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. Our pharmaceutical/chemistry
software is licensed to major pharmaceutical, biotechnology, agrochemical, cosmetics, 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 Research Triangle Park, North Carolina, and its common
stock trades on the Nasdaq Capital Market under the symbol “SLP.”
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 early discovery, 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 PBPK modeling
and simulation, prediction of molecular properties from structure, and prediction of drugs to induce liver injury or to treat nonalcoholic
fatty liver disease.
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 consulting services 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 designs,
and simulate outcomes in special populations, such as the elderly and pediatric patients.
Simulations Plus previously acquired Cognigen
Corporation (Cognigen) as a wholly owned subsidiary. Cognigen was originally incorporated in 1992. Through the integration of Cognigen
into Simulations Plus, Simulations Plus became 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.
Simulation Plus also acquired DILIsym Services,
Inc. (DILIsym) as a wholly owned subsidiary. We believe the combination of Simulations Plus and DILIsym provides substantial future
potential based on the complementary strengths of each of the companies. The acquisition of DILIsym positions the Company as the
leading provider of Drug Induced Liver Injury (DILI) modeling and simulation software and related scientific consulting services.
In addition to the DILIsym® software for analysis of potential drug-induced liver injury, DILIsym Services, Inc. also has developed
a simulation program for analyzing nonalcoholic fatty liver disease (NAFLD) called NAFLDsym™. Both the DILIsym and NAFLDsym
software programs require outputs from physiologically based pharmacokinetics (PBPK) software as inputs. The GastroPlus™
PBPK software from Simulations Plus provides such information; thus, the integration of these technologies will provide a seamless
capability for analyzing the potential for drug-induced liver injury for new drug compounds and for investigating the potential
for new therapeutic agents to treat nonalcoholic fatty liver disease.
PRODUCTS
General
We currently offer ten software products
for pharmaceutical research and development: five simulation programs that provide time-dependent results based on solving large
sets of differential equations: GastroPlus®; DDDPlus™; MembranePlus™; DILIsym®; and NAFLDsym™; 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™); a program which is designed for rapid clinical trial data analysis and regulatory submissions
called PKPlus™; and a program called KIWI™ from our Cognigen division that provides an integrated platform for data
analysis and reporting through our proprietary secure cloud.
GastroPlus®
Our flagship product, originally introduced
in 1998, and currently our largest single source of software revenue, is GastroPlus. GastroPlus mechanistically simulates the absorption,
pharmacokinetics, pharmacodynamics, and drug-drug interactions of compounds administered to humans and animals and is currently
the most widely used commercial 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.
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 was 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 was at our own expense, while other members were compensated for their work; however, we were 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 enabled us
to benefit from, and to contribute to, advancing the prediction of human oral bioavailability from preclinical data, and ensured
that we are well-known to member pharmaceutical companies and regulatory agencies.
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 was 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 received up to
$200,000 per year. This RCA could 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 extended for two additional years in September 2016, with primary tasks completed in
September 2018. Additional functionality was further requested by the FDA, and a new funded contract was awarded for the 2018-19
period.
We were awarded another RCA by the FDA
in September 2015; this one to expand the capabilities of GastroPlus to simulate the dosing of long-acting injectable microspheres
for both small and large molecules (biologics). This type of dosage form is usually injected via subcutaneous or intramuscular
routes. This RCA also provides up to $200,000 per year for up to three years. Under this agreement, we are developing simulation
models to deal with the very 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 second year, the RCA was renewed for the third year in September
2017 and was completed in September 2018, with further extensions under consideration with the FDA.
In September 2018, we were pleased to announce
that we were awarded another funded RCA by the FDA to integrate drug product quality attributes into the mechanistic TCAT model
in GastroPlus. This grant award, for $250,000 per year for up to two years, will focus on the incorporation of drug product quality
attributes into dermal physiologically-based pharmacokinetic (PBPK) models developed for dermatological topical dosage forms and
transdermal delivery systems.
In July 2018 we entered into a one-year
funded research collaboration with a large European consortium to further develop and validate the mechanistic Transdermal Compartmental
Absorption and Transit (TCAT™) model in GastroPlus. This project will contribute substantially to improvements in the program,
specifically directed toward the predictions of local exposure within the skin layer following topical administration of various
chemicals. We expect the developments under this agreement will aid companies and regulatory agencies as they strive to implement
an animal-free chemical safety assessment program.
In January 2019 DILIsym Services and Simulations
Plus entered into a two-year, $2.7 million collaboration with a large pharmaceutical company on the development of a new Quantitative
Systems Pharmacology (QSP) model that will provide the ability to predict the efficacy of drugs being developed to treat idiopathic
pulmonary fibrosis (IPF). Part of this funding will go towards expansion of GastroPlus to improve the predictions of compound exposure
upon inhalation of drugs.
In addition to the two active 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 May 2018, we released Version 9.6 of
GastroPlus. Version 9.6 is the most feature-rich and user-friendly release in our history. New functionalities that we believe
provide the most advanced decision-making tool for preclinical and early clinical trial simulation and modeling analysis available
today include:
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New dynamic intestinal fluid options added to the #1-ranked ACAT™ oral absorption model
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New population physiologies for obesity and renal impairment disease states
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Expanded enzyme/transporter distribution information for easier extrapolation across species
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Additional compound model files for standard drug-drug interaction (DDI) substrates & inhibitors
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Upgraded capabilities to all major mechanistic absorption routes, including dermal, pulmonary, ocular, and subcutaneous/intramuscular injections
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Enhanced deconvolution methods for generation of mechanistic
in vitro-in vivo
correlations (IVIVCs)
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Improved output/reporting functions in all simulation modes to facilitate communication across departments and with regulatory agencies
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Significant simulation speed improvements
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Custom template generation for seamless use of GastroPlus to drive DILIsym® SimPops™ liver injury predictions
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Our goal with GastroPlus is to integrate
the most advanced science into user-friendly software to enable researchers and regulators to perform sophisticated analyses of
complex compound behaviors in humans and laboratory animals. Already the most widely used program in the world for PBPK modeling,
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 to further penetrate biopharmaceuticals, food, cosmetics, and general toxicology markets.
Version 9.7 is now in development and release
is expected in early 2019. This version will add a number of important new capabilities, including improvements to population simulations,
dissolution, absorption, PBPK models, and drug-drug interactions, among others.
DDDPlus™
DDDPlus mechanistically simulates
in
vitro
(laboratory) experiments that measure the rate of dissolution of a drug as well as, 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, (3) design
in vitro
dissolution experiments to better mimic
in vivo
(animal and human) conditions,
and (4) . 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.
Version 6.0 of DDDPlus, released
in December 2018, offers a series of new capabilities, including:
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simulation of the
in vitro
dissolution of long-acting injectable dosage forms
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simulation of the
in vitro
dissolution of controlled release bead formulations
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new simulation of artificial stomach-duodenum (ASD) experiments
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ability to fit models from precipitation experiments
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new dissolution apparatus models
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improved output reporting
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MembranePlus™
Similar to DDDPlus, MembranePlus mechanistically
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.
Version 2.0 of MembranePlus was released
in August 2017. This version added:
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simulation of sandwich hepatocyte assays
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simulation of suspended hepatocyte assays
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intracellular protein binding
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integration of ADMET Predictor metabolism predictions
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improved output reporting
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PKPlus™
In August 2016, we released a 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 a simple 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 standalone PKPlus program provides 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 more complex NCA as well as compartmental PK modeling. After receiving considerable feedback on version 1.0,
we began modifying the program to include a number of additional features requested by our users and potential users for release
in version 2.0.
PKPlus version 2.0 was released in February
2018. This new version incorporates a wide variety of requested features from current users as well as evaluators of version 1.0,
including:
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Ability to edit input data prior to incorporating it into a Project database
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21 CFR Part 11 compliance for audit trail and validation
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Validation data sets included
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Compartmental multi-dose simulations
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Command-line capability for rapid validation after installation on customers’ computers and for batch processing
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Nonparametric superposition for analysis of multiple-dose pharmacokinetics
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New statistics graphical outputs
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Ability to save templates for various types of analyses – reduces time required when working with new datasets
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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 only 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.
ADMET Predictor has been top-ranked
for predictive accuracy in multiple peer-reviewed, independent comparison studies for
many years, while generating its results
at a very 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 typically the majority of a virtual 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 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 artificial intelligence (AI) engine 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 machine-learning/AI models with minimal training.
Version 9.0 was released in June 2018,
adding:
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Additional pharmacokinetic (PK) endpoint predictions included with the High-Throughput Pharmacokinetics (HTPK) Simulation Module
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New artificial intelligence (machine-learning) models to predict major clearance mechanisms
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Novel DELTA Model™ approach extends model coverage space adding client data through the ADMET Modeler Module
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Multi-class classification models can now be built using our advanced artificial neural network ensemble (ANNE) methodology
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Intuitive graphical display of Biopharmaceutical Classification System (BCS) and Developability Classification System (DCS)
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Rebuilt most classification models to improve their confidence estimates
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New functionality for easily generating and visualizing fingerprints within the MedChem Studio Module
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We have made significant investments in
two key areas with version 9: improving integration of our top-ranked ADMET Predictor and GastroPlus models to leverage our novel
‘Discovery PBPK’ approaches for chemists, and further enhancing our best-in-class AI engine to assist with drug discovery.
Recent publications from a large pharmaceutical company describing how they have leveraged our ‘Discovery PBPK’ methods
to guide lead optimization illustrate how our unique offerings provide substantial value in this space.
Potential new markets for artificial
intelligence (machine learning)
We are currently investigating applications
of our sophisticated artificial intelligence (machine-learning) engine outside of our normal pharmaceutical markets. To date, we
have conducted several proof-of-concept studies including: (1) predicting 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 AI/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 initially a molecule-drawing
program, or “sketcher”, but now has capabilities far 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 28,000 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 approximately 150 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 7), 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 set based on combinations
of calculated molecular 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™
The MedChem Studio Module in ADMET Predictor
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.
While MedChem Designer can be used to refine
a small number of molecules, the MedChem Studio Module can be used to create and screen 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 able to inhibit two targets
at the same time: COX-1 and COX-2. 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,
clearly demonstrating the power of the ADMET Design Suite.
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 provided
our user community with access to new features that accelerated completion of modeling projects by decreasing run times and facilitating
the comparison and exporting of results across models. These features included 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 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 could now conveniently copy visualization preferences across projects, improving consistency and facilitating
collaboration and communication with clients and colleagues.
KIWI 2 was released in December 2017. This
latest version introduces a repository within the KIWI Cloud service to facilitate the management and organization of data and
documents used and produced to support the modeling and simulation analyses used, in part, to submit new drug applications. The
user interface provides a predefined directory as a default that can be customized, allows file version control, and provides a
comprehensive roles and permissions structure to enhance collaboration among a community of users. As part of this initiative,
an enhanced authentication framework foundation was included to provide the ability for clients to customize authentication rules
according to their internal regulatory policies and procedures. In addition, since it can take hundreds of models to create one
final model, an automated diagnostics dashboard has been added that visually displays the results of over 10 diagnostics that are
used by modelers to decide what direction to take their modeling with the potential to significantly reduce the amount of time
it takes to arrive at a final model.
KIWI 3.0 was released in August 2018. The
latest version incorporates ExploreLive and Explore, two powerful new visualization modules, introduced for exploratory data analysis
of information stored in analysis datasets and NONMEM outputs. In addition, new automated diagnostics are now performed for every
NONMEM run, visually reported in the Summarize module. KIWI version 3.0 also features improved infrastructure and security,
as well as a completely redesigned Knowledge Portal used to access the KIWI program. In addition to full feature releases, going
forward regular mini feature releases of KIWI will be distributed to KIWI clients. In 2019 Q1, an enhanced editor and grouping
of visualizations for easy replication was added, resulting in streamlined model development.
We continue enhancing KIWI as part of our
five-year, almost-$5 million contract with the Bill and Melinda Gates Foundation.
DILIsym
The DILIsym software is a quantitative
systems pharmacology (QSP) program that has been in development since 2011. QSP software models are based on the fundamental understanding
of complex biological pathways, disease processes, and drug mechanisms of action, integrating information from experiments and
forming hypotheses for the next experimental model. DILIsym deals with the propensity for some drug molecules to induce temporary
or permanent changes in biological functions within liver cells (hepatocytes) that can result in damage to the liver. Some drugs
cause temporary changes in liver function but the body soon compensates and liver function returns to normal. Other drugs cause
liver function to permanently decline as they continue to be taken. The DILIsym software models a variety of interactions within
the hepatocytes to determine whether a particular drug molecule interrupts normal signaling pathways in a manner to induce injury
to the cells.
Version 8A of the DILIsym software was
released in January 2019. This version is again delivered as a secure executable that incorporates new proprietary code enabling
tighter integration with our GastroPlus PBPK software. Securing the code is necessary to ensure that results are consistent across
all users to assure regulatory agencies that the calculated results are from a validated version. Open source programs are subject
to modification by the user and so each use could have a different set of calculations, so validation would not be assured. In
addition, a number of important new capabilities were added:
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10 New validation compounds
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New Cholestatic liver injury mechanism
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New Oxidative stress (ROS) NRF2 adaptation response framework
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New Human SimPops with variability in bilirubin processing pathways
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New Liver injury biomarker GLDH
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Live DILIsym documentation website updated with new training resources
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NAFLDsym
Where DILIsym is used to investigate the
likelihood that a known drug molecule would cause injury to the liver, NAFLDsym is concerned with a liver that is already diseased
by excess fat and investigates the likelihood that various molecules might provide beneficial therapeutic benefits to treat or
cure the disease. DILIsym can be considered a “shrink wrap” software product, usable across many companies and drug
development projects. NAFLDsym, on the other hand, requires modification for each of a number of different mechanisms of action
that potential new drug compounds could use to treat the disease, and so is a customized tool used in consulting projects for each
new client project. NAFLDsym version 2A will be released for licensing and consulting use in spring of 2019. The software now includes
the three most important components of NAFLD/NASH: steatosis, inflammation, and fibrosis.
RENAsym
Where DILIsym is used to investigate the
likelihood that a known drug molecule would cause injury to the liver, RENAsym will be focused on investigating and predicting
drug-induced kidney injury, or acute kidney injury (AKI). RENAsym will be another “shrink wrap” software product, usable
across many companies and drug development projects. The software will utilize predictions of drug exposure in the kidney from
PBPK platforms such as GastroPlus, along with in vitro data related to certain kidney injury mechanisms, to make predictions. The
first expected release of RENAsym will be available in Fall of 2020. The initial development is being funded via an NIH small business
grant.
Contract Research and Consulting Services
Our scientists and engineers have expertise
in drug absorption via various dosing routes (oral, intravenous, subcutaneous, intramuscular, ocular, nasal/pulmonary, and dermal),
pharmacokinetics, pharmacodynamics, and drug-drug interactions. They have attended over 200 scientific meetings worldwide in the
past four years, often speaking and presenting. We conduct contracted consulting studies for large customers (including many of
the top twenty 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.
Currently we are approximately half way
through the work on a five-year consulting agreement with the Bill and Melinda Gates Foundation to implement a platform for coordinating
the data generated by global teams engaged in model-based drug development.
We are also currently working with the
FDA on three Research Collaboration Agreements (RCAs): the funded efforts for ocular/transdermal dosing and the unfunded IVIVC
effort, both described above under “GastroPlus”.
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 80-100 drug projects per year. Traditionally, the model-based analysis of clinical trial data was
different from the modeling analysis offered by GastroPlus; the former relied more on statistical and semi-mechanistic models,
whereas the latter is based 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
deep 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. Beginning in 2014, the
U.S. F.D.A and other regulatory agencies began to emphasize the need to push mechanistic PBPK modeling and simulation into clinical
pharmacology, with final guidance documents completed in 2018, and we have seen the benefit of having our clinical pharmacology
teams across all three divisions working together to achieve this goal.
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 Dassault Systèmes Americas
Corp. (formerly known as Accelrys, Inc.), a San Diego division of Dassault Systemes in France, pursuant to which a small royalty
is paid to Dassault Systèmes Americas Corp. from revenues on each license for the Metabolism 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. (Therapeutic Systems Research Laboratories) 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 nonassertion
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.
All payments were made as of April 2017. The total consideration is being amortized at a constant rate of $150,000 per quarter
until it is completely amortized, after which no further expense will be incurred. To date, this has resulted in expense savings
over $1,500,000 compared to 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, Korea, 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 100 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 independent distributors
in Japan, China, India, and Korea 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 GastroPlus User Group following the example set in Japan. Over 1,000 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, North Carolina (Research Triangle Park), and New York (Buffalo),
we also employee people who are able to work remotely using collaboration software. 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 flagship product, GastroPlus, is the most widely used commercial PBPK modeling
platform and has one significant competitor; others could be developed over time, but with the high barrier to entry, it would
be difficult to validate new software to levels required to support regulatory submissions. Our PKPlus software product will compete
with one major and a few minor software programs. 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. We believe DILIsym and NAFLDsym enjoy a unique market position, with no significant competition.
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 and scientific
consulting service providers, but also with the in-house development and scientific consulting 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, KIWI, DILIsym,
and NAFLDsym 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)
continue to attract and retain a highly skilled scientific and engineering team, (5) aggressively promote 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.
Results of Operations
Comparison of Three Months Ended February 28, 2019 and
2018.
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
|
|
|
|
|
2/28/19
|
|
|
2/28/18
|
|
Net revenues
|
|
$
|
8,472
|
|
|
|
100.0%
|
|
|
$
|
7,357
|
|
|
|
100.0%
|
|
Cost of revenues
|
|
|
2,208
|
|
|
|
26.1
|
|
|
|
2,115
|
|
|
|
28.8
|
|
Gross profit
|
|
|
6,264
|
|
|
|
73.9
|
|
|
|
5,242
|
|
|
|
71.2
|
|
Selling, general and administrative
|
|
|
2,809
|
|
|
|
33.2
|
|
|
|
2,340
|
|
|
|
31.8
|
|
Research and development
|
|
|
724
|
|
|
|
8.5
|
|
|
|
484
|
|
|
|
6.6
|
|
Total operating expenses
|
|
|
3,533
|
|
|
|
41.7
|
|
|
|
2,824
|
|
|
|
38.4
|
|
Income from operations
|
|
|
2,730
|
|
|
|
32.2
|
|
|
|
2,418
|
|
|
|
32.9
|
|
Other income (expense)
|
|
|
(35
|
)
|
|
|
(0.4
|
)
|
|
|
(33
|
)
|
|
|
(0.4
|
)
|
Income from operations before taxes
|
|
|
2.696
|
|
|
|
31.8
|
|
|
|
2,385
|
|
|
|
32.4
|
|
Benefit (Provision for) for income taxes
|
|
|
(596
|
)
|
|
|
(7.0
|
)
|
|
|
1,090
|
|
|
|
14.8
|
|
Net income
|
|
$
|
2,099
|
|
|
|
24.8%
|
|
|
$
|
3,475
|
|
|
|
47.2%
|
|
Net Revenues
Consolidated net revenues increased by
15.2% or $1.11 million to $8.47 million in the second fiscal quarter of Fiscal Year 2019 (“2QFY19”) from $7.36 million
in the second fiscal quarter of Fiscal Year 2018 (“2QFY18”). Changes by division are as follows:
|
·
|
Lancaster: $456,000 increase, representing a 10.0% increase to $5.01 million
|
|
·
|
Buffalo (Cognigen): $426,000 increase, representing a 22.8% increase to $2.29 million
|
|
·
|
North Carolina (DILIsym): $233,000 increase, representing a 24.8% increase to $1.17 million
|
Consolidated software and software-related
sales increased $522,000 or 12.3%, while consolidated consulting and analytical study revenues increased $593,000 or 19.0% over
2QFY18.
Cost of Revenues
Consolidated cost of revenues increased
by $92,000, or 4.4%, in 2QFY19 to $2.21 million from $2.12 million in 2QFY18. Labor-related cost increased by $220,000, a combination
of increased labor count, and salary increases. Direct contract expenses decreased by $123,000 this fiscal quarter compared to
the prior year due to lower testing costs in the period.
Cost of Revenues as a percentage of
revenues decreased by 2.7% in 2QFY19 to 26.1% as compared to 28.8% in 2QFY18, due to higher sales and
lower direct contract cost incurred.
Gross Profit
Consolidated gross margin
increased $1.02 million or 19.5%, to $6.26 million in 2QFY19 from $5.24 million in 2QFY18. The Lancaster division’s
gross margin increased $451,000 or 12.1%, resulting in an 83.2% gross margin percentage. The Buffalo division’s
gross margin increased $239,000 or 23.9%, resulting in a gross margin percentage of 54.0%. DILIsym of North Carolina showed
an increase in gross margin of $332,000 or 63.3%, resulting in a gross margin of 73.2%
Overall gross margin as a percentage of
revenue increased by 2.7% to 73.9% in 2QFY19 from 71.2% in 2QFY18.
Selling, General and Administrative Expenses
Selling, general, and administrative (SG&A)
expenses increased $470,000, or 20.1% to $2.81 million in 2QFY19 from $2.34 million in 2QFY18. As a percent of revenues, SG&A
was 33.2% for 2QFY19, compared to 31.8% in 2QFY18.
The major increases in SG&A expense
were:
o
|
Selling expenses, including commissions and advertising, increased $35,000.
|
o
|
Legal and professional fees increased by $26,000 due to compliance related audit and review costs.
|
o
|
G&A Salaries and Wages increased by $223,000; this increase is a combination of increased stock compensation costs, annual salary increases, 401k expense, and increased head count.
|
o
|
Recruiting and hiring increased $67,000.
|
o
|
Insurance Expense increased $34,000; mostly health-related medical costs due to cost increases and higher employee counts.
|
The major decreases in SG&A expense
were:
o
|
No material decreases in SG&A expenses were noted.
|
Research and Development
Total research and development cost increased
$174,000 in 2QFY19 compared to 2QFY18. In 2QFY19 we incurred approximately $1,299,000 of research and development costs, of this
amount, $575,000 was capitalized and $724,000 was expensed. In 2QFY18 we incurred approximately $1,124,000 of research and development
costs, of this amount, $640,000 was capitalized and $484,000 was expensed.
Income from operations
Income from operations increased $313,000
or 13.0% in 2QFY19 compared to 2QFY18.
·
|
Lancaster
|
Increased $69,000 or 3.7%
|
·
|
Buffalo
|
Increased $73,000 or 22.3%
|
·
|
No. Carolina
|
Increased $171,000 or 87.81%
|
Provision for Income Taxes
The provision for income taxes was an expense
of $596,000 for the 2QFY19 compared to a tax benefit of $1,090,000 for the 2QFY18. The difference is that in the prior year we
had completed an assessment of deferred taxes based on the new tax rates enacted under the Tax Cuts and Jobs Act of 2017 (the “2017
Tax Act”) requiring the company to recognize the effects of changes in tax laws or tax rates in the financial statements
for the period in which such changes were enacted. Based on the assessment the Company posted a one-time tax benefit in the amount
of $1,500,000 in the second fiscal quarter of 2018, the result of estimating future deferred liabilities at the lower tax rates
under the newly enacted tax laws.
The effective rate for the three months
was an expense of 22.1% compared to a benefit of 45.7% in the prior year. The significant change is from the effect of the tax
benefit due to the rate change applied to deferred tax liabilities in 2018.
Net Income
Net income decreased by $1.37 million,
or 39.6%, in 2QFY19 to $2.1 million from $3.47 million in 2QFY18. The decrease in net income comes mainly from the effects of the
posting of the $1,500,000 one-time tax benefit in 2QFY18
.
Comparison of Six Months Ended February 28, 2019 and 2018
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):
|
|
Six Months Ended
|
|
|
|
2/28/19
|
|
2/28/18
|
|
Net revenues
|
|
$
|
16,008
|
|
|
|
100.00%
|
|
|
$
|
14,425
|
|
|
|
100.00%
|
|
Cost of revenues
|
|
|
4,407
|
|
|
|
27.5
|
|
|
|
3,851
|
|
|
|
26.7
|
|
Gross profit
|
|
|
11,601
|
|
|
|
72.5
|
|
|
|
10,574
|
|
|
|
73.3
|
|
Selling, general and administrative
|
|
|
5,530
|
|
|
|
34.5
|
|
|
|
4,748
|
|
|
|
32.9
|
|
Research and development
|
|
|
1,254
|
|
|
|
7.8
|
|
|
|
845
|
|
|
|
5.9
|
|
Total operating expenses
|
|
|
6,784
|
|
|
|
42.4
|
|
|
|
5,593
|
|
|
|
38.8
|
|
Income from operations
|
|
|
4,817
|
|
|
|
30.1
|
|
|
|
4,981
|
|
|
|
34.5
|
|
Other income
|
|
|
(100
|
)
|
|
|
(0.6
|
)
|
|
|
(79
|
)
|
|
|
(0.6
|
)
|
Income from operations before taxes
|
|
|
4,717
|
|
|
|
29.5
|
|
|
|
4,902
|
|
|
|
34.0
|
|
Benefit (Provision for) for income taxes
|
|
|
(1,082
|
)
|
|
|
(6.8
|
)
|
|
|
289
|
|
|
|
2.0
|
|
Net income
|
|
$
|
3,635
|
|
|
|
22.7%
|
|
|
$
|
5,191
|
|
|
|
36.0%
|
|
Net Revenues
Consolidated net revenues increased
by $1.58 million or 11.0% to $16.01 million in the first six months of Fiscal Year 2019 “6moFY19”) from $14.43
million in the first six months of Fiscal Year 2018 (“6moFY18”). Changes by division are as follows:
·
|
Lancaster: $780,000 increase, representing a 9.1% increase to $9.37 million
|
·
|
Buffalo (Cognigen): $577,000 increase, representing a 15.3% increase to $4.36 million
|
·
|
North Carolina (DILIsym): $225,000 increase, representing an 11.0% increase to $2.28 million
|
Consolidated software and software-related
sales increased $780,000 or 9.8%, while consolidated consulting and analytical study revenues increased $1.18 million or 18.2%
over 6moFY18.
Cost of Revenues
Consolidated cost of revenues increased
by $556,000, or 14.4%, in 6moFY19 to $4.41 million from $3.85 million in 6moFY18. Labor-related costs accounted for $544,000 of
this increase. Other significant increases in cost of revenues included an additional $63,000 of software amortization expense.
During the period direct contract costs decreased by approximately $71,000.
Cost of Revenues as a percentage of revenue increased by 0.8%
in 6moFY19 to 27.5% as compared to 26.7% in 6moFY18.
Gross Profit
Consolidated gross margin increased
$1.03 million or 9.7%, to $11.60 million in 6moFY19 from $10.57 million in 6moFY18. The Lancaster division’s gross
margin increased $657,000 or 9.3%, resulting in a gross margin percentage of 82.2%. The Buffalo division’s
gross margin increased $127,000 or 5.7%, resulting in a gross margin percentage of 53.5%, and DILIsym of North Carolina
showed an increase in gross margin of $242,000 or 18.4%, resulting in a 68.5% gross margin percentage.
Overall gross margin as a percentage of
revenue decreased by 0.8% to 72.5% in 6moFY19 from 73.3% in 6moFY18.
Selling, General and Administrative Expenses
Selling, general, and administrative (SG&A)
expenses increased $782,000, or 16.5% to $5.53 million in 6moFY19 from $4.75 million in 6moFY18. As a percent of revenues, SG&A
was 34.6% for 6moFY19, compared to 32.9% in 6moFY18.
The major increases in SG&A expense
were:
o
|
Commissions expense: $52,000
|
o
|
Contract labor: $40,000 made up of outsourced services and increased Director compensation program costs
|
o
|
Employee 401k expense: $36,000
|
o
|
G&A Salaries and Wages increased by $343,000; this increase is predominantly related to increased head count in Lancaster and Buffalo
|
o
|
Insurance Expense $59,000; mostly health-related medical costs due to cost increases and higher employee counts
|
o
|
Payroll tax expense increased $40,000
|
o
|
Recruiting and hiring: $80,000
|
o
|
Software licenses: $45,000
|
The major decreases in SG&A expense
were:
o
|
Trade show costs decreased $57,000
|
Research and Development
Total research and development cost increased
$201,000 in 6moFY19 compared to 6moFY18. In 6moFY19 we incurred approximately $2,193,000 of research and development costs, of
this amount, $940,000 was capitalized and $1,253,000 was expensed. In 6moFY18 we incurred approximately $1,993,000 of research
and development costs, of this amount, $1,147,000 was capitalized and $845,000 was expensed.
Income from operations
Income from operations decreased $164,000
or 3.3% in 6moFY19 compared to 6moFY18.
·
|
Lancaster
|
Increased $35,000 or 1.0%
|
·
|
Buffalo
|
Decreased $131,000 or 15.6%
|
·
|
No. Carolina
|
Decreased $69,000 or 11.3%
|
Other income (expense)
Other income(expense) was an
expense of $100,000 compared to expense of $79,000 in 6moFY18. This $21,000 difference primarily
reflects foreign currency exchange loss.
Provision for Income Taxes
The provision for income taxes was an expense
of $1,082,000 for the 6moFY19 compared to a tax benefit of $289,000 for the 6moFY18. The difference is that in the prior year we
had completed an assessment of deferred taxes based on the new tax rates enacted under the Tax Cuts and Jobs Act of 2017 (the “2017
Tax Act”) requiring the company to recognize the effects of changes in tax laws or tax rates in the financial statements
for the period in which such changes were enacted. Based on the assessment the Company posted a one-time tax benefit in the amount
of $1,500,000 in the second fiscal quarter of 2018, the result of estimating future deferred liabilities at the lower tax rates
under the newly enacted tax laws.
The effective rate for the six months was
an expense of 22.9% compared to a benefit of 5.9% in the prior year. The significant change is from the effect of the tax benefit
due to the rate change applied to deferred tax liabilities in 2018.
Net Income
Net income decreased by $1.56 million,
or 30.0%, in 6moFY19 to $3.64 million from $5.19 million in 6moFY18. $1,500,000 of this decrease, representing approximately 96%
of the change, is from the effects of the reassessment of deferred taxes under the new rates enacted under the Tax Cuts and Jobs
Act of 2017. Without the deferred tax benefit, net income would have decreased by approximately $100,000 or 2%.
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 ten 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.