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Simulations Plus, Inc. (NASDAQ:SLP)

Q3 2014 Earnings Conference Call

July 08, 2014 04:15 pm ET

Executives

Renee Bouche - Investor Relations

Walt Woltosz - Chairman of the Board, President and Chief Executive Officer

John Kneisel - Chief Financial Officer

John DiBella - Vice President - Sales & Marketing

Analysts

Renee Bouche

Good afternoon. It is Tuesday, July 8, 2014, and on behalf of Simulations Plus, I welcome you to our Third Quarter Fiscal Year 2014 Financial Results Conference Call and Webinar.

Chairman and Chief Executive Officer, Walt Woltosz, will be presenting this afternoon. Joining Walt, as panelists, are Chief Financial Officer, John Kneisel; and Vice President of Marketing and Sales, John DiBella.

An opportunity to ask questions will follow Walt's presentation. You may send your written question using the questions pane on your control panel or you may use the hand-raising icon on your control panel. (Operator Instructions) This call is being recorded for playback at our website, www.simulations-plus.com.

It's now my pleasure to turn the presentation over to Walt Woltosz, Chairman and CEO of Simulations Plus.

Walt Woltosz

Thank you, Renee, and welcome everyone to our Third Quarter Fiscal Year 2014 Conference Call and Webinar. As usual, I will read the safe harbor statement to kind of keep our attorneys happy.

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.

Highlights for the third quarter, this was an outstanding quarter. We broke records all over the place. This was our 27th consecutive profitable quarter, so coming up on seven years of consecutive profitability.

Sales, just over $3.7 million, almost 21% increase from $3.1 million. Part of that was due to a $300,000 order that was moved by our customer, one of our major customers from the second quarter to the third quarter in order to synchronize that renewal with all of their other purchases, so we expect that to stay in the third quarter going forward, but even without this order, sales would have been up 11%.

Gross profit, a new record, little over $3.5 million versus $2.6 million last year, increase of almost 33%. This was due to a number of factors. Again, the $300,000 order, but also we are no longer paying royalties on the formal TSRL agreement. There is a $25,000 amortization associated with the buyout of that agreement, and that's because there were only two weeks of the quarter that were under the effect of the buyout, so future quarters will all be amortized at $150,000 until the entire amount has been amortized.

SG&A increased 33% to about $1.2 million from about $900,000. As a percent of revenues, SG&A was up to 32% from about 29%. That’s a variety of factors there, the largest one being consulting and professional fees. That's attorney's fees in connection with negotiating with TSRL agreement and also some marketing travel expenses, sales commissions and salaries and wages are of course increased and benefits are over the previous year.

R&D expense dropped almost 14% to about $235,000 from $206,000. We have expanded the life sciences staff, and again salaries and wages are up over the past year. Net income, up almost 32% to $1.3 million from about $990,000. Diluted earnings per share up to $0.08 per share, an increase of $0.02 or 33% from $0.06 a share last year, and we did distribute a cash dividend of $0.05 per share during the third quarter. That is back to the normal, what I’d say normal, the originally declared dividend amount when we first started paying dividends in 2012.

Cash at the end of the quarter on May 31 was $7.8 million. As of yesterday, it was $8.8 million. That's after we distributed about $800,000 in dividends in May, and also paying out $2.5 million of the TSRL buyout to TSRL. Our shareholders' equity was up to just under $16 million on May 31.

The TSRL agreement buyout will settle the dispute that we had with respect to royalties on optional modules, which we had never paid, though we should not have to pay, so we negotiated this buyout agreement, where now the royalty expense that used to be part of cost of goods sold and was a function of the GastroPlus sales level will no longer be a factor in expenses. This now fixes the amount of future expense.

The original agreement had no termination dates, so the future expense was indeterminate. Now that is fixed. The consideration under the agreement was $6 million. We paid $3.5 million on signing, $2.5 million in cash, and $1 million of stock at the price of, I think, $6.07 under the agreement.

Future payments, we will pay in April 2015 and 2016, $750,000. Then in 2017, $1 million and we expect to fund those all out of operating cash flows. In fact, that will pretty well come from the payments that would have been made to the royalties going forward at the old agreement.

The effect of the P&L is that the $6 million will be amortized over 10 years at $150,000 per quarter. Again, the first quarter, this Q3, there was only $25,000 amortized because it is only one-half of the month that was under the new agreement.

Just for information, last fiscal year, we paid $623,000 in royalties to TSRL, so going forward it will be $600,000 a year, and we expect that royalties that might have been paid on the basic GastroPlus program and we probably have exceeded that number going forward because the sales continued to grow. This will have a substantial beneficial effect over time assuming GastroPlus sales continue to grow, which will be assumed for now, and we did have some one-time professional fees occurred as part of the cost negotiation which we saw in the increased SG&A.

The income statement, you can see here, I won't read all of these numbers to you. I think, I have covered almost all of them already. Income from operations, you can see up about 30%, 33% from $1.5 million to $2 million. Other income was insignificant. This is basically currency exchange, mostly with the Japanese yen, but also with some other countries now. Then the income from operations before taxes of the IT, again $2 million versus $1.533 million, and so net income is up and diluted earnings per share, both up nicely.

For the nine months ended May 31, sales were up just under $1 million, about 11.3%. Cost of sales decreased about 12% to 13%. Gross profit increased about 16% and gross margin increased to just under 88% from about 84% for the nine months, so the nine months washes out that $300,000 transfer from the second to third quarter, because fourth quarter is of course included in the nine months.

Gross margin, I mentioned SG&A did increased, again one-time consulting and professional fees. Sales commissions are up as we increased our sales in Asia, with our dealers in both China and Japan, and of course salaries and wages are up which is customary with virtually all companies.

Our R&D expense increased about 18%. We have increased our life sciences staff, added several new scientists in the last 12 months, and the nine-month Fiscal Year '14 this year included R&D expenditures for our COX-2/COX-1 new chemical entity project that those types of expenditures were not included in their last year's nine months.

Net income increased by $161,000 or 6.1% and now that puts us at a little over to $2.8 million for the first nine months and $2.6 million by comparison in FY'13. The tax rate that we had for the third quarter was considerably higher up around 37%. I did get an email question from Walter Ramsley with respect to that and when we get to the questions, I'll repeat that ask John Kneisel to discuss that.

Diluted earnings per share for the nine months up $0.01 to $0.17 from $0.16, and during the nine months we distributed total of $0.14 a share in dividends to our shareholders. Nine-month income statement, again I won't read all of these. It will see the improvement there in income from continuing operations almost $4.2 million $3.8 million and all the way down $0.17 a share versus $0.16.

Our revenues by quarter, as you can see our trend continues a little bit. If you look at Q2, the $3.1 million almost the same as the previous year, again that was a result of that $300,000 order that moved into Q3, which of course give us a bigger jump Q3, but on balance we continue a very positive slope quarter-over-quarter for almost all of the quarters over the last six years of which I am here.

Gross profit, similar trend. EBITDA, similar trend. This will bounce up and down a little bit with taxes and so, but in general the trends are quite positive. We are very pleased. Then net income by quarter, also again I should say EBITDA does not get affected by taxes. Net income is the one that's going to be affected by taxes, but even after the higher tax rate for this quarter you can see the net income is up nicely over year.

New customers, again, nice trend here as well, 20 new customers in the third quarter. Just looking at the balance sheet from the end of last fiscal year, August 31 through the nine months, you can see the comparisons here and the bottom line is shareholders' equity is up in spite of paying out the dividends that we paid out in shareholders' equity per fully diluted share up from $0.87 to $0.98.

In terms of cash, so our cash balance, you can see at the Q3 FY'14, the $2.5 million dollar payout to TSRL to buyout the royalty agreement and we are quick recovery already of $1 million from what it was on May 31st as of yesterday.

To review our products and services, we continue to have the same product line at the moment that MembranePlus. We now expect it to be released during the current quarter, which will end up August 31st of course. We are very, very close. Documentation is done, final validation tests are being run and the programs is looking very nice.

We have covered all the way from early discovery into clinical trials both our products. The ADMET Predictor and MedChem Studio and MedChem Designer products tend to be oriented more towards networks, discover and pre-clinical work, GastroPlus and DDDPlus, typically starting pre-clinical, although a little bit of discovery there and going all the way into clinical data analysis and then consulting services in collaborations, discovering the entire span from early discovery to even post patent and generic formulations.

As far as our products, GastroPlus, of course, remains our flagship product with about 60% to 65% of our revenues coming from GastroPlus. We have a new version. It's an interim version really, version 8.6, very close to release. This will be improving our drug, drug interaction predictions to allow for populations simulations with interactions. Also, we will be looking at some new animal and physiologically based pharmacokinetic models and a little tighter integration with latest version with ADMET Predictor models.

ADMET Predictor Version 7.0 was released in March, and we have a small enhancement, actually, significant enhancement in 7.1. We expect it to be released this month. We enhanced our ionization model that's a pKa model in collaboration with Bayer HealthCare in Germany. We have retrained all the property models in Version 7, so that our predictions are more accurate now with the more enhanced ionization predictions from the line above.

We have added new models for transporters and new toxicities and we have improved and expanded the metabolism predictions. ADMET Predictor continues to enjoy a very top-ranked position in terms of prediction and accuracy in the industry among its 15 or 20 peers.

MedChem Designer and MedChem Studio have been updated. We recently released version 4.0 during the third quarter in May, and we have added now an optical structure recognition feature. What this means is, the scientists can be looking at a PDF file or the technical paper let's say or a slide presentation or some bitmap drawing of a molecular structure, which is just lines and pixels on the screen and you can basically capture that with a little camera tool and that will convert that set of lines into description of the actual chemical structure.

It's a very nice feature when we are doing a lot of research as many of our customers do and it's available in both MedChem Designer and MedChem Studio. The screen methods that we have for large molecular libraries have been improved in terms of computational speeds, so they are faster and also included now 64-bit versions that can handle much larger amounts of memory and therefore a much larger chemical libraries in a single run.

DDDPlus continues Version 4.0, continues as we have had before. We have continued to grow the customer base. We have not put a lot of development into DDDPlus. I expect to get back into that shortly to be adding some additional capabilities that we believe would enhance the program and make it attractive to an even larger market.

Then MembranePlus, we had the scientist who was developing MembranePlus, went on maternity leave. We actually expect her to come back next week, I guess, and very healthy baby. Mom and baby are doing fine, so we had a change of scientist. The new scientist working on this has done an excellent job and we now expect to release to be in the coming weeks and this program will be a new product.

We know that there is considerable interest in the industry for this product, because it allows companies who do permeability experiments in cell cultures, so layers of cells grown in small wells and robots sort of plates that allow companies to measure how quickly a new drug can go through the cell layer and this is important, especially for drugs that are dosed orally, you want to know how quickly they are going to get through the cells of the intestine and getting to the blood stream and get to their target.

It turns up that when these experiments are run, there are quite a number of complicated phenomena that take place within the experiment and so when you go from one company to another on the same - what suppose to be the same experiment on the same drug, you can get radically different results, so the whole purpose of running these experiments is to be able to predict the permeability is going to be in human or perhaps in rat or dog for the pre-clinical experiments, so when company would say, well, this is a high permeability compound, another one say it's a low-permeability compound.

How do you take that information, you convert it to what it's really going to be in vivo, in the live animal and MembranePlus will help us to show each company with their experimental conditions, why the result was why it was and then how to take that experimental result from the lab and translate it forward into an animal and human.

Our sales program continues to be very aggressive. We had 19 scientific meetings and conferences during the third quarter. That included U.S., Europe and Asia, and 9 scientific posters and presentations. In early this quarter, we attended and presented at our first aerospace conference (Inaudible) and two other of our engineers. One is our newest engineer who just joined just graduate from Auburn University and aerospace engineering with the Master's degree, same as mine, just a few years later. We gave our first presentation, when we talk about that, we are excited too.

Trainings and workshops, we conducted three on-site training courses at client sites and we also conducted training workshops in Germany, New Jersey and Korea. Workshops are multi-day workshops, where students are paid to come to the workshop and learn about typical GastroPlus or also ADMET Predictor, MedChem Studio and MedChem Designer.

We have continued to do our strategic digital marketing initiative, so webinars, hosted three of those. Our new software updates and applications with over 550 registrations and we also maintain active updates from LinkedIn, Facebook and Twitter accounts to help get out the word to the world.

As far as collaborations and consulting and grants, we have our ongoing five-year collaboration with the FDA Center for Food Safety and Applied Nutrition. I think we are in our third year now, very successful program, very encouraging feedback from the FDA scientists who are using ADMET Predictor and ADMET Modeler to build their own toxicity models for food additives and contaminants and we continue to collaborate with them on that.

We have a new five-year collaboration we announced recently with the FDA's Office of Testing and Research, and this was to determine the value of using the kind of in vitro, in vivo correlation that we have in GastroPlus, which we call mechanistic IVIVC. All that means is that, in the typical IVIVC, and I am sorry about the technical alphabets, but typical IVIVC says, here is the solution test we ran in a laboratory and we see how fast the tablets dissolve, so you get curve that shows percent dissolved versus time.

Now you dose that and you take blood samples and you say, all right here is the blood concentration versus time, so that's the in vivo there that the solution experiment was in vitro data and you would like to correlate that how does the in-vitro the solution correlate with what's going on in the blood concentration of a natural human subject.

Well, the methods used in the past to do that have been some pretty simple statistical equations, where we do the full mechanistic model within GastroPlus of exactly what happened. The tablet had to disintegrate into small particles and then those particles had to dissolve and then get absorbed in different parts of the intestinal tract and then distribute into different tissues and so on, so it's a different approach that involves a lot more science, a lot more detailed modeling and the FDA is now interested testing that and seeing if it is a better way as we have been trying to tell for about 15 years and the rest of the industry, so it is being used today, but it's not officially part of an FDA guidance and we are hoping that with this new collaboration, we will be able to make that happen.

Our consulting studies continue. We have five active products right now, six more in the proposal stage. Consulting business just seems to continue to grow and that's good because the consulting efforts give us both, and insight into what our customers' names - insight into what our software can do and very often results in the software sales.

We do believe that there is a front (Inaudible) we are getting a lot of background noise with someone. There is a fundamental industry shift, where more and more companies. As you saw, we had 20 new customers this quarter, a new record for the third quarter. More and more companies and the partners are seeing the value of simulation and modeling software, so I believe this is going to continue. I believe, we are a long way from 25% penetrated in the market. I think we are well below that, so I believe the potential market is still much, much larger than what we see today.

Third quarter new customers included new companies in U.S., Europe, India, Japan and China, and also some new divisions of U.S. EPA and the Chinese FDA, who have added licenses of multiple programs.

Our FDA collaborations, I have already talked about the Center for Food Safety and Nutrition and the IVIVC, but basically in both cases we are providing copies of our software in exchange for collaboration with the scientists at the FDA access to some of the data that they may have that is not proprietary. Some of their data is proprietary and they cannot share that with us, but the idea is to exchange what we can and work with them if they see potential improvements to the software that would help them do their work better and feed that back to us and that gives us some guidance into what to do in the next version.

Our NCE project, I reported on this last time, but just to reiterate our second new chemical entity project was COX-2 enzyme, but also the COX-1 enzyme needed to be inhibited, but at a lesser level. In this project, unlike our Malaria project a couple years ago, where we had a single target missed when we had to find molecules that would two different targets at the same time with the same molecule and the goal was to find molecules that had higher affinity that would bind more to COX-2 than to COX-1.

In the long run, we were able to - our synthesis company was able to synthesize four of the eight molecules that we requested they were not able to synthesize the other four within the time and budget constraints that we had, but the four that we are synthesized all hit both COX-2 and COX-1, so they were given both enzymes and one of them inhibited COX-2 about sevenfold stronger than COX-1.

For a software company to do this with its own software with nothing but two-dimensional structures is really quite a remarkable achievement. We have done it twice now. We have done malaria and COX-2. We are now in a process of presenting our results to our customers around the world in various scientific meetings to demonstrate just how powerful our ADMET Design Suite is.

As far as growth opportunities, MembranePlus I mentioned new software product. We continue to enhance our current software product, so in GastroPlus we have not yet released to the journal industry, journal and oral cavity dosing modules that have been finished up. Those are in the hands of the companies that funded those developments and will be in the next major release of GastroPlus Version 9.0, which we will have out this fall.

We are also adding a biologics that the antibodies to GastroPlus and that we expect also to be in the next major release Version 9.0 in this fall and we are also looking at adding large animal such as horses, swine or pigs and perhaps some other animals to GastroPlus.

We are now talking more and more with clinical pharmacology departments not only in industry, but also regulatory agencies like the FDA, the MHRA in England. I think it's the MPA in the Sweden, the EMA of course Europe, the Japanese PMDA and so clinical pharmacology departments who have tended to use more statistical approaches to their modeling are now getting interested in the detailed mechanistic modeling that we do in GastroPlus, so combining the mechanistic modeling with the pharmacodynamic modeling is something that more and more of the agencies and the companies are interested in, so we seeing an exciting opening there to departments that for 15 years or 18 years have been somewhat resistant to look at the detailed mechanistic model.

For testing cloud computing as a means to offer both software and services and that's working actually very well. We have had as number of our programs available on the cloud and we have even used the cloud in some of the training sessions that we have had in Australia, in Korea and in other places and the cloud is becoming quite a useful tool that makes especially the training, very, very convenient.

AEROModeler, I am going to talk about in another slide shortly. I mentioned this earlier, last quarter this is a new software product that predicts aerodynamic force coefficients for missiles of arbitrary shapes and arbitrary mach number and angles of attack and there are some other aerospace opportunities that we see.

Then the last one on this slide is the MRIModeler. This is magnetic resonance imaging data. The first application that we have looked is classifying patients as healthy more likely to experience autism and I have another slide on that one.

Now, the AEROModeler looks at you could see the drawing here about typical missile type configuration with a number of different dimensions there, so all of those numbers where you see dimensions or angles are variables that can describe the shape of a given this and the what you'd like to be able to do is predict the lift and drag coefficients or normal force and axial force coefficients and the moments how much does this thing want to rotate based on the airflow at different mach numbers and different angles of attack.

Now the most accurate way to do that is, using computational fluid dynamics or CFD, but those are very, very compute-intensive and they are slow, so what we have done is we have taken our artificial neural network technology how our ADMET Predictor ADMET Modeler software and modified that so that we could work with the file structures and input variables of aerodynamic modeling problem. One of the big differences is in the world of chemistry, we typically look at about maybe 400 independent variables and independent variable would be each one of those dimensions that you see there on the missile and you can see there is only about a dozen of amount of missile, but in chemistry we are looking at hundreds.

On the other hand for the missile, we might have a 0.5 million data points that we can use to train the model, wherein a chemistry we might only have a few hundred to perhaps $10,000 or $20,000 in a few rare cases, where we have that much data but most of the databases we have are much smaller, so we are going to modify the program to handle much, much larger data sets and train efficiently and the curves you see on the right. I hope you can see that there's a series of dots that those lines go through, the dots are the experimental values its experimental there actually generated by another computer program that is slower computer program, developed at the Redstone, Arsenal and Huntsville, Alabama and the line is our prediction. You can see the predictions are virtually perfect.

This is very, very exciting. This has been attempted by others and have not achieved this kind of accuracy and the value of being able to do this with the neural networks is that they're very, very fast. Once you get them trained you can input missile design and what angle of attack in milliseconds get out the force moment coefficients that you need the perhaps to calculate a trajectory that you might be simulated We presented this June 23rd to 26th, we were already in Huntsville at this National Space & Missile Materials Symposium.

It's quite exciting experience to go to something like that and have people from Boeing, Raytheon and Lockheed Missile Defense Agency and ATK, which it used to be a very large rocket motor company and others show a significant interest in what we are doing here the nice thing about trying to present something that's based on simulation and modeling to the aerospace industry is that they do this every day unlike the pharmaceutical industry, which is still lagging sadly probably 20 years behind aerospace and the use of simulation so it's a relatively easy message to convey to folks who are doing simulation and modeling on a daily basis.

Other opportunities in aerospace, rapid missile identification from tracking and other data, so you get some radar data or some observables of some sort from perhaps an intelligence source or whatever and you would say I would like to figure out what that missile can actually do. How hard can it turn? How many genes can it pull and turn if it's chasing a target. How far can it go?

This is a challenge to our intelligence agencies to be able to find ways to give our forces a way of recognizing when they see a launch. If you are sitting on a ship 20 miles off the coast of Korea and you see a launch, you have only a matter of seconds to decide is that coming at me or is that just benign rocket test and if I shoot it down I'll cause some internationals. This is actually the subject of the master's thesis of our newest employee, the aerospace engineer from [it works.]

Our store separation, the figure in lower right shows an F-16 model in the wind tunnel with a fuel tank dropping away its fuel tank is being supported by an arm from behind and so they will do this in the wind tunnel and the one tunnel at various speeds and position that fuel tank at various positions to try to calculate the forces on the fuel tank, because the last thing you want is for that fuel tank to come back up and hit the airplane or hit one of those sidewinder missiles that's hanging under the wing there.

Being able to predict the forces on item that's dropped whether it's a bomb, a missile, a fuel tank from an airplane at different mach numbers and angles of attack and size of the angles is a very important capability to Just can't run every possible combination in the wind tunnel and certainly you can't drop all of those things at large numbers of angles of attack and mach numbers in real life, so you have to take the data that you get from small number be the real flight experiments on wind tunnel experiments arise.

One of the interesting things about the meeting in Huntsville was that a large part of the meeting, because it was materials meeting, dealt with high-performance materials for things to go very fast. When you go very fast, you get very hot. You know what happens on reentry from space and while it space shuttle had to have the special carbon tiles on the bottom to act as a heat shield so there's a lot going on both with metals and composite materials and it turns out that optimizing the properties of these materials is not only what you put into the material to make it, but how you make it. What is the process? The steps that you go through in terms of putting the stuff together and that has not yet been able to be modeled using physics, so we believe that the machine learning types of models that we are using on your medical patients again have a potential application here and based on the feedback we got it sounds like other folks think it might have the possibility as well .

Then finally combustion in stability modeling for liquid propellant rocket motors, we had a presentation that we made about two months ago to the Air Force research Lab here At Edwards, which is the group that is focused on in combustion and stability in liquid propellant rocket motors and they are showing definite interest in applying the technology in this area, so we see a number of potential both, growth opportunities in aerospace.

In the healthcare area, the MRI Modeler and again is another application of the same neural network engine. In this case, we didn't have 0.5 million data point as we had with the aerodynamic models. We had 18,000 independent variables you have to find out which ones actually makes sense to generate them the model that you're looking for.

Just to speed this up a little bit, if you look at the charts on the right there with the dots in them, the upper-right and lower-left corner of those four quadrants there in those plots are true positives which means yes the subject experiences autism and yes the model predicts that they would experience autism.

The upper left and lower right had hardly any doubts and would be false positives and false negative, so that would be a case where you say well we think this person has autism and yet they didn't or we don't think this person is autism even if they did and you can see the vast majority of predictions are where they belong in true positive and true negatives. We will be presenting this work at conference at MIT in Boston on September 11th to 13th.

To summarize, third quarter revenues and earnings continued our six-year almost seven-year profitable trend. Highest revenues and earnings ever, we negotiated an agreement is expected to reduce royalty cost going forward, so that should our profitability. We have added three new PhDs in fiscal year '13 another in April 2014 and then new aerospace engineering masters level just started aerospace engineering masters level just started last month were continuing to interview additional scientists. We have just had another one accept an offer. This is an IT person, computational technology, but also biochemistry background as well.

We continue to use our life sciences and computational technologies teams to support marketing and sales and find that scientist-to-scientist communication is extremely effective way to generate new sales. We continue our conference and tradeshow and workshop schedule. We have go new workshops scheduled for North America, Europe and Asia this year and the courses offered, which are going to focus on specific research functions. Coming up again this year trips to Japan, China, of course across the U.S. and Europe to visit clients and to host seminars scheduled over the next several months.

Our cash position continues to be strong. We continue to return cash to our shareholders. We paid out now about $8 million in total dividend since 2012, yet our cash still remains $8.8 million today and that's after paying out $2.5 million to TSRL for that agreement. We expect the dividend to remain at $0.05 for the quarter, but of course the board of directors must prove that each quarter and have the discretion to change that if they see any changing needs in the business.

Okay. That's the end of the slides and I will now go to the questions and we will see if I can manage this properly.

Question-and-Answer Session

Operator

There is a question. Okay. Howard Hoffman.

Unidentified Analyst

What was the revenue from the 20 new customers?

Walt Woltosz

Well, John DiBella, can you answer that one?

John DiBella

Yes. It was approximately $480,000 from the 20 new customers, so about 12% to 13% of total revenue.

Walt Woltosz

Again from Howard, given the elimination of royalty payments to TSRL for GastroPlus sales, would it be safe to model gross margin in the upper 80% to low 90% area depending on GastroPlus sales for your other offerings, do you pay any royalties and at what rate?

The initial effect is probably not going to be huge. Our gross margins tend to run 83% to 84%, pretty consistently they were up this past quarter, because of the drop in the royalties and in the amount of only $25,000 being amortized for the TSRL agreement, but it's going to stay at exactly $150,000 per quarter going forward, so that’s $600,000 per year. Last year, the actual royalty payout and $623,000, so see there is not a huge difference yet, but as the sales continue to grow, the excess there is going to continue to improve.

For our other offerings, the only other royalty that we pay right now is a very small royalty to a company that used to be called Accelrys, and I can't remember their new name since they were bought out by Dassault Group recently. That's a very small amount that we pay on the metabolism module in ADMET Predictor.

What was the dollar amount of the one-time fees due to negotiating with TSRL agreement?

I don't have that at my fingertips, but it was not an expensive one. We will have to get back to you on that one.

Since 1Q '14, receivables increased approximately $1.3 million. Why?

John Kneisel, do you want to answer that one?

John Kneisel

Yes. We actually had a lot of sales. We had about $1.9 million of sales in the month of May, so it jumped receivables up at the end of the period.

Walt Woltosz

I should have guessed that. Those quarter end sales are not unusual. Very often, the customers are waiting till the last minute to get their orders in, and so that happened there. Purchased by the EPA of five licenses of GastroPlus and the ADMET Predictor, can you provide some color as to commercial entities needing your simulation software as the EPA increases their usage of GastroPlus ADMET Predictor.

John D, you want to take that one?

John DiBella

Sure. The EPA is the regulatory group that's going to be managing research activities primarily from non-pharma-type companies, and the hope is that their continued use of the software is going to encourage those companies focused on research in industrial chemicals, cosmetics, food ingredients to take a closer look at our software and use it to fill in some of the gaps with respect to toxicity predictions and to also use it to screen some of their compounds internally and prioritize testing, so I think it's going to be very helpful for us to continue with this penetration into the non-pharma markets, especially as it relates to toxicity and screening of new entities.

Walt Woltosz

Thank you, John.

Walt Woltosz

From James Morato, do you have any pre-orders of MembranePlus that you can talk about? John D?

John DiBella

Not yet, but we do have a list of companies that are very interested in evaluating the program when it's ready, so I think there is some pent up demand for testing it out, and as soon as it's ready, we will work with those guys to get things in place.

Walt Woltosz

Thank you, John.

Are the two NCE project results valued as assets in the balance sheet? If not, why not? If so, what are they valued at?

No, we haven't put those into the balance sheet. These are projects where our goal here was simply to demonstrate how powerful the software tools that we have really are, so basically taking what I would call a bold step to kind of stick our necks out and tell the world even before the molecules were synthesized that we were going to do this when we would report the results and let the chips fall where they may, and in both cases we hit what we would call homeruns.

Now, none of these molecules will ever be a drug in and of itself. These are what we call lead molecules, and this is the way the industry works, but typically the way you get to a lead molecule is much more time-consuming and much more expensive than what we have been able to achieve using our software, and of course I have to give credit to the folks that generated some initial data that was out in the public domain that we could use as a basis for training our models for activity for the last project.

For example, we had to train our models using our ADMET Modeler, our neural network technology to be able to predict the likely activity against both COX-2 and COX-1 enzymes, and then use those models to evaluate. I guess, we hit as many as 2 million new molecules that we went through and screened for various reasons. They either didn't get the target strongly enough or they had toxicity problems or solubility problems or a variety of other problems that our software predicted, so we threw out all the garbage and honed in a handful of molecules just using our tools and this public domain data.

So, our goal was to show that you can do that and you will get to lead molecules very quickly, and then you go into the more traditional methods where the chemist has to really use their experience and knowledge and additional data. We don't predict everything with our ADMET Predictor software. We predicted about 145 properties, but there's hundreds more that would be important just in terms of the kinds of toxicity that might be produced, and we just don't have the data yet to build models for all those.

Again, these are not things that we would be thinking of as an asset where you might if you are in a biotech company and you said you know we got a molecule that really looks like this module is going to be the next drug for this particular therapy and we want to license this module to one of the big guys and take it forward. In a case like that, you might look at something like that as an asset, but it's really not where we are - the stage that we are in with our molecule design.

Good question though. I don't see any other questions on the texts. I don't see any raised hands.

John DiBella

Walt, we had a couple of questions that came in by e-mail.

Walt Woltosz

Well, can you read those, I can't show that on my screen for a moment.

John DiBella

Sure. No problem. Question was the tax rate was 37.4% however quite a bit higher than before is that due to [Jerry Brown]. What were the other factors at work? What's the expected tax rate for the year?

Walt Woltosz

We spread our R&D credits out over the year, so when we have a really high profit quarter, the rates will come up a little bit grants is (Inaudible) to be around 33% for this fiscal year when we get done at this point. There was another question John DiBella. I think this one was for you. Demonstration products in the company generated attractive results. How much of an impact do you have on your existing customers and producing other orders?

John DiBella

I think he is referring to the NCE for a proof-of-concept projects. If so, we just had a webinar, the first one for COX-2 design project. About three or four weeks ago, we had to close to 200 people registered over 100 and 110, 122 participated live, number of people have been requesting some evaluations of the software after hearing about it. We've also gotten a number of new quote requests to add some features from existing clients.

I think it's been received well and we've only just started really with the promotion and advertising of this second project. The plan is now to do some submissions of abstract to different conferences and I think eventually publish some work as well, so it's moving in the right direction.

John DiBella

Okay. Then there is one more question. I think, Walt, this one is probably for you. It appears as though much of the company's sales efforts are directed to tradeshows and other professional gatherings wouldn't it improve results to have open offices in Europe, Asia, and East Coast or where the potential buyers are concentrated?

Walt Woltosz

Well, actually that's a marketing and sales question, but we have a dealer in Japan that we work with for the past 15, 16 years. He is doing a good job. We have a dealer in China. The way I see it, opening an office implies having a location, having the overhead expense to the location and then having a person who understands what we do, how we do it and is able to go out there and represent it.

As I have answered this question before, this is a very technical sale. We really need to have someone who can go out stand in front of a group of 15 to 25 or 30 PhDs all experts in their own areas and be able to tell what we do, why we do it, and pretty well answer all of the questions. You can't answer everything. Nobody can, but you got to be able to really understand the various products and how they work and that's not something where you can just go out and hire someone because have the PhDs chemistries - we will train you for a couple of months, so you go out and do all this.

It takes much, much longer especially with the Gastro Plus product, so our approach has been and it's successful to bring people into our life sciences team, let them gain the experience through working on the products either as developing additional software, through using the products in some of our consulting studies, through helping to present the training courses and it takes a year to two years typically for someone ready to go out there on their own and represent the company at the various scientific meetings or the customer site.

The model we have seems to be working quite well. I don't relish the idea of having actual employees in foreign countries. It turns out that our representative in Japan and China are not employees. They are independent, so to open a sales office implies and - I would rather find an independent distributor if there was one. We did try one out in New England a few years ago, I didn't really work out. I don't think he ever sold anything that I can remember, so we think the model we have is working well.

John DiBella

I don't have any more questions on that list.

Walt Woltosz

Okay. I don't see any more questions on the webinar.

With that, I thank you and I will turn it back to Renee.

Renee Bouche

Thank you, all. Great quarter, great presentation. This concludes today's conference call and webinar. If you missed any part of today's presentation, the replay will be available at our website, www.simulations-plus.com.

Thank you for joining us and have a wonderful afternoon.

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Source: Simulations Plus' (SLP) CEO Walter Woltosz on Q3 2014 Results - Earnings Call Transcript
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