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Edited Transcript of SLP earnings conference call or presentation 9-Jan-18 9:15pm GMT

Q1 2018 Simulations Plus Inc Earnings Call

LANCASTER Jan 10, 2018 (Thomson StreetEvents) -- Edited Transcript of Simulations Plus Inc earnings conference call or presentation Tuesday, January 9, 2018 at 9:15:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brett A. Howell

Simulations Plus, Inc. - President of Division

* John Anthony DiBella

Simulations Plus, Inc. - President of the Lancaster Division

* John R. Kneisel

Simulations Plus, Inc. - CFO

* Renee Bouche

* Thaddeus Henry Grasela

Cognigen Corporation - President

* Walter S. Woltosz

Simulations Plus, Inc. - Co-Founder, Chairman & CEO

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Presentation

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Renee Bouche, [1]

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Good afternoon, and happy new year, everyone. It's Tuesday, January 9, 2018. And on behalf of Simulations Plus, I welcome you to our first quarter fiscal year 2018 financial results conference call and webinar.

Presenting this afternoon will be CEO and Chairman, Walt Woltosz; Chief Financial Officer, John Kneisel; and Division Presidents, John DiBella, Ted Grasela and Brett Howell. An opportunity to ask questions will follow today's presentations. 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 to ask your question directly. Please be sure to enter the unique audio PIN displayed when you joined the call. This call is being recorded for playback at our website, www.simulations-plus.com.

Before we begin the presentations, we'll start with our safe harbor statement. 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 for 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.

Now it's my pleasure to introduce you to Walt Woltosz, CEO and Chairman at Simulations Plus.

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Walter S. Woltosz, Simulations Plus, Inc. - Co-Founder, Chairman & CEO [2]

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Thanks, Renee, and thanks to everyone who is joining our call today to review our first quarter fiscal 2018 results.

So a quick overview. For anyone who's new to Simulations Plus, we are a global provider of software and consulting services for R&D, primarily in the pharmaceutical industry but also in food and cosmetics and general chemicals. In the pharmaceutical research area, we go from the earliest drug discovery, when a chemist first draws a molecule or perhaps uses a computer program to create a million brand-new molecules that have never existed in hopes that something might become a drug. We go on through preclinical development, lab work and animal work and through the first-in-human trials, onto safety research and assessment, onto Phase II and Phase III clinical trials, beyond patent life to supporting generic companies, post-patent. And also, we become involved in integration of data from multinational R&D efforts through our Cognigen division at Buffalo.

For the first quarter, a very good quarter, revenue was up $1.7 million, just over 30%, to $7.1 million. Net income, up $354,000 or 26% to $1.7 million. Nice increase due to a very good performance of our Cognigen division and the addition of the DILIsym Services division and Research Triangle Park in North Carolina. So this is the first, first quarter where we've had all 3 divisions. DILIsym was acquired in last summer's fourth quarter, but this is the first full fiscal year now that we'll have all 3 divisions.

Diluted earnings per share, up 22.8% to $0.10 per share. Software renewal rates, about 80% based on number of accounts or 88% on fees. We have small accounts, sometimes academic accounts that kind of rotate in and out as graduate students move on. But fees are a better indicator of the actual commercial side of software licensing.

We added 21 new software clients during the quarter, and our explosive consulting pipeline resulted in significant increase in revenues.

We are a company that spans, as I mentioned, all the way from the earliest discovery through clinical trials onto post-patent work with the generic companies and the data management aspects. On the discovery side, we have our ADMET predictor, MedChem Studio and MedChem Designer software tools.

Moving into preclinical. Those tools overlap with our simulation tools, DDDPlus and MembranePlus, that simulate in vitro experiments or laboratory experiments, DDD being for dissolution experiments and MembranePlus being for experiments that measure the rate at which molecules can penetrate through a layer of cells or in another type of experiment, a simulated fluid called PAMPA.

GastroPlus is our flagship product for physiologically based pharmacokinetics. It is the largest revenue source of our software products, and it is the leading PBPK or, physiologically based pharmacokinetics software in the world right now with the number of licenses far exceeding the #2 company.

PKPLus, a new product we brought out about 1.5 years ago. Version 2 will be out shortly. We've been saying that for a number of months, but we truly are in final testing and documentation now. We expect the PKPLus version 2 to be out within a matter of weeks.

KIWI is the data management -- data integration and management software developed at Cognigen and is being used now in a number of organizations, including a very large major research foundation, to integrate data coming in from research organizations around the world working on common problems.

DILIsym and NAFLDsym are products that Brett Howell, our CEO of the -- President of our DILIsym division, will discuss. DILIsym stands for drug-induced liver injury simulation. So this refers to injury to the liver caused by medicines or potential medicines where NAFLDsym, nonalcoholic fatty liver disease simulation, is looking at the disease itself, nonalcoholic fatty liver disease and trying to find therapeutic agents that can help treat that disease. And Brett will talk a little more about that.

I'm going to cross the whole span. As you can see at the bottom here, we have consulting services and collaborations, collaborations with the FDA, with industry partners and so on -- and academic partners.

Recently, a new commissioner of the FDA, Scott Gottlieb, has really pushed on the idea that modeling and simulation are going to have to be important new tools to shorten the time to market and the cost of developing drugs. It's a very expensive process. And one of the things that he says, as you can see underlined in red there, the use of in silico tools in clinical trials that can help make drug development and regulation more efficient. And he points out here, the Center for Drug Evaluation and Research, CDER, is currently using modeling and simulation to predict clinical outcomes and a variety of other things here. And the FDA has a large number of licenses for our GastroPlus software, and so we're very much involved and have funded -- collaboration work being funded by the FDA to take a state of the art even further in our GastroPlus software.

Since 2015, our consulting team has built PBPK models and written reports for internal review and submissions to the various regulatory agencies, as you can see here. So preclinical development and first-in-human predictions, 16 different projects; formulation optimization, 15; drug-drug interaction predictions, 10; virtual bioequivalence trials simulations. And you can see the others here. But the point is, here, if you add all these up, there's, what, probably on the order of 50 or more submittals to regulatory agencies, the FDA, the EMA in Europe, the MHRA in England and other FDA and clinical agencies in other countries around the world.

With that, I'll hand it over to John Kneisel, our Chief Financial Officer, to provide the financial overview.

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John R. Kneisel, Simulations Plus, Inc. - CFO [3]

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All right. Thank you, Walt. I'll go to the first slide. Our consolidated revenues, like Walt said, were up by 30.5% or $1.7 million in the first quarter. Lancaster was up $346,000. That was about a 9% -- or just over 9% increase to $4 million. Buffalo was up 11%, increase to $1.9 million. And North Carolina, brought in $1.1 million, just over $1.1 million for the quarter. Again, as Walt says, they were acquired in June of '17 and they were not part of the prior year numbers there. So again, our consolidated software and software sales were up 10% in the quarter. And consulting was the remainder of the increase.

The cost of revenues in the quarter increased about $400,000. $262,000 of that increase was labor related. $139,000 of that were labor from DILIsym. The remainder was increases in labor from labor count at the other 2 divisions along with increases in stock-based compensation and cost of training-related expenses and other amortization expenses that increased from the acquisition of DILIsym. Overall, our cost of revenue as a percentage of revenue actually remains fairly constant. It was just about 0.1% change for the period.

Overall, our gross margin increased $1.3 million or about 30.6% to about $5.3 million in the period over the prior year. $318,000 of the increase came from California, which showed an 82.4% margin. Buffalo division increased $139,000 or 13% with margins of 63%. And DILIsym showed $794,000 in the period with a 71% margin. If you were to look at the prior quarter, their margins were a little lower. And that's because North Carolina in that quarter had a lot more contracts that had a lot of labor -- or lab testing in the quarter, which tends toward a lower margin. But as you can see, the margins are relatively constant between the 2 years, 50 -- or 75.4% compared to 75.3%.

Moving to SG&A expense. The expenses increased 29% to $2.4 million. As a percentage of revenues, SG&A was about 34% in the quarter compared to 29% the prior year. That $550,000 increase was made up of $91,000 of the market expenses. We used some contract labor this period and also had some increases in directors' compensation programs in that dollar amount. Salaries and wages were up about $151,000 in that section, which was compensation costs of about -- or stock compensation cost of $47,000 and then salaries of $72,000 at DILIsym.

Our insurance expense went up due to the health-related costs for the higher employee counts of 34,000, which came from the new subsidiary. And as expected, payroll taxes were up at the higher cost of the labor. Our amortization expense also increased $53,000. That was all related to the new acquisition, amortization of intangibles. We did see a decrease in legal expenses due to a reduction in document review, mostly associated with the acquisition in the prior year.

Moving down to the other income. We had -- inside that number is the 2 items. There's about an $86,000 reduction in other income. The prior year, we had foreign currency gains. We had a small foreign currency loss this time. And also, we have to impute some interest for fair value accounting on the acquisition-related liabilities. When we brought DILIsym on, we booked liabilities at fair value and those amounts are going up as we move forward. So there's about $38,000 worth of imputed interest for the fair value increase in the period. Net income increased to $354,000 or 26% for the quarter to just over $1.7 million from what was just under $1.4 million in the prior year.

EBITDA overall increased 27%. Most of that increase came from North Carolina from the EBITDA calculation.

And I think we can move on to the charts, Walt. As you can see, with the added revenues of DILIsym, we continue to grow. Obviously, this is our largest quarter ever, at least on this chart, you can see that. Again, the quarters we keep growing. As we go, you can see the jump in the fourth quarter. Again, that also came from DILIsym along with the growth in the other divisions.

Next chart, the consolidated net income, you can see that continued trend upward quarter by quarter. And next line, and as expected, diluted earnings per share continues to grow as income grows. Consolidated EBITDA, again, for those who track the numbers, that is continuing to go up as we proceed forward.

This next slide shows our cash position and shows how we've used cash. We're fairly judicious in the way we use cash. You can see the -- in the bottom section, the blue bars show the pattern of our distributions for dividend. Over the years, we've been paying out -- for about 3.5, 4 years, I believe, down at the bottom, we are paying $0.05 dividend. In this last quarter, we increased it to $0.06. And then those red bars are the uses of cash for other items.

One, we used the TSRL comments or the amounts where we renegotiated our major royalty agreement. We now own no more under that agreement. We're free and clear. Although we do have depreciation or amortization of the agreement going forward, but we have no more cash to go out on that. And the other bars are the cash that we've paid out for acquisitions going forward while maintaining the red line, maintaining our cash balances over a period of time.

Moving on. We consider our balance sheet very stable. We're a well-capitalized R&D company, software company, still with good liquidity. The chart is the one thing, and looking at this chart, you'll notice that the current ratios have gone down. That's because within this next year, we have cash to pay out for the acquisition-related payments just affecting our current ratio, but we're still well capitalized in those payments. It will easily be paid through our cash reserves and operating profits. And we consider ourselves poised for better -- even better results in the future.

At this point, I'll turn it over to John DiBella, our President of Lancaster division.

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John Anthony DiBella, Simulations Plus, Inc. - President of the Lancaster Division [4]

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Okay. Thank you, John, and happy new year to everyone on the call. Diving deeper into the products that Walt described earlier. Our software development team in Lancaster is working very hard on new releases of all programs. The next version of GastroPlus, the flagship PBPK modeling platform, is set for release over the next month. This version has really something for everyone, including new population models for clinical pharmacology departments and enhancements to our mechanistic absorption models for pharmaceutical scientists. These and other enhancements should really help us expand the types of consulting support we can provide and also help us further penetrate into the clinical space with GastroPlus.

ADMET Predictor [version 9] will be released this spring, over the next few months. We received extremely positive feedback on the redesigned HTPK Simulation Module, which is an optional add-on feature that was part of the ADMET Predictor version 8.5 release in November. And our plans are to continue to add functionality to this module along with a few additional enhancements to other features really with the goal of getting PBPK modeling into the hands of chemists to more efficiently select lead molecules and help with lead optimization activities.

We released MembranePlus version 2 in September and expect to release DDDPlus version 6 in early spring 2018. These in vitro simulation tools really help inform the inputs for GastroPlus PBPK models. And we expect the new features coming in DDDPlus and probably towards the end of the year with MembranePlus to continue to help lead growth in their sales.

And finally, PKPLus version 2 is slightly delayed but will be released this month. The new items being implemented come directly from user feedback, and we are really excited to get this new -- next release into the hands of scientists who are looking to bring in PKPLus and just needed a few additional items at it.

Next slide, please. John has already discussed the company's strong performance in quarter 1. And here, I'd like to describe a few highlights for the Lancaster division. Revenue growth for the quarter was approximately 9.5%, driven by very strong demand for our PBPK consulting services. We worked with 22 companies, along with the FDA, on funded projects in the quarter. And our 6 full-time scientists continue to manage multiple projects each as we head into calendar year 2018.

The software revenue growth was dinged a little bit by several multinational companies that shut research sites in Asia over the past quarter, where we had licenses in place. But we still had solid growth in the number of new license customers, and especially encouraging is realizing new software licenses at domestic companies in India, Japan and China, along with the expansion of licenses at the China FDA and also Health Canada.

As you can see on the bar chart in the upper right, we realized a 4% increase in the number of software license units that were sold for the quarter. We added 21 new software clients, including 11 commercial companies. And for us, as a reminder, a new client is defined as a brand-new company or organization which is never licensed before or an existing group that added licenses in new departments or research sites.

And for the quarter, you can see that pie chart in the lower right. Software renewal license revenue was 68% of our total with new software license revenue coming in at 16% and consulting, training services making up the remaining 16%.

Next slide, please. We continue to see a nice distribution of software license revenue globally within this quarter. 45% coming from North America, 27% in Europe and 28% in Asia for the quarter. With multiple workshops hosted in Asia over the past 3 or 4 months, we expect to see more sales in the growing markets there, especially India and Korea as we head into 2018.

Next slide, please. And finally, in terms of marketing activities, the marketing group spent a lot of time creating new video content for our website, which has seen double-digit percent growth in traffic versus the preceding quarter. The team is also working very hard on migrating content from the Cognigen and DILIsym Services websites to have one location where visitors can come and appreciate and understand all of the solutions we provide. Additionally, the scientists were very busy hosting workshops and also attending or presenting at conferences around the world. And our calendar is full of events for 2018 going forward.

And finally, to help with promotional activities, we hosted 3 webinars on various modeling applications with several hundred individuals registered for each one and also maintained a robust social media presence that has seen a significant increase in engagement over the past year.

I'm now happy to invite Ted to give an update on the Cognigen operations.

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Thaddeus Henry Grasela, Cognigen Corporation - President [5]

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Thank you, John. John Kneisel had talked about our financial performance, and I thought what I would do this afternoon is talk a little bit about what's going on behind the scenes to make that happen.

So we've been really focused on continuing to grow the Cognigen division both in terms of consulting revenue and also enhancements to the KIWI platform. And I'll talk about those in a moment. But we've been successful at recruiting and onboarding a number of software engineers that we need to continue to work with the KIWI platform, and that's funded by the approximate 5-year long research funding that we have from a foundation. We've also brought on a number of scientists, including some senior scientists that are really able to get up to speed very quickly and start working on projects.

We've had a number of new marketing initiatives, and we're experimenting with different business and sales models. And I'll talk a little bit about those in a moment. But we also recognize and want to be just congratulating all the scientists across the divisions for looking for opportunities to cross-sell our products, finding synergy in terms of the scientific expertise that resides across the company and helping to bring these cross-selling opportunities to fruition. And again, we're -- now because of onboarding the software engineers, are able to continue to accelerate the KIWI development.

Next slide. So just in terms of consulting services, in 2018, so far, we have relationships with 21 companies. And we're working on 34 drugs, a total of 54 projects. So far, we have 2 new companies that we hadn't worked with before in this fiscal year. We have 14 new projects that were brand new and just started, 8 projects that had an expanded scope because of the success that we had and the value that our clients are finding in the analysis that we perform. And 3 projects had a reduced scope because of issues of performance with the drug itself. Right now, in terms of the pipeline, it's very healthy. And we have 37 outstanding proposals with 25 different companies that we're waiting to hear about.

We're expanding on the global health initiatives and working in malaria and developing a disease drug model for that. And I'll talk a little bit more about that in a moment. But companies are also using our modeling techniques to bridge global regulatory submissions. So if a company has approval to market a drug in the U.S., they may take the data that was used for that submission, subject it to some modeling and simulation, a limited amount of new data in a new region and then use that as a basis for regulatory submission. So it's a very efficient way of using our modeling and simulation services to bridge between countries.

We're also finding success in embedding our pharmacometric services within companies and increasingly find that as we start working with the company on the data that comes from their first-in-human studies, that we're able to track that compound through the later stages of development into commercialization. And that creates a really great pipeline of new projects as we go along contingent on continued satisfactory performance from our group, which we work very hard at ensuring.

And so far in fiscal year 2018, we've presented 5 posters and we have 3 peer-reviewed publications. And we continue to be very busy, working on 20 additional publications with 5 conference abstracts. And it's important to recognize that these publications and presentations at scientific meetings are a really important way for us to promote the creativity and innovation that we bring to these projects to seek new clients.

Our most common therapeutic area continues to be oncology, followed by neurology, endocrinology and infectious disease. And in general, about half of the projects that we work on in any given year are submitted for regulatory review. And of course, over time, the -- as compounds work their way through the research and development life cycle, they end up getting submitted.

We had a great success this past fall. And we were asked to write a paper on how we would imagine using modeling and simulation to full effect in the development of malaria therapeutics. And we published this paper describing essentially all of the software techniques -- software products that we have at different levels of the research and development life cycle. And we did this with people from the Gates Foundation as well as their industry partners in the Medicines for Malaria Venture and a number of academic groups. So this becomes a template that we would like to be able to promote to improve the efficiency of the development of these important therapeutic drugs but then also serve as a way of illustrating the value of our software products like the KIWI platform in terms of performing the modeling and simulation and also communicating with groups around the world.

So in summary, we've worked very hard to increase our marketing and sales efforts. Our pharmacometric services continue to expand. We have a healthy pipeline that now includes global health initiative projects like the malaria project I just spoke about. We're working on new types of projects where we're using modeling and simulation to bridge across the regions in the global regulatory filings. And we're working harder to develop closer relationships with our clients so that we can see opportunities across the whole life cycle of research and development.

We have explored a number of different cross-selling opportunities with Lancaster and DILIsym. And that's going to allow us to create even broader business models with our clients and reaching even more deeply into their needs, and again, expanding scientific synergies.

In terms of the KIWI platform, we're accelerating its design and deployment. As I mentioned, we have -- the first stage of hiring is completed. And in this past quarter, we successfully introduced the data repository module. And I'll have more to say about that in the next earnings call.

Thank you. I'll turn it over to Brett Howell to talk about DILIsym Services.

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Brett A. Howell, Simulations Plus, Inc. - President of Division [6]

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Okay. Thank you, Ted. And again, echoing what's been said already, happy new year to everyone. So I want to start out on the next slide by orienting everyone to what we do at DILIsym services, especially given our position as the new group in the company. So not everyone may be familiar.

So our vision really and our focus is safer and more effective medicines through modeling and simulation into the very synergistic fit with both Cognigen and the Lancaster division. We offer comprehensive program services that focuses on software licensing and training as well as, as you'll see as we look at our revenue breakdown, a large amount on the consulting projects. As a part of our consulting, we not only do modeling and simulation, but we also do data, study design and data interpretation and also consulting for companies on an hourly basis in some cases related to regulatory submissions.

The 2 pieces of software that I'll discuss today that you'll hear about is DILIsym, this is focused on the prediction and the understanding of drug-induced liver injury; and then NAFLDsym, this is focused on the prediction of the efficacy of drugs or the effectiveness of drugs at treating nonalcoholic fatty liver disease or NASH, nonalcoholic steatohepatitis.

Next slide, please. So just a few notes about our first Q1 with the company and the breakdown of our revenue. In terms of our software consulting projects, you can see that the DILIsym software and the projects associated with that software in green made up a bulk of our revenue, around 70%. The -- we currently have 17 active consulting projects ongoing. Again, this software focuses on helping companies, predict problems they may have with drug-induced liver injury and also help them understand scenarios where they already observed some sort of a problem. This often involves data management as well as analysis components. And as John Kneisel mentioned during the financial overview, oftentimes we have subcontractors that are gathering laboratory data for us to use as a part of those projects that becomes part of our cost.

Our NAFLDsym consulting projects, we have one very large project ongoing at the moment that is focused on enhancing our software to allow us to include 2 new important areas. So the current existing version of the software focuses on fatty liver or steatohepatitis. But this new project is allowing us to enhance the software in ways that I'll mention on the next slide.

And then finally, our DILIsym software licensing program, which we execute through our consortium contracts, as you can see, made up the additional 13% of our revenues. So when you combine the DILIsym software-related consulting with the DILIsym licensing, you get about 87% of our revenues with the balance coming from our NAFLDsym program. And we are focused on, of course, enhancing our DILIsym software as well as working with the FDA for them to get set up and acquire additional licenses for evaluation of the software. They currently have 2 licenses, but they are actively adding additional licenses now. So that bodes well for the future in terms of regulatory use and evaluation.

Next slide, please. So just some -- a few product notes. DILIsym [version 7A] was just released yesterday to our consortium members as well as academic users. This includes -- this release includes a large number of expanded features that our users have been requesting. So we're excited about that. NAFLDsym development, as I mentioned, is continuing through our largest individual company sponsorship. And the main areas of focus for that addition are fibrosis and inflammation. These are 2 of the most important pathways with respect to treating nonalcoholic fatty liver disease. And so we believe that's going to greatly enhance our ability going forward to consult -- to conduct NAFLDsym consulting projects.

And then finally, we have been actively working on putting together a proposal for [RENAsym], a new product that we haven't developed yet but we foresee starting development on soon. And this is focused on drug-induced kidney injury. So it's very much synergistic with what we do around liver and would allow us to expand to another vital organ that is often of concern with respect to safety.

And then with respect to all of these products, we are actively working towards increased communication with the GastroPlus platform to make the whole process more efficient for the users as well as the KIWI platform.

And on the next slide, Slide 30, I'll just talk -- I'll say a few things about marketing. So we have a plan to give a number of scientific talks and courses this year, including exhibits at 6 or more venues, most of those national meetings. We are co-exhibiting and marketing with both Cognigen and Simulations Plus at most of those meetings so we get a real nice marketing synergy there across divisions, different customers that we all have worked with individually. And as well, we are, as John DiBella mentioned, working towards migration of more content to the Simulations Plus website for a better presence of all 3 divisions on the site.

Next slide. So just to summarize, we're excited that we've now got a new version of our flagship product, DILIsym, but we are actively developing across all of our products new versions that we think will expand the user base. We're working on the synergies that come from the acquisition. Obviously, this is just the second quarter under that acquisitions. So still a lot of work to do. Our number of consulting clients continues to grow. We've now worked with well over 30 companies on the consulting capacity, and we've also expanded the number of companies that have now licensed DILIsym. 18 companies have now licensed DILIsym at some point in the history of the consortium, and of course, the Food and Drug Administration, as I mentioned.

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Walter S. Woltosz, Simulations Plus, Inc. - Co-Founder, Chairman & CEO [7]

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Thank you, Brad, Ted, John D., John K. So final summary, just to wrap it up. The first quarter, very good quarter. Revenues, up 30.5%. Income, up 26%. Diluted earnings per share, up 22.8%.

All 3 divisions performing very well. The synergies that we expected between divisions are being realized and expanded. We are addressing regulatory agency focus on applying PBPK model in clinical pharmacology and safety research. And there are some new guidance documents appreciated by the Food and Drug Administration and the European Medicines Agency that are helping drive interest.

Just before the acquisition of Cognigen in 2014, both the FDA and the MHRA in England hosted full-day meetings specifically focused on applying physiologically based pharmacokinetic, or PBBK, modeling in clinical pharmacology. And so the timing couldn't have been better for us because just a few months later, we were combined together to be able to help push PBPK into clinical pharmacology. We now have scientists at Cognigen who are experts at using PBBK modeling and working with the Lancaster team. You can see the result in the consulting -- the growth in consulting contracts that have come in partially due to that.

We are executing well in a 5-year, just under $5 million contract with a major research foundation on malaria. And we believe that this offers a potential for additional contracts with other organizations or with other diseases besides malaria.

Our DILIsym Services acquisition, an exciting development in the past calendar year, expands our offerings into systems toxicology where there we're looking at what's going on inside of cells with the complex networks that take place that involve what's called quantitative systems, pharmacology or toxicology. So we think, combined with the PBPK, with the clinical trial data analysis at Cognigen, the QSP analysis at DILIsym Services, that we do continue to lead the trend towards greater use of modeling and simulation in pharmaceutical research and development.

And I always like to say what we sell, as much as anything, is productivity. If you can model something in software and avoid clinical trials, avoid in vitro work, avoid animal tests or at least guide them to be run more efficiently, the payback is tremendous. So I think the leverage that we have through in silico modeling and simulation is very high. And I expect to see the growth continue as we've seen in the past.

With that, I'm going to turn it back over to Renee to moderate the questions.

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Questions and Answers

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Renee Bouche, [1]

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Thank you, Walt. The first couple of questions, I think, will go to John Kneisel. The first is -- concerns the income statement, which is showing some interest expense. What is that related to? And will it continue in future quarters?

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John R. Kneisel, Simulations Plus, Inc. - CFO [2]

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Yes, I think I may have answered that during the call. But that is related to the acquisition. And that is imputed interest on the fair value of the liabilities. We needed to estimate what we think the liabilities were and there were some discounting. So that's the interest that is associated with that, that liability.

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Renee Bouche, [3]

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Okay. The next question is the new tax law. Do you anticipate any impact from it? And if so, what?

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John R. Kneisel, Simulations Plus, Inc. - CFO [4]

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Well, it's quite early on the tax law. We are a fiscal year filer. It will not affect our current tax return this year but will affect some of our deferred taxes. We've been discussing the impacts of that with our tax advisers and looking into them. But I can't really say anything about that yet until we go through it. I mean, it's just barely the ink's dry on the paper in Congress. So we'll be looking into that and posting an adjustment when we have a chance to look at the all the actual components of it in the tax law.

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Walter S. Woltosz, Simulations Plus, Inc. - Co-Founder, Chairman & CEO [5]

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Just to make sure people understood what you said, when you said it won't affect this year, what you're referring to is the calendar year 2017, correct?

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John R. Kneisel, Simulations Plus, Inc. - CFO [6]

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No. What I'm talking about, our current tax year returns filed for 8/31/18 will not be affected by the tax rate change that occurred in it. It's for the calendar -- the tax law affects the tax filings in 2018 for corporate tax returns. However, we -- it will affect deferred taxes for our current year because that's on a forward-looking basis. But we have to look at the components of the deferred taxes and assess each one of those. And until we've had a chance to look at those, I can't really say what's going to happen to our deferred taxes. And we have a lot of deferred tax liabilities on the books. So we have to look at each one of the components of that before we can assess it and make any kind of statement or adjustment in the financials.

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Walter S. Woltosz, Simulations Plus, Inc. - Co-Founder, Chairman & CEO [7]

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Okay. Now I'm confused. We pay taxes on a calendar year basis, right?

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John R. Kneisel, Simulations Plus, Inc. - CFO [8]

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Yes, but we post our income taxes -- component of our income taxes as deferred income taxes. And those look to the future effects of the timing differences associated with the future tax effects of those timing differences. And that is what will be affected. Right now, I can't tell what those are without reviewing the whole entire tax package because Congress makes changes to things and we haven't even had a chance to read through the whole act.

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Walter S. Woltosz, Simulations Plus, Inc. - Co-Founder, Chairman & CEO [9]

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Okay. I hope our listeners on the call understood it better than I do.

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John R. Kneisel, Simulations Plus, Inc. - CFO [10]

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More to come.

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Walter S. Woltosz, Simulations Plus, Inc. - Co-Founder, Chairman & CEO [11]

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Okay. Right.

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Renee Bouche, [12]

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Okay. The next question, I think we had quite a bit of detail in the presentation, but perhaps more can be said. Can you provide some additional color regarding our consulting pipeline in terms of level of sophistication, potential value and number of projects being worked on as well as bidding on?

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Walter S. Woltosz, Simulations Plus, Inc. - Co-Founder, Chairman & CEO [13]

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John D., you want take that one?

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John Anthony DiBella, Simulations Plus, Inc. - President of the Lancaster Division [14]

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I'm happy to start, and then I'll invite Ted and Brett to also comment as well because I really only have details on the Lancaster division. The Lancaster division, we're currently working on 24 projects with bids out for another 8 today. And fees typically for us on projects are going to range from around $50,000 going up to $150,000 or more, depending upon additional modeling tasks that are being added as we proceed. The PBPK modeling projects themselves, they usually bring together scientists from a number of departments within a company, not ours but our client, as data requirements for the models are extensive and our ability to communicate results back to the companies, to our clients requires a certain level of expertise. And as Walt presented in one of the first slides today, the types of projects that we can work on with PBPK modeling approaches really span the preclinical and clinical development phases. And we are starting to see a number of projects with companies where we've started working with them to address some very specific questions, and now this project has expanded as we've gone forward and identified a number of additional needs that have to be addressed. And so I think that's really where there's a lot of excitement right now for us, is the ability to identify additional areas within a company where our modeling and simulation solutions can help. Ted or Brett, if you wanted to add anything else.

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Thaddeus Henry Grasela, Cognigen Corporation - President [15]

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I'm sorry, I was on mute.

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Walter S. Woltosz, Simulations Plus, Inc. - Co-Founder, Chairman & CEO [16]

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Go ahead, Brett. Go ahead. Please go ahead.

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Brett A. Howell, Simulations Plus, Inc. - President of Division [17]

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Sure, I'll start and then you can finish up. Just a couple comments with respect to the DILIsym division on the consulting side. I mentioned we have 17 ongoing consulting projects. We have, depending on how you define active bids in terms of the level of concreteness of the bid or the level of detail with which you've gone with the client and in terms of getting to the finish line and having an active contract, we have somewhere between, let's say, 3 and 10 proposals or probably more like 3 to 15 proposals where we've discussed or put together written proposals for clients for future projects. And the value of our contracts typically ranges from $50,000 or $25,000 up to $500,000, depending on the size, or larger in some cases. And so obviously, there's a lot of variables there. I will say that with respect to our consulting for DILIsym, because the nature of those projects is safety related, it's not uncommon for us to have projects pop up, very urgent immediate projects that come up and all of a sudden are active and there's really short notice. Ted?

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Thaddeus Henry Grasela, Cognigen Corporation - President [18]

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Yes, just to say that an important part of our value proposition is the fact that once we start working with the client, we work very hard to make sure that we stay involved with the compound over the course of the research and development life cycle. So as I mentioned when I was talking about our status of the pharmacometric services, we had 8 projects that expanded scope in 2018. And that reflects the fact that the drug is seeing positive results, and we're continuing to gain work with those compounds. So it's a continuing effort to service the projects that we currently have and continue to develop those relationships while at the same time, finding new clients that we can be working with. And as I mentioned, right now, we have 37 outstanding proposals with 25 different companies. Some of them are new. Some of them are companies that we've already work with but we haven't been working with a particular drug. So overall, I would say that we have a very robust pipeline, if you were looking for color.

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Renee Bouche, [19]

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Thank you, Ted. And the next question is concerning artificial intelligence. There was a recent report from the BBC that researchers at an Oxford hospital had developed artificial intelligence that can diagnose scans for heart disease and lung cancer. What progress is being made with our AI potential, including MRIModeler?

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Walter S. Woltosz, Simulations Plus, Inc. - Co-Founder, Chairman & CEO [20]

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Okay. Yes, I guess that's one for me. We have had to put that project on hold until we can finish the PKPLus version 2, which John DiBella mentioned, we expect to have released this month. We have made some advances in prototyping, a deep-learning capability, last summer. But again, we have to apply the resources to get this new version of PKPLus out, which we deemed as a higher priority. I am very excited about artificial intelligence, and I have seen more and more articles about the use of it in pharmaceutical research. In image processing, we did -- a few years ago, with our, I'll call it, shallow learning type of artificial intelligence, we did some work on interpreting magnetic resonance imaging data for either healthy subjects or those with some form of autism spectrum disorder. And we're quite successful compared to the published results at that time in being able to classify subjects based on the imaging data as either healthy or likely to be experiencing one of the forms of autism spectrum disorder. Image recognition, facial recognition, complex problems like that are areas where deep learning has been eminently successful. And so we did want to expand our capabilities to go to deep learning. And at what I mean by that is neural networks that contain more than one layer of neurons between the inputs and the outputs. It gets a little technical, but we do have that capability prototyped and saw some modest improvements in prediction of properties of molecules. But truthfully, the data sets that we use in that type of work are quite small compared to the richness of data that you see in like facial recognition or image processing types of problems. So we are excited that we have this expanded capability, but we have had to put it on hold. And hopefully, during this calendar year, we're going to see some more work in that area.

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Renee Bouche, [21]

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Okay. Thank you, Walt. The next question, in terms of annual renewal fees, is the upper 80 percentile a good percentage for modeling purposes?

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John R. Kneisel, Simulations Plus, Inc. - CFO [22]

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I'll take this one. Renewal rates in terms of accounts and fees that have been seen in the last 2 quarters, I think, are anomalies. I believe we'll settle back to our normal historical averages in the low to mid-90% range going forward, unless something completely unexpected happens.

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Renee Bouche, [23]

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Okay. Thank you, John. The next question is concerning DILIsym's revenue. 83% of DILIsym's revenue this quarter came from consulting projects. To what degree is this consulting revenue recurring from quarter-to-quarter?

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Walter S. Woltosz, Simulations Plus, Inc. - Co-Founder, Chairman & CEO [24]

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Brett, that's for you.

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Brett A. Howell, Simulations Plus, Inc. - President of Division [25]

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Sorry about that. I was on mute. Yes, I can address. And then if the others, including John Kneisel, want to jump in, make comments as well, feel free. But most of our consulting revenue is in the time frame of 3 to 8 months in project duration. So most of that consulting revenue is turned over each year. There are a few projects that are more than 12 months in length. But none of that consulting revenue is equivalent to a renewal fee for software. So those fees are not recurring, rather they are picked up through new clients and/or additional products. There are a lot of companies, as Ted mentioned, that will expand the scope of a project or move to a new project with the same company. And in that way, some of that ends up being effectively recurring. But those are under new contracts.

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Renee Bouche, [26]

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As a follow-on to that, there's another question concerning the consulting projects. Regarding the 24 current consulting projects at Lancaster and 17 current consulting projects at DILIsym, what's the average expected time remaining on these projects? And how much of these consulting revenues are comprised of hourly billings?

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John Anthony DiBella, Simulations Plus, Inc. - President of the Lancaster Division [27]

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I'll start with Lancaster. Average time remaining on the projects today are probably 6 to 10 weeks or so. And the number of these projects that are hourly billing is very small. These projects are typically priced following a fixed-price, milestone-based proposal model.

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Brett A. Howell, Simulations Plus, Inc. - President of Division [28]

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Yes. And my answers are not significantly different. So probably the average time left is in the range of 8 to 16 weeks, 2 to 4 months. And the hour -- the percentage of the contracts that are hourly is less than -- lower over a time period -- historical period of our revenue over less than 1%. So almost every contract is fixed fee in nature.

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John R. Kneisel, Simulations Plus, Inc. - CFO [29]

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So we're not out of the norm, correct, John?

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John Anthony DiBella, Simulations Plus, Inc. - President of the Lancaster Division [30]

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Sorry?

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John R. Kneisel, Simulations Plus, Inc. - CFO [31]

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However, not out of the norm for what we've seen historically. It's not like we've had longer-term projects?

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John Anthony DiBella, Simulations Plus, Inc. - President of the Lancaster Division [32]

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Right, exactly. Yes.

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Renee Bouche, [33]

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And we have a question concerning the expected tax rate. What is the expected tax rate for financial reporting purposes in fiscal 2018 and also fiscal 2019, John?

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John R. Kneisel, Simulations Plus, Inc. - CFO [34]

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Yes. Currently, with the change in the tax act, it's a little hard to say where that's actually going to go without the ultimate analysis. Without the change in the tax act, I'd say it would probably maintain the historical trends that we've seen. But like I said, with the changes, until we get through the whole analysis, I can't quite really to give any kind of guidance as to where that's going to go.

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Renee Bouche, [35]

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Okay. The next question, I think, is back to John DiBella. What were the anomalies that caused the lower renewal rates? And what caused them?

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John Anthony DiBella, Simulations Plus, Inc. - President of the Lancaster Division [36]

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Yes, there were a number of large pharmaceutical companies that closed sites for one reason or another. I think for most of those companies, that is now completed. And our licensing model is one in which most of the companies today are still accessing our software through a site-based licensing model. So these large multinational companies will have licenses and full first user license fees paid at each of these different sites. And so when one closes, that hits us. But what tends to happen is a number of those scientists will then relocate to one of the other sites. We'll see an increase in the volume of licenses at the sites that remain open. And also, a number of these companies now are starting to evaluate true kind of global license plans, and I think that will only help with renewal revenues going forward, if we can migrate a lot of these companies over to a more global license model.

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Renee Bouche, [37]

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Okay. Thank you, John. Walt, I don't see any additional questions.

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Walter S. Woltosz, Simulations Plus, Inc. - Co-Founder, Chairman & CEO [38]

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Okay. Well, very good set of questions. I'm going to try to understand how this tax thing works myself. Well supposedly, taxes are going down, but apparently, it's not all that straightforward to at least determine a rough estimate of how much that might be. But very successful first quarter. Things are firing at all cylinders and look forward to a very good fiscal year 2018. So I'll turn it back to Renee to close out the conference call.

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Renee Bouche, [39]

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Well, thank you, everyone, for the excellent 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 all for joining us today, and have a splendid afternoon.