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. 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 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 designs, and
simulate outcomes in special populations, such as the elderly and pediatric patients.
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 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.
In June 2017, Simulation Plus acquired
DILIsym Services, Inc. (DILIsym) as a wholly owned subsidiary pursuant to a stock purchase agreement dated May 1, 2017. On June
1, 2017, the Company consummated the acquisition of all outstanding equity interests of DILIsym pursuant to the terms of the Stock
Agreement, with DILIsym becoming a wholly owned subsidiary of the Company. 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
contract research 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™. The difference between DILIsym and NAFLDsym is that DILIsym estimates the potential for
a particular drug molecule to induce liver injury (i.e., to cause damage), while NAFLDsym estimates the likelihood of new molecules
to treat nonalcoholic fatty liver disease (i.e., to repair damage), and is unique to the mechanisms involved in such treatment.
As such, DILIsym can be a single program that addresses a wide variety of molecules across various companies, while NAFLDsym requires
customizing the software for each mechanism of action. 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™); our newest 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, begun in 2012 and completed in 2017, 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 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 is participating
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 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 and will be completed in September
2018.
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 will be completed in September 2018 unless extended.
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 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 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 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, metabolism, 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, 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. Current improvements in development and testing include
new capabilities to simulate
in vitro
dissolution experiments for long-acting injectable microspheres as part of our work
under the FDA-funded grant mentioned above.
Version 6.0 of DDDPlus is in development
testing and will offer 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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improved 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™
MembranePlus was released in October 2014.
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™
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 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. We believe the potential number of eventual users for PKPlus is in the thousands
worldwide and that it has the potential to eventually become a significant revenue producer.
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 enjoyed 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.
We released version 8.1 of ADMET Predictor
in January 2017. This release included:
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both 64-bit and
32-bit executables, making it possible to handle larger data sets
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optimization of
spreadsheet and model-building functions to improve efficiency
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streamlined and
much more efficient model-building in ADMET Modeler using our proprietary machine-learning engine
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combinatorial substituent
and scaffold replacement operations in the MedChem Studio Module
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new in silico Ames
tests to produce reliable confidence predictions that are more broadly applicable
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our proprietary
ADMET Risk™ scores accessible graphically in histograms
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Version 8.5 was released in November 2017,
adding:
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a new Simulation
Module to predict absorption and bioavailability for libraries of molecules from their structure
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ability to optimize
doses to achieve desired steady-state concentrations
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new property models
for rat fraction unbound in plasma, blood/plasma concentration ratio, and metabolism by certain enzymes
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all MedChem Studio
features now available through the same graphical user interface as ADMET Predictor
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new synthetic difficulty
model
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improved visualization
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multithreading and
other speed enhancements
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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 launched in 2011.
It 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 26,000 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 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 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™
MedChem Studio has been integrated into
the ADMET Predictor platform but can still be licensed separately without requiring a license for ADMET Predictor. 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. We have now merged MedChem
Studio with ADMET Predictor 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
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.
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 7A of the DILIsym software was
released in January 2018. This version changes the software from an open-source platform to 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:
|
·
|
Additional validation
compounds
|
|
·
|
New optimization
interface allowing complex fitting using genetic algorithms
|
|
·
|
Clinical Monitoring
feature allowing dynamic clinical trials with dose alterations based on specified thresholds
|
|
·
|
Weight-adjusted
dosing option
|
|
·
|
Export enhancements
providing better information on simulation setup within exported Excel® file
|
|
·
|
MATLAB 2017b friendly
– faster simulations
|
|
o
|
Combined ALT biomarker
parameter variability with toxicity pathway parameters
|
|
o
|
Mitochondrial biogenesis
parameter variability
|
|
·
|
Creation of custom
cohorts from existing SimPops/SimCohorts
|
|
·
|
Updated initial
conditions infrastructure allowing importing custom SimPops in compiled version
|
|
·
|
Update Output Table
with more clinically important metrics built-in
|
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.
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 frequently 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.
We continue working 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 currently are working with the FDA
on three Research Collaboration Agreements (RCAs): the funded efforts for long-acting injectable microspheres/ocular dosing and
the unfunded IVIVC effort, both described above under “GastroPlus”.
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. 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, and we have seen the benefit of having our clinical pharmacology team in the Cognigen division and our scientists
in our Lancaster, California (Simulations Plus) division 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 BIOVIA (formerly known as Accelrys,
Inc.), a San Diego division of Dassault Systemes in France, 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. (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 $1,250,000 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 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 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 (Lancaster, Guerneville, San Jose, and San Diego), North Carolina
(Research Triangle Park), and New York (Buffalo); team members in most cases can 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 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. 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, 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, 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 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.
In June 2017, Simulation Plus acquired
DILIsym Services, Inc. (DILIsym) as a wholly owned subsidiary pursuant to a stock purchase agreement dated May 1, 2017. On June
1, 2017, the Company consummated the acquisition of all outstanding equity interests of DILIsym pursuant to the terms of the Stock
Agreement, with DILIsym becoming a wholly owned subsidiary of the Company. 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 simulations software and
contract research 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™.
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, 2017
we distributed $0.20 per share in dividends to our shareholders. In November 2017, February 2018 and May 2018, we distributed
a quarterly dividend of $0.06 per share. We anticipate future dividends to be $0.06 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 May 31, 2018 and 2017.
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
|
|
|
|
5/31/18
|
|
|
|
5/31/17
|
Net revenues
|
|
$
|
8,553
|
|
|
|
100.00%
|
|
|
$
|
6,749
|
|
|
100.0%
|
Cost of revenues
|
|
|
2,023
|
|
|
|
23.6
|
|
|
|
1,445
|
|
|
21.4
|
Gross profit
|
|
|
6,530
|
|
|
|
76.4
|
|
|
|
5,304
|
|
|
78.6
|
Selling, general and administrative
|
|
|
2,604
|
|
|
|
30.4
|
|
|
|
1,955
|
|
|
29.0
|
Research and development
|
|
|
508
|
|
|
|
5.9
|
|
|
|
254
|
|
|
3.7
|
Total operating expenses
|
|
|
3,112
|
|
|
|
36.4
|
|
|
|
2,209
|
|
|
32.7
|
Income from operations
|
|
|
3,418
|
|
|
|
40.0
|
|
|
|
3,095
|
|
|
45.9
|
Other income (expense)
|
|
|
(21
|
)
|
|
|
(0.2
|
)
|
|
|
(10
|
)
|
|
(0.2)
|
Income from operations before taxes
|
|
|
3,397
|
|
|
|
39.7
|
|
|
|
3,085
|
|
|
45.7
|
Benefit (Provision for) for income taxes
|
|
|
(991
|
)
|
|
|
(11.6
|
)
|
|
|
(1,005
|
)
|
|
(14.9)
|
Net income
|
|
$
|
2,406
|
|
|
|
28.1%
|
|
|
$
|
2,080
|
|
|
30.8%
|
Net Revenues
Consolidated net revenues increased by
26.7% or $1.80 million to $8.55 million in the third fiscal quarter of Fiscal Year 2018 (“3QFY18”) from $6.75 million
in the third fiscal quarter of Fiscal Year 2017 (“3QFY17”). Changes by division are as follows:
|
·
|
Lancaster: $706,000
increase, representing a 14.3% increase to $5.65 million
|
|
·
|
Buffalo (Cognigen):
$141,000 increase, representing a 7.8% increase to $1.94 million
|
|
·
|
North Carolina (DILIsym):
recorded revenues of $957,000. (Acquired June 1, 2017, they were not a part of the prior year numbers)
|
Consolidated software and software-related
sales increased $830,000 or 17.4%, while consolidated consulting and analytical study revenues increased $974,000 or 49.1% over
3QFY17.
Cost of Revenues
Consolidated cost of revenues increased
by $578,000, or 40.0%, in 3QFY18 to $2.02 million from $1.44 million in 3QFY17. Labor-related cost accounted for $284,000 of this
increase, a combination of increased labor count, salary increases, and bonuses at our subsidiaries based on increased earnings.
Included in the increase was $167,000 of salary expense at DILIsym. Other significant increases in cost of revenues included $179,000
of direct contract expenses paid for testing at DILIsym, an increase of $41,000 of software amortization, as well as an additional
$79,000 of amortization expense associated with acquired technologies associated with DILIsym’s drug-induced liver injury
technologies.
Cost of Revenues as a percentage of revenue
increase by 2.2% in 3QFY18 to 23.6% as compared to 21.4% in 3QFY17. This change comes from higher salaries and direct costs of
contract studies in 3QFY18.
Gross Profit
Consolidated gross profit increased $1.23
million or 23.1%, to $6.53 million in 3QFY18 from $5.30 million in 3QFY17. $639,000 of this increase is from the California division,
which showed an 86.6% gross margin. The Buffalo division gross profit increased $69,000 or 6.6% with gross margin of 57.5%, and
DILIsym of North Carolina showed $519,000, a 54.2% gross margin.
Overall gross margin as a percentage of
revenue decreased by 2.24% to 76.4% in 3QFY18 from 78.6% in 3QFY17.
Selling, General and Administrative Expenses
Selling, general, and administrative (SG&A)
expenses increased $649,000, or 33.2% to $2.60 million in 3QFY18 from $1.95 million in 3QFY17. As a percent of revenues, SG&A
was 30.4% for 3QFY18, compared to 29.0% in 3QFY17.
The major increases in SG&A expense
were:
·
|
Commission expense:
$70,000 increased sales in international markets
|
·
|
Contract labor:
$53,000 made up of certain outsourced services and director fees paid
|
·
|
G&A Salaries
and Wages increased by $276,000; this increase is a combination of increased stock compensation costs, 401k, annual salary
increases, increased head count in Lancaster and Buffalo, and first-time third-quarter salaries at DILIsym after acquisition
|
·
|
Insurance Expense
increased $68,000; mostly health-related medical costs due to cost increases and higher employee counts, of which $34,000
was first time costs associated with DILIsym
|
·
|
Payroll tax expense
increased $62,000, the effect of higher salary expense and first time costs of $31,000 associated with DILIsym
|
·
|
Professional Accounting
and Audit increased $77,000; this year’s tax and internal compliance service started later in the fiscal year; as well
as increased costs of a new subsidiary
|
·
|
Trade show and Travel
$57,000; increase in shows and trainings compared to prior year
|
·
|
Amortization expense
increased $53,000 due to new acquisition amortization for DILIsym intangibles
|
The major decreases in SG&A expense
were:
·
|
Legal fees decreased
$105,000 due to a reduction in acquisition-related document review
|
·
|
Recruitment &
Hiring $31,000; lower hiring costs this year
|
Research and Development
Total research and development cost increased
$522,000 in 3QFY18 compared to 3QFY17. In 3QFY18 we incurred approximately $993,000 of research and development cost. Of this
amount, $485,000 was capitalized and $508,000 was expensed. In 3QFY17 we incurred approximately $598,000 of research and development
costs. Of this amount, $344,000 was capitalized and $254,000 was expensed.
Income from operations
Income from operations increased $323,000
or 34.7% in 3QFY18 compared to 3QFY17.
·
|
Lancaster
|
Increased
$356,000 or 13.3%
|
·
|
Buffalo
|
Decreased
$31,000 or 7.4%
|
·
|
No.
Carolina
|
Recorded
an operating profit of $3,000 for the quarter, their first third quarter reporting since being acquired on June 1, 2017.
|
Provision for Income Taxes
The provision for income taxes was $991,000
for 3QFY18 compared to $1,005,000 for 3QFY17.
The effective rate for the quarter was
29.1% compared to 32.2% in the prior year. The change is from the effect of the new tax rates under new Federal tax laws enacted
as of January 1, 2018. Federal statutory tax rates decreased from 34% to 21% as of January 1, 2018. The Company has used a blended
rate for the current period to calculate current income tax expense.
Net Income
Net income increased by $327,000, or 15.7%,
in 3QFY18 to $2.41 million from $2.08 million in 3QFY17.
Comparison of Nine Months Ended May 31, 2018 and 2017
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):
|
|
Nine Months Ended
|
|
|
|
5/31/18
|
|
|
5/31/17
|
|
|
|
|
|
|
|
|
Net revenues
|
|
$
|
22,979
|
|
|
|
100.00%
|
|
|
$
|
17,872
|
|
|
|
100.0%
|
|
Cost of revenues
|
|
|
5,874
|
|
|
|
25.6
|
|
|
|
4,335
|
|
|
|
24.2
|
|
Gross profit
|
|
|
17,105
|
|
|
|
74.4
|
|
|
|
13,537
|
|
|
|
75.8
|
|
Selling, general and administrative
|
|
|
7,352
|
|
|
|
32.0
|
|
|
|
5,767
|
|
|
|
32.3
|
|
Research and development
|
|
|
1,354
|
|
|
|
5.9
|
|
|
|
953
|
|
|
|
5.3
|
|
Total operating expenses
|
|
|
8,706
|
|
|
|
37.9
|
|
|
|
6,719
|
|
|
|
37.6
|
|
Income from operations
|
|
|
8,399
|
|
|
|
36.5
|
|
|
|
6,818
|
|
|
|
38.2
|
|
Other income
|
|
|
(100
|
)
|
|
|
(0.4
|
)
|
|
|
19
|
|
|
|
0.1
|
|
Income from operations before taxes
|
|
|
8,298
|
|
|
|
36.1
|
|
|
|
6,837
|
|
|
|
38.3
|
|
Benefit (Provision for) for income taxes
|
|
|
(701
|
)
|
|
|
(3.1
|
)
|
|
|
(2,200
|
)
|
|
|
(12.3
|
)
|
Net income
|
|
$
|
7,597
|
|
|
|
33.1%
|
|
|
$
|
4,637
|
|
|
|
25.9%
|
|
Net Revenues
Consolidated net revenues increased by
28.6% or $5.11 million to $22.98 million in the first nine months of Fiscal Year 2018 “9moFY18”) from $17.87 million
in the first nine months of Fiscal Year 2017 (“9moFY17”). Changes by division are as follows:
·
|
Lancaster: $1,562,000
increase, representing a 12.3% increase to $14.25 million
|
·
|
Buffalo (Cognigen):
$534,470 increase, representing a 10.3% increase to $5.72 million
|
·
|
North Carolina (DILIsym):
recorded revenues of $3.01 million. (Acquired June 1, 2017, they were not a part of the prior year third quarter numbers)
|
Consolidated software and software-related
sales increased $1,594,000 or 13.3%, while consolidated consulting and analytical study revenues increased $3.51 million or 59.8%
over 9moFY17.
Cost of Revenues
Consolidated cost of revenues increased
by $1.54 million, or 35.5%, in 9moFY18 to $5.87 million from $4.33 million in 9moFY17. Labor-related cost accounted for $835,000
of this increase, a combination of increased labor count, salary increases, and bonuses at our subsidiaries based on increased
earnings. Included in the increase was $288,000 of salary expenses at DILIsym. Other significant increases in cost of revenues
included $88,000 of software amortization, $458,000 of direct contract expenses paid for testing at DILIsym, as well as an additional
$237,000 of amortization expense associated with acquired technologies associated with DILIsym’s drug-induced liver injury
technologies. Training-related expenses were down $65,000 compared to the prior year.
Cost of Revenues as a percentage of revenue increased by 0.6%
in 9moFY18 to 25.6% as compared to 24.2% in 9moFY17.
Gross Profit
Consolidated gross profit increased $3.57
million or 26.4%, to $17.10 million in 9moFY18 from $13.54 million in 9moFY17. $1,360,000 of this increase is from the Lancaster
division, which showed an 83.8% gross margin. The Buffalo division gross profit increased $369,000 or 12.5% with a gross margin
of 58.1%, and DILIsym of North Carolina showed $1.84 million, a 61.1% gross margin.
Overall gross margin as a percentage of
revenue decreased by 1.4% to 74.4% in 9moFY18 from 75.8% in 9moFY17.
Selling, General and Administrative Expenses
Selling, general, and administrative (SG&A)
expenses increased $1,586,000, or 27.5% to $7.35 million in 9moFY18 from $5.77 million in 9moFY17. As a percent of revenues, SG&A
was 32.0% for 9moFY18, compared to 32.3% in 9moFY17.
The major increases in SG&A expense
were:
·
|
Commissions expense:
$141,000 related mainly to increased international sales
|
·
|
Market expenses:
$174,000 related to trade show and conference attendance
|
·
|
Contract labor:
$174,000 made up of outsourced services and increased Director compensation program costs
|
·
|
Employee 401k expense:
$59,000
|
·
|
G&A Salaries
and Wages increased by $439,000; this increase is a combination of increased stock compensation costs of $59,000, first time
salaries of $197,000 at DILIsym after acquisition, annual salary increases and increased head count in Lancaster and Buffalo
|
·
|
Insurance Expense
$221,000; mostly health-related medical costs due to cost increases and higher employee counts, of which $97,000 was associated
with DILIsym
|
·
|
Payroll tax expense
increased $174,000, the effect of higher salary expense and first time costs of $81,000 associated with DILIsym
|
·
|
Professional Accounting
tax and audit increased $101,000; Increased costs associated with accounting initiatives, compliance and audit for new subsidiary
|
·
|
Rent: $49,000 mostly
due to first time costs associated with added facilities costs at DILIsym
|
·
|
Software licenses:
$46,000
|
o
|
Amortization expense
increased $158,000 due to new acquisition amortization for DILIsym intangibles
|
The major decreases in SG&A expense
were:
·
|
Legal expenses decreased
$228,000 due to a reduction in document review
|
Research and Development
Total research and development cost increased
$1,099,000 in 9moFY18 compared to 9moFY17. In 9moFY18 we incurred approximately $2,985,000 of research and development costs,
of this amount, $1,632,000 related to the development of software and was capitalized and $1,353,000 was expensed. In 9moFY17
we incurred approximately $1,880,000 of research and development costs, of this amount, $928,000 related to the development of
software and was capitalized and $952,000 was expensed.
Income from operations
Income from operations increased $1,580,000
or 23.2% in 9moFY18 compared to 9moFY17.
·
|
Lancaster
|
Increased
$833,000 or 14.5%
|
·
|
Buffalo
|
Increased
$140,000 or 13.0%
|
·
|
No.
Carolina
|
Recorded
operating income of $607,000, their first 9moFY18 reporting since acquisition on June 1, 2017
|
Other income (expense)
Other income was an expense of $100,000
compared to income of $19,000 in 9moFY17, a decrease of $119,000. The majority of the change comes from an imputed interest expense
of $114,000 associated with acquisition-related liabilities.
Provision for Income Taxes
The provision for income taxes was $701,000
for 9moFY18 compared to $2.20 million for 9moFY17.
The decrease comes mainly the completion
of 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). Financial Accounting Standards Board (“FASB”) Accounting Standards Codification Topic 740, Income Taxes
(“ASC 740”) requires that the company recognize the effects of changes in tax laws or tax rates in the financial statements
for the period in which such changes were enacted. Among other things, changes in tax laws or tax rates can affect the amount
of taxes payable for the current period, as well as the amount and timing of deferred tax liabilities and deferred tax assets.
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.
Federal statutory tax rates decreased
from 34% to 21% as of January 1, 2018. The Company has used a blended rate for the current period to calculate current income
tax expense since four months were in calendar year 2017 and five were in 2018 under the new tax law.
The effective rate for the nine months
was 8.45%, compared to an expense of 32.2% 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.
Net Income
Net income increased by $2.96 million,
or 60.2%, in 9moFY18 to $7.60 million from $4.64 million in 9moFY17. $1,500,000 of this increase, representing approximately 20%
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 increased by $1.46 million, or 31.5%.
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.