowledge to guide early drug discovery (molecule design and screening), preclinical, and clinical development
programs. They also use it to enhance their understanding of the properties of potential new medicines and to use emerging data
to improve formulations, select and justify dosing regimens, support the generics industry, optimize clinical trial design, and
simulate outcomes in special populations, such as the elderly and pediatric patients.
PRODUCTS
General
We currently offer eight software products
for pharmaceutical research and development: three simulation programs that provide time-dependent results based on solving large
sets of differential equations: GastroPlus™; DDDPlus™; and MembranePlus™; three programs that are based on predicting
and analyzing static (not time-dependent) properties of chemicals: ADMET Predictor™; MedChem Designer™; and MedChem
Studio™ (the combination of ADMET Predictor, MedChem Designer, and MedChem Studio is called our ADMET Design Suite™);
one recently-announced program for rapid clinical trial data analysis and regulatory submissions called PKPlus™; and one
program called KIWI™ that provides an integrated platform for data analysis and reporting through our proprietary secure
cloud. During the fourth fiscal quarter of the fiscal year ended August 31, 2016, we announced the release of our newest software
offering, PKPlus™, a next-generation software package for noncompartmental and compartmental pharmacokinetic analysis and
reporting, which is further described below.
GastroPlus
Our flagship product and currently our
largest source of revenue is GastroPlus. GastroPlus simulates the absorption, pharmacokinetics, and pharmacodynamics of drugs administered
to humans and animals, and is currently the most widely used software of its type by pharmaceutical companies, the U.S. Food and
Drug Administration (FDA), the U.S. National Institutes of Health (NIH), and other government agencies in the U.S. and other countries.
The FDA currently has 70 GastroPlus licenses.
Because of the widespread use of GastroPlus,
we were the only non-European company invited to join the European Innovative Medicines Initiative (IMI) program for Oral Bioavailability
Tools (OrBiTo). OrBiTo, begun in 2012, is an international collaboration among 27 industry, academic, and government organizations
working in the area of oral absorption of pharmaceutical products. Because we are outside of the European Union, our participation
in this project is at our own expense, while other members are compensated for their work; however, we are a full member with access
to all of the data and discussions of all other members. We believe our investment to participate in this initiative enables us
to benefit from, and to contribute to, advancing the prediction of human oral bioavailability from preclinical data, and ensures
that we are well-known to member pharmaceutical companies and regulatory agencies.
In September 2016 we announced that Simulations
Plus had been invited to join the European SimInhale Consortium and had been admitted to this prestigious group focused on advancing
the state of the art for simulation of inhaled dosage forms. As one of only two U.S. participants, Simulations Plus will participate
in activities designed to
advance particle designs for improved deposition and interaction with lung
tissue; promote realistic computer simulations of particle aerosolization, delivery, and deposition; promote patient-tailored inhaled
medicines; promote integration of device and formulation design; and promote critical assessment of toxicity issues and related
risks.
In September 2014, we entered into a research
collaboration agreement (RCA) with the FDA to enhance the Ocular Compartmental Absorption and Transit (OCAT™) model within
the Additional Dosing Routes Module of GastroPlus. The objective of this agreement is to provide a tool for generic companies and
the FDA to assess the likely bioequivalence of generic drug formulations dosed to the eye. Under this RCA, we receive up to $200,000
per year. This RCA may be renewed for up to a total of three years based on the progress achieved during the project. After a successful
second year, the RCA was renewed for its third year in September 2016, and will expire in September 2017.
We were awarded another RCA by the FDA
in September 2015, this time to expand the capabilities of GastroPlus to simulate the dosing of long-acting injectable microspheres.
This type of dosage form is usually injected via subcutaneous or intramuscular routes, but can also be used for ocular dosing.
Once again, this RCA provides up to $200,000 per year for up to three years. Under this agreement, we are developing simulation
models to deal with the slow dissolution/decomposition of the microsphere carrier material that gradually releases the active drug
over periods as long as weeks or months. After a successful first year, the RCA was renewed for the second year in September 2016,
and will expire in September 2017 unless re-renewed.
In addition to the two funded efforts with
the FDA described above, we also have an unfunded RCA with the FDA’s Office of Generic Drugs (OGD) that began in 2014. The
objective of this RCA, which has a five-year term, is directed toward the FDA’s evaluation of mechanistic IVIVCs (
in vitro-in
vivo
correlations) to determine whether mechanistic absorption modeling (MAM) can relate laboratory (
in vitro
) dissolution
experiment results to the behavior of dosage forms in humans and animals (
in vivo
) better than traditional empirical methods.
In April 2015, we released Version 9.0
of GastroPlus. This was the largest single upgrade we had made to the program since it began commercial use in 1998. The added
level of science and technology enabled valuable new functionalities that we believe provided the most advanced decision-making
tool for preclinical and early clinical trial simulation and modeling analysis available today. Several of the significant enhancements
include:
|
·
|
ability to simulate the absorption and distribution of biologics (antibodies and proteins);
|
|
·
|
ability to simulate dosing to the skin, including patches, creams, ointments, and subcutaneous injections; and
|
|
·
|
tighter integration with our ADMET Predictor™ software to increase the utility of the program in early drug discovery.
|
Our goal with GastroPlus is to integrate
the most advanced science into user-friendly software to enable pharmaceutical researchers and regulators to perform sophisticated
analyses of complex drug behaviors in humans and laboratory animals. Already the most widely used program in the world for physiologically
based pharmacokinetics (PBPK), the addition of these new capabilities is expected to expand the user base in the early pharmaceutical
research and development process, while also helping us further penetrate the biopharmaceuticals, food, cosmetics, and general
toxicology markets.
We are now finalizing the development of
version 9.5 of GastroPlus, which will add a number of new capabilities and will refine and enhance some of the existing capabilities
in the program, including intramuscular dosing, simulation of antibody-drug conjugates, additional animal physiologies, enhanced
report generation, and enhancements to the PBPK tissue models. We expect to release version 9.5 in the second fiscal quarter of
FY2017.
DDDPlus
DDDPlus simulates
in vitro
(laboratory)
experiments that measure the rate of dissolution of a drug and, if desired, the additives (excipients) in a particular dosage form
(e.g., powder, tablet, capsule, or injectable solids) under a variety of experimental conditions. This unique software program
is used by formulation scientists in industry and the FDA to (1) understand the physical mechanisms affecting the disintegration
and dissolution rates of various formulations, (2) reduce the number of cut-and-try attempts to design new drug formulations, and
(3) design
in vitro
dissolution experiments to better mimic
in vivo
(animal and human) conditions. Version 5.0 of
DDDPlus, which added a number of significant enhancements, was released in April 2016. This version added new formulation types
(controlled release bilayer tablet, delayed release coated tablet, and immediate release coated beads), expanded formulation specification
options, biorelevant solubilities and surfactant effects on dissolution, tablet compression and disintegration models, links with
GastroPlus, and updated licensing.
MembranePlus™
MembranePlus was released in October 2014.
Similar to DDDPlus, MembranePlus simulates laboratory experiments, but in this case, the experiments are for measuring permeability
of drug-like molecules through various membranes, including several different standard cell cultures (Caco-2, MDCK), as well as
artificially formulated membranes (PAMPA). The value of such simulations derives from the fact that when the permeabilities of
the same molecules are measured in different laboratories using (supposedly) the same experimental conditions, the results are
often significantly different. These differences are caused by a complex interplay of factors in how the experiment was set up
and run. MembranePlus simulates these experiments with their specific experimental details, and this enables scientists to better
interpret how results from specific experimental protocols can be used to predict permeability in human and animals, which is the
ultimate goal. A few initial sales of MembranePlus have been made. Similar to DDDPlus ten years ago, this program is a new concept
that requires educating scientists on how and why to use it, and our marketing and sales program has been tasked with providing
that training.
PKPlus™
On August 25, 2016, we announced the release
of a new standalone software product called PKPlus, based on the internal PKPlus Module in GastroPlus that has been available since
2000. The PKPlus Module in GastroPlus provides quick and easy fitting of compartmental pharmacokinetic (PK) models as well as noncompartmental
analysis (NCA) for intravenous and extravascular (oral, dermal, ocular, pulmonary, etc.) doses; however, the PKPlus Module in GastroPlus
was not designed to meet all of the requirements for performing these analyses for Phase 2 and 3 clinical trials, nor to produce
report-quality output for regulatory submissions. The new standalone PKPlus program has been developed to provide the full level
of functionality needed by pharmaceutical industry scientists to perform the analyses and generate the outputs needed to fully
satisfy regulatory agency requirements for both NCA and compartmental PK modeling. We believe the potential number of eventual
users for PKPlus is in the thousands world-wide and that it has the potential to eventually become one of our leading revenue producers.
ADMET Predictor™
ADMET (Absorption, Distribution, Metabolism,
Excretion, and Toxicity) Predictor is a chemistry-based computer program that takes molecular structures (i.e., drawings of molecules
represented in various formats) as inputs and predicts approximately 150 different properties for them at an average rate of over
100,000 compounds per hour on a modern laptop computer. This capability allows chemists to generate estimates for a large number
of important molecular properties without the need to synthesize and test the molecules, as well as to generate estimates of unknown
properties for molecules that have been synthesized, but for which only a limited number of experimental properties have been measured.
Thus, a chemist can assess the likely success of a large number of existing molecules in a company’s chemical library, as
well as molecules that have never been made, by providing their molecular structures, either by drawing them using a tool such
as our MedChem Designer software, or by automatically generating large numbers of molecules using various computer algorithms,
including those embedded in our MedChem Studio software.
For many years, ADMET Predictor has been
top-ranked for predictive accuracy in multiple peer-reviewed, independent comparison studies, while generating its results at a
high throughput rate. Although the state of the art of this type of software does not enable identifying the best molecule in a
series, it does allow early screening of molecules that are highly likely to fail as potential drug candidates (i.e., the worst
molecules, which is usually the majority of a chemical library) before synthesizing and testing them. Thus, millions of virtual
compounds can be created and screened in a day, compared to potentially months or years of work to actually synthesize and test
a much smaller number of actual compounds.
The most recent release of ADMET Predictor,
version 8.0, was released on August 1, 2016. This new version features a completely redesigned and modernized interface as well
as a number of new capabilities to enhance the performance and user-friendliness of the program. In addition, we have integrated
a number of MedChem Studio features into the new ADMET Predictor, and created a tighter integration between the two programs when
a MedChem Studio license is obtained along with an ADMET Predictor license.
The optional ADMET Modeler™ Module
in ADMET Predictor enables scientists to use their own experimental data to quickly create proprietary high-quality predictive
models using the same powerful machine-learning methods we use to build our top-ranked property predictions. Pharmaceutical companies
expend substantial time and money conducting a wide variety of experiments on new molecules each year, generating large databases
of experimental data. Using this proprietary data to build predictive models can provide a second return on their investment; however,
model building has traditionally been a difficult and tedious activity performed by specialists. The automation in ADMET Modeler
makes it easy for a scientist to create very powerful models with minimal training.
We expect to release version 8.1 in the
second fiscal quarter of FY2017. This new release will include:
|
•
|
Both 64-bit and 32-bit executables, making it possible to handle larger data sets
|
|
•
|
The chemistry-aware spreadsheet has been made more efficient to accommodate larger data sets
|
|
•
|
Model-building in ADMET Modeler has been streamlined and made much more efficient
|
|
•
|
The MedChem Studio™ Module includes combinatorial substituent and scaffold replacement operations
|
|
•
|
New
in silico
Ames tests have been added to produce reliable confidence predictions and are more broadly applicable
|
|
•
|
ADMET Risk™ are now accessible graphically in histograms
|
Potential new markets for machine
learning
We are currently investigating applications
of our sophisticated machine-learning engine outside of our normal pharmaceutical markets. To date, we have conducted several proof-of-concept
studies including: (1) building predictive models for missile aerodynamic force and moment coefficients as a function of missile
geometry, Mach number, and angle of attack, (2) classifying/identifying missiles and other objects from radar tracking data, (3)
mapping jet engine compressor performance to predict when maintenance might be required, and (4) classifying patients as healthy
or experiencing some disease state or genetic disorder evidenced by magnetic resonance imaging (MRI) of the brain. Other potential
applications for this modeling engine have also been identified; however, our focus to date has been primarily in these areas.
We believe our proprietary machine-learning
software engine has a wide variety of potential applications and we intend to pursue funding to develop customized tools to further
monetize our investment in this technology by expanding our markets beyond the life sciences and chemistry. In addition, we are
examining a variety of expanded capabilities to add to the basic modeling engine to accommodate even larger data sets (“big
data analytics”) and new applications.
MedChem Designer™
MedChem Designer was launched in 2011.
It was initially a molecule-drawing program, or “sketcher”, but now has capabilities exceeding those of other molecule-drawing
programs because of its integration with both MedChem Studio and ADMET Predictor. We provide MedChem Designer for free because
we believe that in the long run it will help to increase demand for ADMET Predictor and MedChem Studio, and because most other
existing molecule-drawing programs are also provided for free. Our free version includes a small set of ADMET Predictor’s
best-in-class property predictions, allowing the chemist to modify molecular structures and then see a few key properties very
quickly. With a paid ADMET Predictor license, the chemist would see the entire approximately 150 predictions that are available.
Over 18,000 copies of MedChem Designer have been downloaded by scientists around the world to date.
When used with a license for ADMET Predictor,
MedChem Designer becomes a
de novo
molecule design tool. With it, a researcher can draw one or more molecular structures,
then click on the ADMET Predictor icon and have approximately150 properties for each structure calculated in seconds, including
our proprietary ADMET Risk™ index. Researchers can also click on an icon to generate the likely metabolites of a molecule
and then predict all of the properties of those metabolites from ADMET Predictor, including each of their ADMET Risk scores. This
is important because a metabolite of a molecule can be therapeutically beneficial (or harmful) even though the parent molecule
is not.
Our proprietary ADMET Risk score provides
a single number that tells the chemist how many default threshold values for various predicted properties were crossed (or violated)
by each structure. Thus, in a single number, the chemist can instantly compare the effects of different structural changes in many
dimensions. The ideal score is zero; however, a low score greater than zero might be acceptable, depending on what property(s)
caused the points to be assigned. If the number is too high (greater than 5 or 6), the molecule is not likely to be successful
as a drug. The default rules can be modified and new rules can be added by the user to include any desired rule set based on any
combination of calculated descriptors, predicted properties, and user inputs. As chemists attempt to modify structures to improve
one property, they often cause others to become unacceptable. Without ADMET Risk, the chemist would have to individually examine
many key properties for each new molecule (and its metabolites) to determine whether any of them became unacceptable as a result
of changing the structure.
MedChem Studio™
MedChem Studio is a powerful software tool
that is used both for data mining and for
de novo
design of new molecules. In its data-mining role, MedChem Studio facilitates
searching large chemical libraries to find molecules that contain identified substructures, and it enables rapid identification
of clusters (classes) of molecules that share common substructures. MedChem Studio version 4.0 was released during fiscal year
2014. We have now merged MedChem Studio with the refactoring of ADMET Predictor 8.0, so that either program can be entered through
the same interface, and the communication between the two programs is enhanced through the seamless integration of both technologies.
We believe this will enhance the attractiveness of both ADMET Predictor and MedChem Studio to medicinal and computational chemists.
While MedChem Designer can be used to refine
a small number of molecules, MedChem Studio can be used to create and screen (with ADMET Predictor) very large numbers of molecules
down to a few promising lead candidates. MedChem Studio has features that enable it to generate new molecular structures using
a variety of
de novo
design methods. When MedChem Studio is used with ADMET Predictor and MedChem Designer (the combination
of which we refer to as our ADMET Design Suite), we believe the programs provide an unmatched capability for chemists to search
through large libraries of compounds that have undergone high-throughput screening experiments to find the most promising classes
(groups of molecules with a large common part of their structures) and molecules that are active against a particular target. In
addition, MedChem Studio can take an interesting (but not acceptable) molecule and, using a variety of design algorithms, quickly
generate many thousands to millions of high quality analogs (similar new molecules). These molecules can then be screened using
ADMET Predictor to find molecules that are predicted to be both active against the target and acceptable in a variety of ADMET
properties. We demonstrated the power of the ADMET Design Suite during two NCE (new chemical entity) projects wherein we designed
lead molecules to inhibit the growth of the
plasmodium falciparum
malaria parasite in one study and lead molecules that
were combined COX-1 and COX-2 inhibitors. In each case, we announced ahead of time that we were attempting to do this, and we reported
the results when the projects were complete. Every molecule we designed and had synthesized hit their targets in both projects.
KIWI™
Drug development programs rely increasingly
on modeling and simulation analyses to support decision-making and submissions to regulatory agencies. To ensure high-quality analyses,
organizations must not only apply high-quality science, but must also be able to support the science by being able to validate
the results. KIWI is a cloud-based web application that was developed to efficiently organize, process, maintain, and communicate
the volume of data and results generated by pharmacologists and scientists over the duration of a drug development program. The
validated workflow and tools within KIWI promote traceability and reproducibility of results.
The pharmaceutical industry has been rapidly
adopting cloud technology as a solution to ever-expanding computer processing needs. Leveraging our 20-plus years of experience
in providing an architecture supporting modeling and simulation efforts, we have developed KIWI as a secure, validated, enterprise-scale
environment, enabling global teams to collaborate on model-based decision making. KIWI has proven to be a valuable platform for
encouraging interdisciplinary discussions about the model development process and interpretation of results. We continue to receive
positive feedback about the functionality implemented in KIWI and the value of the approach we have taken to harness cloud technology.
We continue to improve functionality and collaboration within the KIWI platform, and we expect the licensing fee will be a source
of recurring revenue for further development and growth. KIWI Version 1.3 was released in May 2015. This version of KIWI provides
our user community with access to new features that accelerate completion of modeling projects by decreasing run times and facilitating
the comparison and exporting of results across models. These features include dynamic comparisons of model parameter estimates
and diagnostic plots, export of model run records for regulatory submissions, and accelerated infrastructure with the upgrade to
the latest versions of NONMEM® and Perl-speaks-NONMEM running in a 64-bit Linux environment.
KIWI Version 1.6 was released in September
2016. This new version introduced major enhancements in the functionality of visualization tools offered by the platform. These
enhancements include simplifying the creation of plots and comparing them across multiple models, thus accelerating the model refinement
process. In addition, analysts can now conveniently copy visualization preferences across projects, improving consistency and facilitating
collaboration and communication with clients and colleagues.
Contract Research and Consulting Services
Our scientists and engineers have expertise
in drug absorption via various dosing routes (oral, intravenous, ocular, nasal/pulmonary, and dermal), pharmacokinetics, and pharmacodynamics.
They have been speakers or presenters at over 150 scientific meetings worldwide in the past four years. We frequently conduct contracted
consulting studies for large customers (including the five largest pharmaceutical companies) who have particularly difficult problems
and who recognize our expertise in solving them, as well as for smaller customers who prefer to have studies run by our scientists
rather than to license our software and train someone to use it. The demand for our consulting services has been steadily increasing,
and we have expanded our consulting teams to meet the increased workload.
We continue working on a five-year consulting
agreement with a major research foundation to implement a platform for coordinating the data generated by global teams engaged
in model-based drug development.
We currently are working with the FDA on
three different Research Collaboration Agreements (RCAs): two funded efforts for the ocular model and long-acting injectable microspheres
and the unfunded IVIVC effort, all described above under “GastroPlus”. We also successfully completed the fifth year
of our five-year renewable collaboration with the Center for Food Safety and Nutrition of the FDA to develop predictive toxicity
models for food additives and contaminants.
Pharmacometric Modeling
We have a reputation for high-quality analyses
and regulatory reporting of data collected during preclinical experiments as well as clinical trials of new and existing pharmaceutical
products, typically working on 30-40 drug projects per year. The model-based analysis of clinical trial data that we perform is
different from the modeling analysis offered by GastroPlus; the former relies more on statistical and semi-mechanistic models,
whereas the latter relies on very detailed mechanistic models. Statistical models rely on direct observation and mathematical equations
that are used to fit data collected across multiple studies along with describing the variability within and between patients.
Mechanistic models are based on a detailed understanding of the human body and the chemistry of the drug and involve mathematical
and scientific representation of the phenomena involved in drug dissolution/precipitation, absorption, distribution, metabolism,
and elimination. Collectively, the models guide drug formulation design and dose selection.
Because of the synergies achieved through
the integration of our Buffalo division (Cognigen) into Simulations Plus, our first full fiscal year of combined operations resulted
in significantly increased revenues and earnings. Our clinical pharmacometricians in Buffalo, supported by our consulting team
in California, are learning to use the PBPK modeling capabilities of GastroPlus and are performing such studies under new and expanded
contracts with pharmaceutical customers.
PRODUCT DEVELOPMENT
Development of our software is focused
on expanding product lines, designing enhancements to our core technologies, and integrating existing and new products into our
principal software architecture and platform technologies. We intend to continue to offer regular updates to our products and to
continue to look for opportunities to expand our existing suite of products and services.
To date, we have developed products internally,
sometimes also licensing or acquiring products, or portions of products, from third parties. These arrangements sometimes require
that we pay royalties to third parties. We intend to continue to license or otherwise acquire technology or products from third
parties when it makes business sense to do so. We currently have one license agreement, with BIOVIA, a San Diego division of Dassault
Systemes in France (formerly known as Accelrys, Inc.), pursuant to which a small royalty is paid to BIOVIA from revenues on each
license for the Metabolite module in ADMET Predictor. This license agreement continues in perpetuity and either party has the right
to terminate it.
In 1997 we entered into an exclusive software
licensing agreement with TSRL, Inc. (aka Therapeutic Systems Research Laboratories) (TSRL), pursuant to which TSRL licensed certain
software technology and databases to us, and we paid royalties to TSRL. On May 15, 2014, we and TSRL entered into a termination
and non-assertion agreement pursuant to which the parties agreed to terminate the 1997 exclusive software licensing agreement.
As a result, the Company obtained a perpetual right to use certain source code and data, and TSRL relinquished any rights and claims
to any GastroPlus products and to any claims to royalties or other payments under that agreement, and we agreed to pay TSRL total
consideration of $6,000,000 as follows: (a) $3,500,000 by May 20, 2014, which amount was comprised of $2,500,000 in cash and $1,000,000
worth of our common stock (which was 164,745 shares based upon the April 25, 2014 closing price per share of $6.07 per share),
(b) $750,000 payable on or before April 25, 2015, (c) $750,000 payable on or before April 25, 2016, and (d) $1,000,000 payable
on or before April 25, 2017. All payments have now been made except the final $1 million, which will be paid in April 2017. Our
outstanding payment obligation described above is non-interest-bearing and will be amortized at a constant rate of $150,000 per
quarter until it is completely amortized, after which no further expense will be incurred. For most quarters, we expect that this
will result in a savings over the royalty payments that would have been paid to TSRL if paid consistent with past practices.
MARKETING AND DISTRIBUTION
We distribute our products and offer our
services in North America, South America, Europe, Japan, Australia, New Zealand, India, Singapore, Taiwan, and the People’s
Republic of China.
We market our pharmaceutical software and
consulting services through attendance and presentations at scientific meetings, exhibits at trade shows, seminars at pharmaceutical
companies and government agencies, through our website, and using various communication channels to our database of prospects and
customers. At various scientific meetings around the world each year there are numerous presentations and posters presented in
which the reported research was performed using our software. Many of these presentations are from industry and FDA scientists;
some are from our staff. In addition, more than 50 peer-reviewed scientific journal articles, posters, and podium presentations
are typically published each year using our software, mostly by our customers, further supporting its use in a wide range of preclinical
and clinical studies.
Our sales and marketing efforts are handled
primarily internally with our scientific team and several senior management staff assisting our marketing and sales staff with
trade shows, seminars, and customer trainings both online and on-site. We believe that this is more effective than a completely
separate sales team for several reasons: (1) customers appreciate talking directly with software developers and consulting scientists
who can answer a wide range of in-depth technical questions about methods and features; (2) our scientists and engineers gain an
appreciation for the customer’s environment and problems; and (3) we believe the relationships we build through scientist-to-scientist
contact are stronger than relationships built through salesperson-to-scientist contacts. We also have one independent distributor
in Japan and two independent representatives in China who also sell and market our products with support from our scientists and
engineers.
We provide support to the GastroPlus User
Group in Japan, which was organized by Japanese researchers in 2009. In early 2013, a group of scientists in Europe and North America
organized another group following the example set in Japan. Over 850 members have joined this group to date. We support this group
through coordination of online meetings each month and managing the user group web site for exchange of information among members.
These user groups provide us valuable feedback with respect to desired new features and suggested interface changes.
PRODUCTION
Our pharmaceutical software products are
designed and developed by our development teams in California and New York, with locations in Lancaster, Petaluma, San Jose, San
Diego, and Buffalo. In addition, we have one team member working out of North Carolina and our Chief Executive Officer works primarily
from Auburn, Alabama. Our products and services are now delivered electronically – we no longer provide CD-ROMs and printed
manuals or reports.
COMPETITION
In our pharmaceutical software and services
business, we compete against a number of established companies that provide screening, testing and research services, and products
that are not based on simulation software. There are also software companies whose products do not compete directly with, but are
sometimes closely related to, ours. Our competitors in this field include some companies with financial, personnel, research, and
marketing resources that are larger than ours. Our management believes there is currently no significant competitive threat to
GastroPlus; however, in spite of a high barrier to entry, one could be developed over time. Our new PKPlus software product will
compete with one major and a few minor software programs; however, the capabilities and design features of PKPlus, along with more
affordable licensing, are expected to generate significant interest. MedChem Studio, MedChem Designer, and ADMET Predictor/ADMET
Modeler operate in a more competitive environment. Several other companies presently offer simulation or modeling software, or
simulation-software-based services, to the pharmaceutical industry.
Major pharmaceutical companies conduct
drug discovery and development efforts through their internal development staffs and through outsourcing. Smaller companies generally
need to outsource a greater percentage of this research. Thus, we compete not only with other software suppliers, but also with
the in-house development teams at some of the larger pharmaceutical companies.
Although competitive products exist, both
new licenses and license renewals for GastroPlus have continued to grow. We believe that we enjoy a dominant market share in this
segment. We believe our ADMET Predictor/ADMET Modeler, MedChem Studio, MedChem Designer, DDDPlus, MembranePlus, PKPlus, and KIWI
software offerings are each unique in their combination of capabilities and we intend to continue to market them aggressively.
We believe the key factors in our ability
to successfully compete in this field are our ability to: (1) continue to invest in research and development, and develop and support
industry-leading simulation and modeling software and related products and services to effectively predict activities and ADMET-related
behaviors of new drug-like compounds, (2) design new molecules with acceptable activity and ADMET properties, (3) develop and maintain
a proprietary database of results of physical experiments that serve as a basis for simulated studies and empirical models, (4)
attract and retain a highly skilled scientific and engineering team, (5) aggressively our products and services to our global market,
and (6) develop and maintain relationships with research and development departments of pharmaceutical companies, universities,
and government agencies.
In addition, we actively seek strategic
acquisitions to expand the pharmaceutical software and services business and to explore opportunities in aerospace and general
healthcare.
STRATEGY
Our business strategy is to do the things
we need to do to promote growth both organically (i.e., by expanding our current products and services through in-house efforts)
and by acquisition. We believe in the “Built to Last” approach - that the fundamental science and technologies that
underlie our business units are the keys both to improving our existing products and to expanding the product line with new products
that meet our various customers’ needs. We believe the continued growth of our pharmaceutical software and services business
segment is the result of steadily increasing adoption of simulation and modeling software tools across the pharmaceutical industry,
as well as the world-class expertise we offer as consultants to assist companies involved in the research and development of new
medicines. We have received a continuing series of study contracts with pharmaceutical companies ranging from several of the largest
in the world to a number of medium-sized and smaller companies in the U.S. and Europe.
On July 23, 2014, we signed a merger agreement
with Cognigen Corporation of Buffalo, New York. The merger closed on September 2, 2014, and Cognigen became our wholly owned subsidiary.
We believe the combination of Simulations Plus and Cognigen provides substantial future potential based on the complementary strengths
of each of the companies. It is our intent to continue to search for acquisition opportunities that are compatible with our current
businesses and that are accretive, i.e., adding to both revenues and earnings.
In the fiscal year ended August 31, 2016
we distributed $0.20 per share in dividends to our shareholders. In November 2016 the we distributed a quarterly dividend of $0.05
per share. We anticipate future dividends to be $0.05 per share per quarter; however, there can be no assurances that such dividends
will be distributed, or if so, whether the amounts will be more, less, or the same as expected. The Board of Directors must approve
each quarterly dividend distribution and may decide to increase, decrease, or eliminate dividend distributions at any time.
Results of Operations
Comparison of Three Months Ended November 30, 2016 and
2015.
The following table sets forth our condensed
statements of operations (in thousands) and the percentages that such items bear to net sales (because of rounding, numbers may
not foot):
|
|
Three Months Ended
|
|
|
|
11/30/16
|
|
|
11/30/15
|
|
Net revenues
|
|
$
|
5,418
|
|
|
|
100.0%
|
|
|
$
|
4,838
|
|
|
|
100.0%
|
|
Cost of revenues
|
|
|
1,336
|
|
|
|
24.7
|
|
|
|
1,083
|
|
|
|
22.4
|
|
Gross profit
|
|
|
4,082
|
|
|
|
75.3
|
|
|
|
3,755
|
|
|
|
77.6
|
|
Selling, general and administrative
|
|
|
1,864
|
|
|
|
34.4
|
|
|
|
1,676
|
|
|
|
34.6
|
|
Research and development
|
|
|
290
|
|
|
|
5.4
|
|
|
|
351
|
|
|
|
7.3
|
|
Total operating expenses
|
|
|
2,154
|
|
|
|
39.8
|
|
|
|
2,027
|
|
|
|
41.9
|
|
Income from operations
|
|
|
1,928
|
|
|
|
35.6
|
|
|
|
1,728
|
|
|
|
35.7
|
|
Other income
|
|
|
39
|
|
|
|
0.7
|
|
|
|
(11
|
)
|
|
|
(0.2
|
)
|
Income from operations before taxes
|
|
|
1,967
|
|
|
|
36.3
|
|
|
|
1,717
|
|
|
|
35.5
|
|
(Provision for) income taxes
|
|
|
(606
|
)
|
|
|
(11.2
|
)
|
|
|
(611
|
)
|
|
|
(12.6
|
)
|
Net income
|
|
$
|
1,361
|
|
|
|
25.1%
|
|
|
$
|
1,106
|
|
|
|
22.9%
|
|
Net Revenues
Consolidated net revenues increased by
12.0% or $579,000 to $5.418 million in the first fiscal quarter of Fiscal Year 2017 (“1QFY17”) from $4.838 million
in the first fiscal quarter of Fiscal Year 2016 (“1QFY16”). This net increase was due to a $285,000 increase in revenues
generated by our Lancaster Division, representing a 8.4% increase over 1QFY16, and an increase of $294,000 or 20.6% in revenues
of our Buffalo Division to $1.723 million in 1QFY17 from $1.428 million in 1QFY16. This is a record revenue quarter for Buffalo.
Consolidated software and software-related sales increased $218,000 or 6.8%, while consolidated consulting and analytical study
revenues increased $349,000 or 21.1% over 1QFY16.
Cost of Revenues
Consolidated cost of revenues increased
by $253,000, or 23.3%, in 1QFY17 to $1.336 million from $1.083 million in 1QFY16. Cost of Revenues as a percentage of revenue increased
by 2.3% in 1QFY17 to 24.7% as compared to 24.4% in 1QFY16. $124,000 of the increased costs are allocated labor related to increased
studies and contracts, $45,000 of increased costs associated with training programs presented in 1QFY17, increased software amortization
of $37,000, and $38,000 of direct contract related expenses.
Gross Profit
Consolidated gross profits increased $327,000
or 8.7%, to $4.082 million in 1QFY17 from $3.755 million in 1QFY16. Our Lancaster Division accounted for a $160,000 of the increase,
which came mainly from increased software license sales and related study revenues, while our Buffalo Division contributed $167,000
of the increase. Consolidated Gross profit as a percentage of revenues decreased 2.3 to 75.3% in 1QFY17 from 77.6% in 1QFY16.
Selling, General and Administrative Expenses
Selling, general, and administrative (SG&A)
expenses increased $187,000, or 11.2%, to $1.864 million in 1QFY17, from $1.676 million in 1QFY16.
The major increases in SG&A expenses
this year compared to last year were:
|
·
|
Salaries and Wages increased $25,000 – increases in wages over the prior year and a higher percentage of allocated G&A labor by scientific staff
|
|
·
|
Professional fees increased $152,000 –this increased first quarter cost is mainly the result of the company’s transition to accelerated filer status and the cost of the Company’s first Sarbanes Oxley internal control audit and audit related costs
|
Major Decreases –There were no individually
significant decreases in this quarter compared to last year.
Research and Development
Total research and development cost decreased
$92,000 in 1QFY17 compared to 1QFY16. In 1QFY17 we incurred approximately $525,000 of research and development costs, of this amount,
$235,000 was capitalized and $290,000 was expensed. In 1QFY16 we incurred approximately $618,000 of research and development costs,
of this amount, $267,000 was capitalized and $351,000 was expensed.
Other income (expense)
Other income was $39,000 compared to a
loss of $11,000 in 1QFY16. Foreign currency exchange accounted for $50,000 of the increase, a $35,000 gain in 1QFY17 compared to
a $15,000 loss in 1QFY16. The change is mainly due to the dollar strengthening in relation to the Japanese yen.
Provision for Income Taxes
The provision for income taxes was $606,000
for 1QFY17 compared to $611,000 for 1QFY16. Our effective tax rate decreased 1.9% to 30.8% in 1QFY17 from 35.6% in 1QFY16. This
decrease is a result of additional tax deductions for stock based compensation and higher tax credits in 1QFY17.
Net Income
Net income increased by $255,000, or 23.1%,
in 1QFY17 to $1.361 million from $1.106 million in 1QFY16. Net earnings from our Lancaster division were up $162,000 or 17.6% to
$1.080 million in 1QFY17. Net earnings for our Buffalo division were up $94,000 or 49.9% to $188,000 in 1QFY17.
Liquidity and Capital Resources
Our principal sources of capital have been
cash flows from our operations. We have achieved continuous positive operating cash flow over the last nine fiscal years. We believe
that our existing capital and anticipated funds from operations will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for the foreseeable future. Thereafter, if cash generated from operations is insufficient to satisfy
our capital requirements, we may open a revolving line of credit with a bank, or we may have to sell additional equity or debt
securities or obtain expanded credit facilities. In the event such financing is needed in the future, there can be no assurance
that such financing will be available to us, or, if available, that it will be in amounts and on terms acceptable to us. If cash
flows from operations became insufficient to continue operations at the current level, and if no additional financing was obtained,
then management would restructure the Company in a way to preserve its pharmaceutical business while maintaining expenses within
operating cash flows.