Simulations Plus Inc (SLP) 2011 Q3 法說會逐字稿

Good afternoon. It is Thursday, July 14 2011 and on behalf of Simulations Plus, I would like to welcome you to the Company's third quarter fiscal year 2011 financial results conference call and Webinar. The Chairman and Chief Executive Officer, Walt Woltosz, will be presenting this afternoon. Joining Walt are panelists Chief Financial Officer, Momoko Beran, and Director of Marketing and Sales, John DiBella. An opportunity to ask questions will follow Walt's presentation. (Operator Instructions) This call is being recorded for playback at our website www.simulations-plus.com. It is now my pleasure to turn the presentation over to Walt Woltosz, Chairman and CEO. Walt?

Thanks, Cameron. Let me start by reading the Safe Harbor statement to keep the attorneys happy and for those who end up listening only to the audio later on and may not see the slides. With the exception of historical information, the matters discussed in this presentation are forward looking statements that involve a number of risks and uncertainties. The actual results of the Company could differ significantly from those statements. Factors that could cause or contribute to such differences include, but are not limited to; continuing demand for the Company's products, competitive factors, the Company's ability to finance future growth, the Company's ability to produce and market new products in a timely fashion, the Company's ability to continue to attract and retain skilled personnel, and the Company's ability to sustain or improve current levels of productivity. Further information on the Company's risk factors is contained in the Company's quarterly and annual reports and filed with the Securities and Exchange Commission.

So, for the third quarter ended March 31 we had a very nice quarter. Another record quarter, our 15th consecutive profitable quarter and I was curious and looked it up, it's actually 37th of the last 39 quarters have been profitable. The third-quarter sales were up 10.3% on a consolidated basis, to a record $3.44 million from $3.12 million in last year's third quarter. Pharmaceutical segment sales up 13.5% and the Words+ subsidiary up 0.7%. Net income was up 42.4% to just over $1 million from about $750,000 last year. Diluted earnings per share up 49.4% to $0.07 a share from $0.04 a share in last year's third quarter.

For the 9 months compared to first 9 months of fiscal year 2010, sales were up 12.9% to another record $9.6 million from $8.5 million in the first 9 months of last year. Last fiscal year. Pharmaceuticals segment sales up 16.3% and the Words+ subsidiary sales up 3.1% for the nine months. Net income up 39.7% to $2.5 million from $1.8 million. And diluted earnings per share up 43% to $0.16 from $0.11 in last year's first 9 months.

We have a strong balance sheet. Cash at the end of the third quarter on March 31 was $9.9 million, that was after using over $2 million in cash to repurchase shares during the first 2 fiscal quarters. Cash today is just under $11 million this morning. Shareholders equity increased 5.8% to $13.8 million from $13.1 million at September 1, at the beginning of the fiscal year, and equity per share increased 8.9% in the first nine months to $0.86 a share from $0.79 a share at the beginning of the fiscal year and of course we still have no debt.

Consolidated revenue, you can see, quarter by quarter over the last four fiscal years the first quarter, second quarter, third quarter, fourth quarter. Of course we haven't finished the fourth quarter yet for this year and that's why you only see the first three. You can see the steady growth trend that we have been experiencing in consolidated revenue. Looking at the revenue history, broken down into the pharmaceutical software and services business, and the Words + business, the blue bars here are the pharmaceutical side, the green bar is the Words + side, and of course on the annual revenues what you're seeing there is for 3 quarters of the year. The first 9 months of 2011 where the other years are the entire fiscal year. So, we are almost up to where we were for the entire fiscal year last year on the pharmaceutical side. And doing okay, I will say, on the Words + side.

Pharmaceutical growth you can see here again quarter by quarter, for the first, second, and third quarters for this year, new records each time, fourth quarter we're just in the middle of it right now. And gross margins, this is consolidated, so it concludes both business units. You can see continue to run in the roughly mid-70s to high 70 range.

Income before taxes, here $1.4 million for this quarter, and you can see the comparisons with the other quarters and the other fiscal years. And net income, again, a new record year for the third quarter, for all quarters. First time we have exceeded $1 million in net income in a single quarter.

The consolidated income statement, you can see the comparison here of just the third quarter of this year with the third quarter of last year. The consolidated revenue again up, gross profit margin nearly the same. SG&A down just a little bit, R&D up just a little bit. Total operating expenses down about $50,000. And then you see the net income and the earnings per share.

Some selected balance sheet items, the cash again as of May 31 about $9.9 million. As of today, just under $11 million. And you can see the shareholders equity growth over the last -- the previous four quarters from the third quarter of 2010 to the third quarter of 2011.

As far as our marketing and sales, we believe that there is a fundamental industry shift almost 50, there it is, 47 new customers in the first three quarters, this includes both new companies as well as new departments within existing large customers. It's one thing to sell let's say a GastroPlus license to someone in a drug metabolism and pharmacokinetics department; it's something else to sell a MedChem Studio and ADMET Predictor to people in a completely different area working in chemistry. So, we see growth within the large companies in the same way that we see growth coming from new smaller companies.

We are always evolving the software, as all software companies are. When you release a version you are already working on the next version. The releases that we've had during the third quarter including -- included MedChem Studio 2.0, which has the new MedChem Designer molecule drawing tool and linked to ADMET Predictor for property predictions. And DDDPlus 4.0 which has some new features that I will talk about in a minute.

We've completed our SBIR grant with the National Institutes of Health. The final report has been turned in. That work is now done. We are doing some follow-on work on our own, building on what we learned from that grant, that was about 3 years counting phase 1 and phase 2, and a total of over $600,000. That helped us advance ADMET Predictor even further ahead of the competition. Still continues to be ranked number 1 in the competitive publications that we have seen.

We are now making progress on our 5-year collaboration that was announced earlier this year with the FDA. The Center for Food Safety and Applied Nutrition, and here we are building toxicity models using our ADMET Predictor and ADMET Modeler combination for compounds that are either additives in food in processing or contaminants that can get into food. Nothing can be made perfectly pure, you find bits of herbicides, pesticides, that come in from crops and there is an acceptable level for those, but it is always nice to know what you are likely to find if you develop a new herbicide or pesticide. What would you predict would be the potential toxicities that would come from that?

So, building on data that came from experiments over the years with something like 10,000 or more of these types of additives and contaminants, we can build on the data from what has already been done to build new predictive models so that as we want to evaluate compounds that have not been run through a particular test, either existing ones or perhaps something new that's being proposed, we have a predictive model for these various toxicities that gives us some guidance. We recently formed a second studies team for informatics, cheminformatics to address consulting work in that area. Primarily using ADMET Predictor and MedChem Studio and we have already conducted two small studies in that new area.

As far software enhancements, GastroPlus is our gold standard simulation for oral absorption for pharmacokinetics, we also model other types of absorption besides oral. This has been our flagship product for quite a number of years. Probably brings in around half the revenues on the pharmaceutical side. We added 3 market expanding capabilities last year, and we've seen the licenses for those now, the drug-drug interaction capability and we are expanding that now with some additional capabilities that are in beta test. The ocular and nasal pulmonary drug delivery were included in the release last year and we are expanding those as well. Adding additional capabilities in both ocular and nasal pulmonary modeling.

ADMET predictor, our second flagship product, this is the program that allows chemists to load molecular structures in the form of different file formats that describe how atoms are connected together into a molecule, and that molecule doesn't have to exist. It can be what we call a virtual molecule. There are computer programs, including our own MedChem Studio and MedChem Designer, that can generate new molecular structures that have never been in existence. With ADMET Predictor we can give a very good example of how many of the properties are likely to behave just based on that structure.

I saw a news item this morning that a drug called dronedarone has been pulled from a Phase III study because of cardiac toxicity problems. Out of curiosity, I got a hold of the structure off the Internet, ran it through ADMET Predictor and lo and behold, our cardiac toxicity model that we call hERG, it's a particular calcium channel transporter, in heart tissue that when it gets blocked, it can cause severe arrhythmia and even what's called Torsades de Pointes, where the heart goes into a fibrillation and you die. Sure enough, ADMET Predictor said this is a bad one, and since it has predicted to be toxic for hERG, it's predicted to have a high affinity for the hERG protein. Is that serendipity, I don't think so. Because the predictive value is high enough that it would've been a red flag. So, truthfully, that compound should have been killed way back in discovery before it was even synthesized and yet it made all the way into a Phase III trial. And we're talking probably hundreds of millions of dollars in Phase III trials. This is the value of having tools like this where today we can design molecules and very early on, at least screen out the worst offenders, and this particular molecule would have been seen as essentially a worse offender.

We now predict sites of metabolism in this program, so that when you look at a molecular structure, we can say all right, this particular atom is likely to be metabolized by that particular enzyme. That's a new and very important capability, and a lot of that capability is coming from the SBIR grant that we had with the NIH, where we developed the new atomic level descriptors that can take, in traditional methods, as much as a day per molecule to calculate. We developed a very rapid proprietary method of calculating these quantum level descriptors so that we can now calculate around 200,000 compounds an hour instead of one per day. And that's including all the descriptors and all the models, over 120 different properties that are predicted by ADMET Predictor. It's quite an amazing capability.

MedChem Studio, we did release version 2 in April, this is a major upgrade. We integrated the new MedChem Designer software. This is our molecule sketching program that is also integrated with ADMET Predictor. So, chemists can sketch a molecule, they can modify it, change certain atoms, make copies of it and change different atoms in different copies. Click on a button for ADMET Predictor and out comes 120 plus predicted properties. For example, that drug that I mentioned earlier with the heart problem, you could take that drug, modify it in various ways, and see if you could reduce that hERG toxicity without degrading other properties that you would like to have.

The MedChem Designer is a free program. We put that out as there are other free drawing programs, but we added to it a couple of key ADMET Predictor best ranked property predictions that chemists like to see, and that's a teaser obviously, we want to sell them the whole ADMET Predictor and then the MedChem Studio. So far, we've had downloads and activations, not just downloads, but people activating the software for a total of nearly 800 users to date, over the last, I think it's been about 3 months since we made that available.

DDDPlus, I mentioned version 4 was released in June. The FDA requested us to put in the ability to run what we call a virtual trial. This is where we take a baseline experiment, and when you run a simulation and a program like this you have a certain set of parameters that say all right, I'm going to run a dissolution experiment and I'm going to spin the paddle at 50 RPM. And I'm going to use 900 mL of fluid. And I'm going to use 10 mg of drug. And I'm going to compress the tablet at a certain pressure, and so on. None of those parameters are truly exact. Things vary when you make 1 million tablets. They're not all going to be exactly the same. But the chemists, the formulation scientists have a pretty good idea of how much each parameter is going to vary.

So, what they would like to see is if we simulate, let's say 1,000 experiments, and for each one of those experiments, if we take a random sample of each one of those parameters within its own expected distribution, then we get 1,000 different experiments with 1,000 different results and you hope the results are pretty tightly together. If they are not, then it raises a flag and says maybe you need to think about changing this formulation or perhaps controlling your experiment better or using a different experiment. The virtual trial, again added at the request of the FDA and now available in version 4. Some other capabilities were added to DDDPlus as well. And the customer base continues to grow with that, the FDA also added some more licenses here recently in the third quarter.

So to summarize, for the trailing 12 months, through May 31, this would be the fourth quarter of fiscal year '10, and the first three quarters of fiscal year '11, revenues were up 14.1% to $11.8 million. Net income up 45.6% to $2.87 million. And earnings per share also up 45.6% to $0.18 a share. We are feeling very good about the trailing 12 months, and we believe that we are globally recognized as a leader in our respective market niches. We do have, from everything we hear, an outstanding reputation for both scientific expertise and technological innovation. We are recognized for strong customer support. When the FDA says we want virtual trials in DDDPlus, it wouldn't matter if it was the FDA or a small company. If it's something we can put in and it makes sense, we do it.

Training and support over the phone and through the Internet has become a daily thing here. We have go to meeting sessions going on all the time with various folks to either demonstrate something new, or to give them a little bit of an initial out-of-the-box training and get a kick start with a particular software. And sometimes to troubleshoot actual problems that they're having a problem trying to analyze a particular set of data.

We are expanding our life sciences team. We had a new person start at the beginning of June, we've got another one starting in the couple of weeks at the beginning of August, both PhDs. We continue to interview and we plan to keep expanding the team.

With that, cash in the bank is not drawing a whole lot of interest, so our best bet is if we cannot acquire as much as we have tried, then we are going to grow organically. We had a strategic planning meeting here a few weeks ago with our -- all of our managers and team leaders, and we identified something like 65 different items, some of them are consolidated, but we came down to around 35 or so potential opportunities that we are in the process now of rank ordering to decide, in terms of both time and money, where the best investments are to get the greatest bang for the buck in terms of improving revenues and earnings. So, we will continue to expand life sciences team as well as to use outside services for conducting experiments or perhaps doing library research by graduate student or post doctoral at a university. We want to promote faster development of new products and services, as well as growing the capabilities of our existing products and services.

Also, as we expand life sciences, we also are expanding our marketing and sales team because our philosophy has always been that our life sciences team does support marketing and sales. They get out, they go to the scientific meetings, they meet the customers, they do poster and podium presentations, technical papers, but getting out and meeting people at the scientific meetings around the world we have found has been one of the keys to that growth in the number of customers. We say that we have 47 new customers, most of them come from people that one of our people, one of our scientists has met face-to-face at a scientific meeting somewhere in the world, and that gets followed up by the marketing and sales staff. I want to congratulate the marketing and sales staff, as well as the life sciences team for again another fantastic quarter. We all pull together here and it really is a fantastic place to work with a lot of very talented people. With that, I will conclude the presentation and I will answer questions.

I'm looking at the same little slip to read the questions through that I had last time around. Let's see if I can scroll in this little tiny window. Walter Ramsley, Q4 revenues usually are down sequentially. What accounts for that and is it likely to occur again this year? I've answered that question a lot. Quarter four is June, July, August. That's the summer time and although we here in the US tend to probably still work fairly hard in the summer, a lot of the world doesn't. The Europeans get often six weeks off, Japanese shut down most of the month of August, and so what you end up seeing is that the fourth quarter, and again, because we have an annual license revenue model, the fourth quarter basically is self-perpetuating, as are the other quarters. When someone licenses, a new customer licenses in the third quarter, the spring quarter, then it comes around next year again. Their license renewal comes up in the third quarter. This pattern, you're going to see this pattern repeat.

You will see the second and third quarters, let me go back to one of the earlier slides here for a second. You will see the second and third quarters here for this year, almost identical. The second quarter has been catching up with the third quarter, third quarter is still the strongest by just a little bit. But second quarter and third quarter now are starting to balance out, where first and fourth quarters remained lower. And that is a trend that you're going to see because of the annual license model. The renewals for previous year's licenses come up in the same quarter the next year. Occasionally, we will get one that slips. It's not too often, but it does happen now and then.

Next question here, missing something here because I thought there was another one from Walter. Here's one from Steve Shaw. May have missed this, can you provide any color on the conferences? Have they been successful, will you be expanding and/or increasing them?

They have been successful. As I mentioned, the contacts that we make, the scientists make, either by being at an exhibit booth, by being in a podium presentation, a topic that someone's giving in a room and standing up and making a comment or suggestion, or presenting a poster where they stand by the poster for a certain number of hours and people come by if they are interested, they start talking and ask questions. And so on. Those contacts are what has allowed us to grow.

Let's see if I can expand this. I can read the questions better. I found a way to expand it.

Those contacts are where we begin the marketing and sales cycle. We do get some through the Internet and some just through word of mouth, but the shows are quite important, and I don't know that we will be expanding or increasing them, I would say we are at almost a saturation level now. We've done a lot of testing of conferences over the last couple of years to find out some that we hadn't before, are they worth doing again, and not all of them are, the ones that are, we go back. If they are in the gray area we tend to go back. If they're really not very good, then we don't go back.

Let's see, Walter Ramsey, the tax rate was only 23.5% in Q3, what factors accounted for that? I'm going to ask Momoko to answer that one.

Hi, tax rate was reduced because after we filed the last year of the tax return in May, we do have more R&D tax credit for this year. So, year-to-date at the end of May 31, we expected about 30% of tax rate. However, we have -- last quarter, we have expected about 34%, so this quarter wise, we have a little adjustment to match to the year-to-date rate. Third quarter was a little bit lower. But the -- for this year, probably 30% to 32% is more likely to be tax rate.

Thank you. Next question is Steve Shaw, what was the primary factor driving SG&A down as a percent of revenue? I'm going to defer that one to Momo again.

SG&A decreasing was plus side significantly. We -- just look at the budget, and we are able to incorporate it to reduce the spendings, and we are looking at shipping expense and the travel expense, we try to minimize unnecessary FedEx or unnecessary travel, if we can use the technology that we are meeting type. So, that came up to a pretty good number. And everybody cooperated, and the results show that SG&A declined.

Okay, I see Howard has his hand raised to go on audio, Howard, you should be unmuted now.

Okay, great quarter. I want to cycle back a little bit to when you announced your preliminary numbers. And a particular comment that you made in there that you still believe that there is 1,000 to 2,000 companies just on the pharmaceutical side that are untapped. So, that in general would be I guess the overall market that you are seeking. So, if I take it a step further, if you go with maybe a similar distribution of pharmaceutical revenue that you have now, in macro terms, what are you looking at five years down the road, 10 years down the road if you get to that, at least 1,000 company level? Have you done any calculations?

Only in my head. I think it's extremely realistic for this to be a $100 million year revenue Company. Just selling basically what we have now in terms of products and services. I think it can go considerably higher than that when you look at some of the other folks that are in this space with different kinds of products, but are in the space of simulation and modeling software for pharmaceutical, chemical, aerospace, there are other places we can play in addition to pharmaceutical.

Our life sciences director, Bob Clark, used to work for Monsanto in herbicides and pesticides and we started making some contacts and inroads in that area. We've had the contract we had last year with the Air Force research lab out at Edwards Air Force Base where I used to work when it was called the rocket propulsion lab. They are interested in environmental toxicology modeling and our ADMET Predictor ADMET Modeler software lends itself to modeling that sort of thing. Similar to what we are doing with the FDA's pesticides, herbicide food contaminant side of the things that get into foods, in addition to the nutrients that are added. Yes, if you look only at the pharmaceutical industry, and only at the products we have now, and what I believe the level of usage should be, we are still very, very early in the cycle.

I liken it always to my aerospace experience back in the 1970s, when we started introducing -- because computers started becoming available that were fast enough and cheap enough at the time, not by today's scale, but cheap enough where for $0.5 million to $1 million you could buy a computer like a VAX and bring it into your company and do an awful lot of simulation work. It was still a very new thing and it took awhile for it to catch on. But I believe now, because other industries have demonstrated the utility of simulation and modeling, and the fact that it does save time and money, it is not a cost, it is actually a savings, that the pharmaceutical industry is catching on. And again, we're not going to limit ourselves to just pharmaceuticals. We are going into environmental talks, we are looking at some of the other areas where its makes sense for us to apply the technologies we have.

One of the additional areas in the environmental side which is, I guess sort of a hot topic on and off would be the drilling for natural gas and all the chemicals that might or might not get dispersed in there. Is that an area that the simulation software would be applicable to?

In fact, we already have, in ADMET Predictor, a model that's called bio concentration factor, which is related to how things permeate the ground, and can get into groundwater. So, absolutely, that's an area of interest and it's an area where what we have developed in terms of the underlying tools that the software engines can easily be applied to a variety of areas involving different kinds of chemistry.

Okay. Again, in terms of building the Company for the future. I know it will happen more rapidly as you hire more people, but have you done any work on the new hires that you have brought in over the last two years, and either how much time they have helped free up some of the sales and marketing, or how much support, how much incremental revenue do you believe that a new hire could drive after the first year or so on the job?

Well, it's not something we've tried to analyze. It's one of these things, you bring someone in, you start training, and getting them involved in contract studies or in code development. I can tell you that one good example is the scientist who is working on DDDPlus. Also was working on parts of GastroPlus that have now been released, and our out in use in the world. And she came to us right out of school. But with a lot of capabilities, and so she's got two products basically on the market. Part of GastroPlus that we use for pharmaco dynamic modeling and an upgraded version of the DDDPlus software. I haven't tried to calculate whether she is paying for herself yet or not, but I got a feeling she is.

Okay. And last question is, and this might fit into what your future potential opportunities are, but you've talked about in the last couple of conference calls about developing your own molecule. Have you done that yet, I guess with your other example earlier, is one of the ways that you might do it is look for trials that might have been stopped for some reason and figure out a way to develop something based on that?

You could do that. What we have been working on is something that is specifically oriented towards malaria. The reason being that the Gates Foundation has a very strong interest in that, and if we can show that molecules that we can design and make from scratch do hit the particular target that we are looking at, that affects malaria, then there's a chance for some very significant funding to take that much further than what we would want to do.

We are not a drug company. We are a tool company. But to demonstrate how well our tools work, we are going to put our money where our mouth is and make some molecules and test them. If we make a dozen or so molecules and spend $100,000 and get even one or two that look very interesting, at least at an early stage with a limited number of tests, then that's a real feather in our cap to say look, we not only believe in this software, we invested in actually using it and designing some molecules, and here's what we got. If we don't come up with anything good, we will learn something from it and iterate the next time around.

As mentioned earlier, with $11 million in cash, we've got to do something with it and this is one way that showing the world that there is a new way to design drug molecules, and that we believe this is going to work based on some -- several things that we have already done. But the proof is in the pudding. We are going to do it, and show people.

Okay. And keep up the good work and I look forward to hearing about those 35 potential opportunities down the road. And where they might lead.

Me too. Thanks, Howard. See if I see anyone else here. I think we've answered all the written questions. And I don't see anyone else with their hand up. I will wait just another few seconds here, if no one else has a question. Okay, I guess that's it then.

Thank you very much for attending today, we look forward to the next conference call. The next one will be a 10-K, which as you know, will come out around the end of November. So, it's going to be a while. But feel free to contact the Company, I do talk to investors now and then, willing to take 15 minutes or so and answer questions. Of course, I can't give any information that is not public, but I can emphasize what is public. Thank you again for attending, and we'll see you next time.