Renee Bouche John Anthony DiBella - Vice President of Marketing and Sales Walter S. Woltosz - Co-Founder, Chairman, Chief Executive Officer, President and Chairman of Words+ Inc

Good afternoon. It is Thursday, July 11, 2013, and on behalf of Simulations Plus, I welcome you to our Third Quarter Fiscal Year 2013 Financial Results Conference Call and Webinar. We're mixing things up a bit this afternoon, giving you a new voice. Presenting this afternoon will be Vice President of Marketing and Sales, John DiBella. John is joined by our Chairman and Chief Executive Officer, Walt Woltosz; and Chief Financial Officer, Momoko Beran. An opportunity to ask questions will follow the presentation. [Operator Instructions] This call is being recorded for playback at our website, www.simulations-plus.com. It's now my pleasure to introduce today's presenter, Vice President of Marketing and Sales, John DiBella.

Thank you, Renee, and thanks to everybody for spending some time today to learn a little bit more about our financial performance for the third fiscal quarter ending on May 31. As we normally do, I'll start by reading the 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 of the company could differ significantly from those statements. Factors that could cause or contribute to such differences include, but are not limited to, continuing demand for the company's products, competitive factors, the company's ability to finance future growth, the company's ability to produce and market new products in a timely fashion, the company's ability to continue to attract and retain skilled personnel and the company's ability to sustain or improve current levels of productivity. Further information on the company's risk factors is contained in the company's quarterly and annual reports and filed with the Securities and Exchange Commission. So let's get to the highlights for the second fiscal quarter ending in the end of May 2013. So the third quarter compared to the third quarter from fiscal year 2012, the 23rd consecutive profitable quarter and 45th of the last 47, so going on 5-plus years of profitability and almost 10-plus years of continued growth. Sales were up almost 12% to a third quarter record of nearly $3.1 million from $2.77 million in 2012. Gross profit was up approximately 13% to $2.64 million from $2.33 million. SG&A increased a little bit, about 1.4%. And as a percentage of revenues, SG&A actually decreased to 29% from 32%. The R&D expense decreased 9.5%, and this was primarily due to the 2012 R&D expenditures for the malaria NCE project. Net income from continuing operations…

And I will take the lead on reading the questions. The first one here, can you discuss the terms of the royalty agreement on the base GastroPlus module and what the likelihood of that royalty agreement being bought out? Walter, Momo?

I'll take that question. This is Walt. I'd rather not discuss that right now. There is some discussion going on with respect to that. But there's nothing public that we can disclose at this point.

Okay, we have a multi-question response here from Howard Halpern. How important to long-term growth is the training of FDA and EPA scientists? Well, we feel like it's going to be the FDA, it's going to be the EPA, it's going to be these other regulatory groups, which ultimately will be driving the direction that pharmaceutical research or research being done by industrial chemical companies, cosmetics and so on. They're going to be the ones who drive the direction. And so for us, it's going to be important to make sure that the scientists at these various regulatory agencies have a firm understanding about what our products can do and what they can expect as more and more clients start to submit results over. How does the collaboration with the National Toxicology Program fit into your growth strategy? I'll take this one as well. Again, we know that we've done a pretty good job of penetrating the pharmaceutical and, to an extent, the biotech markets. And right now, the majority of the client base is going to be utilizing the program for chemistry purposes, for preclinical and clinical development activities. One of our key goals is to try and start penetrating other markets, and one of the markets that we've identified is this toxicology arena. And so being able to work with the NIEHS scientists, making sure that they utilize or first are aware of what our products can do, make sure that they can utilize those programs properly and then really identify how our programs can be used as a platform for toxicity testing going forward, it's going to be pretty crucial. So we're going to make sure that we work closely with them. And once we've got this platform in place, make sure that we do some sort of co or joint publication work and make sure that everybody is aware how groups at -- how the regulatory groups, especially NPP, is utilizing the tools and then how they should ultimately be utilizing them. Any thoughts regarding potential price increases? We do consider to have some internal discussions, and I think it has been approximately 4 years since the last price increase. So we're continuing to keep our eye on currency changes and also our own internal costs to see whether or not we need to reinvestigate price increases. So there is a discussion ongoing right now. I don't know, Walt, if you wanted to add anything. Can you provide an update of the...

Sorry, John. I was talking to or trying to unmute myself. Yes, we have had significant increase in income tax rate this year, as well as health insurance and some other expenses. So I think it's time for us to take a good hard look at prices and see if we want to pass on some of our cost increases to our customers.

And I think this one is going to be for you, too, Walt. Can you provide an update on the malaria project or the second NCE project? With regards to the second project, when should we begin modeling in some additional or added R&D costs?

Well, again, malaria project is essentially complete unless we get external funding. We're not planning to put anymore money into the malaria project. Rather, we'd like to look at another target. We do have a target that we're investigating. It's a pretty challenging target because we actually have to hit 2 targets instead of one, and we have to hit them at a certain ratio. So designing a single molecule that binds to two different proteins at the right ratio of binding affinity for each of the 2 is quite a challenge. We think we're on top of it. We're kind of looking at some final analyses that should be done here hopefully this month. And with any luck, if those analyses pan out the way we expect them to, we should be going out for close for a synthesis for the molecules we have during this quarter. I would expect that synthesis would probably begin either late in this quarter in August or certainly in the next quarter, the first quarter of FY '14. The actual cost we won't know until we get the quotes. My gut feel, and not being a chemist, is that these molecules seem to, at least on the surface, look perhaps a little easier to synthesize than the ones that we had for malaria, which were some pretty challenging synthesis problems. But again, I'm not a chemist, so I maybe -- my chemist may be laughing at me here offline. So we'll have to see. I'm expecting that perhaps over the next 12 months, we might be seeing somewhere on the order of $100,000 in expenditures, depending on how much testing we decide to do and how easy the synthesis goes.

One last question, initially at least from Howard is: You stated in the press release, you added 16 new customers. How much revenue did they contribute? The revenue breakdown: the new license revenue was approximately 12% to 13%; consulting, collaboration revenue was on the order of 5% to 6%; trainings were somewhere in the order of 1% to 2%; and renewal revenue made up over 80%. Is there any kind of seasonality that can be detected as of yet? And what is it, if there is seasonality?

Well, I think you can look at -- can you go back to the Slide #5, John? So here's our revenues by quarter, and you can see there is a definite seasonality. And this is self-perpetuating because remember, our business model is based on annual licenses. So you see Q2 and Q3 are traditionally our strongest quarters, and that continues because a company that licenses in 2Q -- Q2 this year is going to renew in Q2 next year. And so with a rare exception, where something might slip from one quarter to the next, this is pretty well a self-sustaining seasonality. The fourth quarter, which is June, July, August -- our fiscal year runs September 1 to August 31 -- so the fourth quarter is this summer. And of course, in Europe and Asia and a lot of the United States, there's a lot of vacations and so on. What's nice to see is that the fourth quarter last year was higher than the first quarter in 2009. So the fourth quarter is also growing, and you can see it appears to be a pretty nice linear trend for that quarter as well. And this is pretty well with no new products during the 5 years that you see here. We've had all the products that we have now on the market for this entire 5-year period. MembranePlus will be joining the product line hopefully this fall. We're shooting to have it ready to show at the American Association of Pharmaceutical Scientists conference, which is in November. That's our biggest conference of the year. And so hopefully, we'll get a little steeper increase out of that. No guarantees, but we certainly take that based on the feedback we're getting about the concept and the posters that we've presented. Doing analysis with it with the beta test version, we think there's going to be a pretty good market for the MembranePlus product. So the seasonality is what you see here, and we don't see any change to that.

I think we addressed this question already. Since your renewal rates are so high, do you have any plans to raise prices in the near future? And if so, approximately how much would the increase be? So I think we are looking closely at our prices and having some serious discussions internally. Have you hired new scientists during the quarter?

During the third quarter, I don't think any started in the third quarter. But we've had 2 already that have started in the fourth quarter.

Yes, this might be actually Q4, for the new 2 Ph.D.s that were added.

Yes, I think that should be Q4 because it was June and July.

Yes.

And we have another one that's committed that will be joining us in October.

One other -- another question. My question is about investment and growth. You mentioned a number of things you were doing to reach customers but looking at your financial statements, you really have remarkable operating margins, revenue growth outpaced sales and marketing in the quarter, expanding margins further. Is there an opportunity to invest more money in sales and marketing to grow faster?

That's for you, John.

As I mentioned, I think what one of the things that we really want to try and do is target some of these new markets. And so I think that there is an opportunity to start going to conferences that are focused in the areas of, again, environmental chemicals, herbicides, pesticides, cosmetics and so on. We're going to be having some new features coming out in some of the new releases soon that will help us present how these software programs can be used specifically for some -- those purposes. As mentioned in the last summary slide, the Life Sciences team, so when we hire Ph.D. scientists, they do spend some time assisting with the marketing and sales activities. And I think that as we add more and more scientists, that will only help as well. And we want to try and continue to work with some of the new initiatives. The webinar series, we want to expand that to cover some of the other product lines so there'll be an investment there. And then with the website redesign, we've got the capabilities now to put up some new interactive features to try and better explain the messages and make sure that people understand what the benefits are to using the software, so we'll be making some more investments. As far as actual investments in personnel, sales personnel and having more feet on the street, I don't think right now that's something we're going to be doing because, again, the audience that we typically target, the end user scientists, very much appreciate being able to interact at the initial level with scientists from our end. And by the time we get somebody properly trained who's just going to be a pure sales person, they would have to generate significant revenue in order to pay for the investment that we've made. So I think we'll probably not be focusing too much on adding more feet on the street in terms of pure sales personnel, but we'll continue to lean on the new scientists that are joining the Life Sciences group. I don't know if you have anything to add, Walt?

No, I think that's been our philosophy all along is that we've had several philosophies with Simulations Plus that have been very successful for us. One is hiring very smart people who fit in, in terms of personal chemistry with the rest of the group. The team here is just an incredibly intelligent and hardworking team, and fun people to work with. They enjoy working with each other. And we also -- we give everybody a private office. That's been a philosophy since we've begun. And the other thing is to get them out of that office, get them out in the real world. As soon as they're settled in a little bit and have an appreciation for what we do, we get them out to these scientific meetings. We're doing, what, 60 or so meetings a year. And so we want people, not to just sit at their computer and develop software or do studies. We want them to get out there and meet the customers, build those relationships because it is a very much a relationship-based business. As much as it sounds like it's a pure science play, it's a very much relationship-oriented as well. And so one of the things we offer our new scientists, they can come, in some cases, in fact, probably the majority of cases, come right out of a university with a new Ph.D. in hand. And within a couple of years, they've got a reputation that spans the globe. They've gotten out there and done the meetings and met folks. They get a reputation. And you can't really do that going to work for a large pharma, where you get stuck in a cubicle and you might get out to one or, if you're really lucky, maybe 2 scientific meetings a year. So we're going to continue that. The support that the scientific team gives marketing and sales is tremendous. We've got some of our folks, our 100,000-mile travelers year after year involved in going to these meetings, staffing the booths, giving scientific presentations, interacting with customers at the customer sites. And it's worked well. So we're going to continue that model.

Okay, I don't see any further written questions. Renee, I don't know if anybody has got their hand up.

No, there are no raised hands, either. So I think that pretty much wraps up the questions.

Okay. Renee, back to you.

All right. Well, thank you, John. 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 so much for joining us, and have a great afternoon.