Simulations Plus, Inc. 10-K

ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management’s Discussion and Analysis is intended to assist the reader in understanding our results of operations and financial condition. Management’s Discussion and Analysis is provided as a supplement to, and should be read in conjunction with, our audited consolidated financial statements beginning on page F-1 of this Report. This Report includes certain statements that may be deemed to be “forward-looking statements” within the meaning of Section 27A of the Securities Act. All statements, other than statements of historical fact, included in this Report that address activities, events or developments that we expect, project, believe, or anticipate will or may occur in the future, including matters having to do with expected and future revenue, our ability to fund our operations and repay debt, business strategies, expansion and growth of operations and other such matters, are forward-looking statements. These statements are based on certain assumptions and analyses made by our management in light of its experience and its perception of historical trends, current conditions, expected future developments, and other factors it believes are appropriate in the circumstances. These statements are subject to a number of assumptions, risks and uncertainties, including general economic and business conditions, the business opportunities (or lack thereof) that may be presented to and pursued by us, our performance on our current contracts and our success in obtaining new contracts, our ability to attract and retain qualified employees, and other factors, many of which are beyond our control. You are cautioned that these forward-looking statements are not guarantees of future performance and those actual results or developments may differ materially from those projected in such statements. Management Overview Fiscal Year 2022 Financial Highlights: • Consolidated revenues increased by $7.4 million, or 16%, to $53.9 million for the year ended August 31, 2022, compared to $46.5 million for the year ended August 31, 2021 • Consolidated gross profit increased by $7.2 million, or 20%, to $43.1 million for the year ended August 31, 2022, compared to $35.9 million for the year ended August 31, 2021 • Income from operations increased by $3.7 million, or 33%, to $14.9 million for the year ended August 31, 2022, from $11.3 million for the year ended August 31, 2021 32 Table of Contents • Net income increased by $2.7 million, or 28% to $12.5 million for the year ended August 31, 2022, compared to $9.8 million for the year ended August 31, 2021 • Diluted earnings per share increased by $0.13, or 28% to $0.60 for the year ended August 31, 2022, compared to $0.47 for the year ended August 31, 2021 Strategy Going Forward: • Continue to pursue customer collaborations to support expansion of our products and services portfolio • Continue our aggressive marketing campaigns and expand our use of social media and digital advertising • Continue to expand our sales staff and distributor channels • Continue to recruit scientific staff to support our product and services innovation • Continue to seek strategic acquisitions that complement our existing solutions portfolio and expand our markets Fiscal year 2022 was yet another record year for the Company. We believe the continued growth of our pharmaceutical software and services business is the result of steadily increasing adoption and awareness of the value of simulation and modeling software tools across the pharmaceutical industry, the continuing push by regulatory agencies for increased use of modeling and simulation, and the expertise we offer as consultants to assist companies involved in the research and development of new medicines. We continue to be a leader in the fast-growing global biosimulation market. Results of Operations Comparison of fiscal year 2022 and fiscal year 2021 (in thousands) Year ended August 31 2022 2021 $ Change % Change Revenue $ 53,906 $ 46,466 $ 7,440 16 % Cost of revenue 10,822 10,600 222 2 % Gross profit 43,084 35,866 7,218 20 % Research and development 3,208 4,047 (839) (21) % Selling, general, and administrative 24,965 20,566 4,399 21 % Total operating expenses 28,173 24,613 3,560 14 % Income from operations 14,911 11,253 3,658 33 % Other income (expense), net 204 (168) 372 (221) % Income before income taxes 15,115 11,085 4,030 36 % Provision for income taxes (2,632) (1,303) (1,329) 102 % Net income $ 12,483 $ 9,782 $ 2,701 28 % Revenues Revenues increased by $7.4 million or 16%, to $53.9 million for the year ended August 31, 2022, compared to $46.5 million for the year ended August 31, 2021. This increase is primarily due to a $5.0 million, or 18%, increase in software-related revenue and $2.5 million, or 13%, increase in service-related revenue when comparing the years ended August 31, 2022, and 2021. Cost of revenues Cost of revenues remained relatively consistent with a slight increase of $0.2 million, or 2%, for the year ended August 31, 2022, compared to the year ended August 31, 2021. The increase is primarily due to a $0.4 million, or 5%, increase in service-related cost of revenue, partially offset by a decrease of $0.2 million, or 5%, in software-related cost of revenue when compared to the year ended August 31, 2021. 33 Table of Contents Gross profit Gross profit increased by $7.2 million, or 20%, to $43.1 million for the year ended August 31, 2022, compared to $35.9 million, for the year ended August 31, 2021. The higher gross profit is due to an increase in gross profit for our software business of $5.1 million, or 21%, and an increase in gross profit for our services business of $2.1 million, or 18%. Overall gross margin percentage was 80% and 77% for the years ended August 31, 2022, and 2021, respectively. Research and development We incurred $6.4 million of research and development costs during the year ended August 31, 2022. Of this amount, $3.2 million was capitalized as a part of capitalized software development costs and $3.2 million was expensed. We incurred $6.9 million of research and development costs during year ended August 31, 2021. Of this amount, $2.9 million was capitalized and $4.0 million was expensed. Selling, general, and administrative expenses Selling, general, and administrative ("SG&A") expenses increased by $4.4 million, or 21%, to $25.0 million for the year ended August 31, 2022, compared to $20.6 million for the year ended August 31, 2021. The increase was primarily due to an increase in personnel costs of $2.9 million, an increase in insurance costs of $0.6 million related to cyber and D&O premiums, and an increase in travel costs of $0.4 million. As a percent of revenues, SG&A expense was 46% for the year ended August 31, 2022, compared to 44% for the year ended August 31, 2021. Other income/expense Total other income was $0.2 million for the year ended August 31, 2022, compared to total other expense of $0.2 million for the year ended August 31, 2021. The increase of $0.4 million is primarily due to an increase in net interest income of $0.5 million and a decrease in the value of contingent consideration of $0.2 million, partially offset by an increase in the loss on currency exchange of $0.4 million. Provision for income taxes The provision for income taxes was $2.6 million for the year ended August 31, 2022, compared to $1.3 million for the year ended August 31, 2021. Our effective tax rate increased by 5% to 17% for the year ended August 31, 2022, from 12% for the year ended August 31, 2021. The effective rate differs from anticipated combined statutory rates of 25% due to R&D credits, foreign-tax-related items (tax credits and foreign-deemed intangible income deductions), and the tax effect for stock compensation and disqualifying dispositions. During the year ended August 31, 2021, as a result of an increase in the Company's stock price, a number of employees exercised and sold ISOs granted to them under their corporate incentive plans, creating corporate tax deductions that lowered the effective tax rate, whereas disqualifying dispositions were not as prevalent during the year ended August 31, 2022. 34 Table of Contents Comparison of fiscal year 2021 and fiscal year 2020 (in thousands) Year ended August 31 2021 2020 $ Change % Change Revenue $ 46,466 $ 41,589 $ 4,877 12 % Cost of revenue 10,600 10,649 (49) — % Gross profit 35,866 30,940 4,926 16 % Research and development 4,047 2,975 1,072 36 % Selling, general, and administrative 20,566 16,360 4,206 26 % Total operating expenses 24,613 19,335 5,278 27 % Income from operations 11,253 11,605 (352) (3) % Other income (expense), net (168) (218) 50 (23) % Income before income taxes 11,085 11,387 (302) (3) % Provision for income taxes (1,303) (2,055) 752 (37) % Net income $ 9,782 $ 9,332 $ 450 5 % Revenues Revenues increased by $4.9 million, or 12%, to $46.5 million for the year ended August 31, 2021, compared to $41.6 million for the year ended August 31, 2020. This increase is primarily due to a $6.1 million, or 28%, increase in software-related revenue, offset by a $1.2 million, or 6%, decrease in service-related revenue when comparing the years ended August 31, 2021, and 2020. Cost of revenues Cost of revenues remained relatively consistent for the year ended August 31, 2021, and 2020. The decrease is primarily due to lower contract research organization fees of $0.2 million, lower tech-support costs of $0.1 million, lower labor-related costs of $0.1 million, and lower training and travel costs of $0.1 million, partially offset by higher amortization of software development costs of $0.5 million related to the purchase of Lixoft. A significant portion of cost of revenues for pharmaceutical software products is the systematic amortization of capitalized software development costs, which is a fixed cost rather than a variable cost related to revenues. The amortization cost of $2.8 million for the year ended August 31, 2021, increased by $0.5 million compared to fiscal year 2020. Cost of revenues as a percentage of revenue was 22.8% for the year ended August 31, 2021, compared to 25.6% for the year ended August 31, 2020, resulting in a decrease of 2.8%. Gross profit Gross profit increased $4.9 million, or 16%, to $35.9 million for the year ended August 31, 2021, compared to $30.9 million for the year ended August 31, 2020. The increase is due to an increase in gross profit for the software business of $5.7 million, or 31%, offset by a $0.8 million, or 7%, decrease in gross profit for the services business. Overall gross margin percentage was 77% and 74% for the year ended August 31, 2021, and 2020, respectively. Research and development We incurred $6.9 million of research and development costs during year ended August 31, 2021. Of this amount, $2.9 million was capitalized and $4.0 million was expensed. We incurred $5.3 million of research and development costs during year ended August 31, 2020. Of this amount, $2.3 million was capitalized and $3.0 million was expensed. The year-over-year increase of $1.6 million, or 30%, in research and development expenditures was primarily due to increased costs in the Simulations Plus, DILIsym, and Lixoft divisions. 35 Table of Contents Selling, general, and administrative expenses SG&A expenses increased by $4.2 million, or 26% to $20.6 million for the year ended August 31, 2021, compared to $16.4 million for the year ended August 31, 2020. The increase was primarily due to a $4.0 million increase in personnel costs. As a percent of revenues, selling, general and administrative expenses was 44% for the year ended August 31, 2021, compared to 39% for the year ended August 31, 2020. Other income/expense Total other expense was $0.2 million for the year ended August 31, 2021, compared to $0.2 million for the year ended August 31, 2020. There was an increase in currency exchange gain of $0.2 million and an increase in interest income of $0.2 million, offset by an increase in the value of contingent consideration of $0.3 million. Provision for income taxes The provision for income taxes was $1.3 million for the year ended August 31, 2021, compared to $2.1 million for the year ended August 31, 2020. Our effective tax rate decreased by 6% to 12% from 18% for the same periods. The effective rate differs from anticipated combined statutory rates of 25% due to R&D credits, foreign-tax-related items (tax credits and foreign-deemed intangible income deductions), and the tax effect of stock-compensation-related items for stock compensation and disqualifying dispositions. During the years ended August 31, 2021, and 2020, as a result of an increase in stock prices, a number of employees exercised and sold incentive stock options granted to them under their corporate incentive plans, creating corporate tax deductions that lowered the effective tax rate Results of Operations by Business Unit Comparison of fiscal year 2022 and fiscal year 2021 Revenues (in thousands) Twelve Months Ended August 31, 2022 2021 Change ($) Change (%) Software $ 32,642 $ 27,670 $ 4,972 18 % Services 21,264 18,796 2,468 13 % Total $ 53,906 $ 46,466 $ 7,440 16 % Cost of Revenues (in thousands) Twelve Months Ended August 31, 2022 2021 Change ($) Change (%) Software $ 3,060 $ 3,235 $ (175) (5) % Services 7,762 7,365 397 5 % Total $ 10,822 $ 10,600 $ 222 2 % 36 Table of Contents Gross Profit (in thousands) Twelve Months Ended August 31, 2022 2021 Change ($) Change (%) Software $ 29,582 $ 24,435 $ 5,147 21 % Services 13,502 11,431 2,071 18 % Total $ 43,084 $ 35,866 $ 7,218 20 % Software Business For the year ended August 31, 2022, the revenue increase of $5.0 million, or 18%, compared to the year ended August 31, 2021, was primarily due to higher revenues from GastroPlus of $2.4 million and an increase in revenue from MonolixSuite Software of $1.6 million. Cost of revenue decreased by $0.2 million or 5% during the same periods, and gross profit increased by $5.1 million, or 21%, primarily due to the increase in revenue. Services Business For the year ended August 31, 2022, the revenue increase of $2.5 million, or 13%, compared to the year ended August 31, 2021, was primarily due to higher revenues from PBPK of $1.4 million and an increase in revenues from QSP/QST of $0.5 million. Cost of revenue increased by $0.4 million, or 5%. Gross profit increased by $2.1 million, or 18%, for the same periods. Comparison of fiscal year 2021 and fiscal year 2020 Revenues (in thousands) Twelve Months Ended August 31, 2021 2020* Change ($) Change (%) Software $ 27,670 $ 21,587 $ 6,083 28 % Services 18,796 20,002 (1,206) (6) % Total $ 46,466 $ 41,589 $ 4,877 12 % *As Lixoft was acquired on April 1, 2020, five months of activity is reflected for fiscal year 2020. Cost of Revenues (in thousands) Twelve Months Ended August 31, 2021 2020* Change ($) Change (%) Software $ 3,235 $ 2,883 $ 352 12 % Services 7,365 7,766 (401) (5) % Total $ 10,600 $ 10,649 $ (49) — % *As Lixoft was acquired on April 1, 2020, five months of activity is reflected for fiscal year 2020. 37 Table of Contents Gross Profit (in thousands) Twelve Months Ended August 31, 2021 2020* Change ($) Change (%) Software $ 24,435 $ 18,704 $ 5,731 31 % Services 11,431 12,236 (805) (7) % Total $ 35,866 $ 30,940 $ 4,926 16 % *As Lixoft was acquired on April 1, 2020, five months of activity is reflected for fiscal year 2020. Software Business For the year ended August 31, 2021, the revenue increase of $6.1 million, or 28%, compared to the year ended August 31, 2020, was primarily due to increases in revenue from MonolixSuite of $2.9 million, an increase from GastroPlus revenue of $2.2 million and an increase from ADMET Predictor Software of $0.8 million. The cost of revenue increased by $0.4 million, or 12%. Gross profit increased by $5.7 million, or 31%, primarily due to the increase in revenue. Services Business For the year ended August 31, 2021, the revenue decrease of $1.2 million, or 6%, compared to the year ended August 31, 2020, was primarily due to a decrease from other services revenue of $1.4 million, a decrease from QSP/QST revenue of $1.0 million, partially offset by an increase from PKPD revenue of $1.1 million. Cost of revenue decreased by $0.4 million, or 5%. Gross profit decreased by $0.8 million, or 7%, for the same periods. LIQUIDITY AND CAPITAL RESOURCES As of August 31, 2022, the Company had $51.6 million in cash and cash equivalents, $76.7 million in short-term investments and working capital of $139.1 million. Our principal sources of capital have been cash flows from our operations. We have achieved continuous positive operating cash flow over the last thirteen fiscal years. On March 31, 2020, the Company entered into a Credit Agreement with Wells Fargo Bank, N.A. The Credit Agreement provided us with a credit facility of $3.5 million through April 15, 2022 (the "Termination Date"), on which date the Credit Agreement terminated in accordance with its terms. As a result, we can no longer draw down against the line of credit. We chose not to renew or pursue an alternative credit facility as we do not foresee a need to utilize such credit facility within the next twelve months. As of the Termination Date, there were no amounts drawn against the line of credit. On March 31, 2020, we entered into a Share Purchase and Contribution Agreement (the “SPCA”) with Lixoft. Under the terms of the SPCA, we agreed to pay the former shareholders of Lixoft total consideration of up to $16.5 million, consisting of two-thirds cash and one-third newly issued, unregistered shares of our common stock. At closing, we paid the former shareholders of Lixoft a total of $10.8 million, comprised of cash in the amount of $9.5 million and the issuance of 111,682 shares of our common stock valued at $3.7 million, net of adjustments and a $2.0 million holdback for representations and warranties. In addition, we paid $3.5 million of excess working capital based on the March 31, 2020, financial statements of Lixoft. In addition, the SPCA called for earnout payments of up to an additional $5.5 million, payable in two-thirds cash and one-third newly issued, unregistered shares of our common stock, based on a revenue-growth formula each year for the two years subsequent to April 1, 2020. The former shareholders could earn up to $2.0 million the first year and $3.5 million in year two. In June 2021, $2.0 million was paid out under the first earnout payment, which was comprised of $1.3 million of cash and shares of our common stock valued at $0.7 million. In April 2022, we released from escrow and distributed the $2.0 million holdback consideration, consisting of $1.3 million in cash and shares of our common stock valued at $0.7 million (amounting to an aggregate of 20,326 unregistered shares of our common stock), to the former shareholders of Lixoft. In May 2022, $3.5 million was paid out under the second earnout payment, which was comprised of $2.3 million of cash and shares of our common stock valued at $1.2 million (amounting to an aggregate of 23,825 unregistered shares of our common stock), to the former shareholders of Lixoft in accordance with the SPCA. 38 Table of Contents We believe that our existing capital and anticipated funds from operations will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for the foreseeable future. Thereafter, if cash generated from operations is insufficient to satisfy our capital requirements, we may have to sell additional equity or debt securities or obtain a new credit facility. In the event such financing is needed in the future, there can be no assurance that such financing will be available to us, or, if available, that it will be in amounts and on terms acceptable to us. If cash flows from operations became insufficient to continue operations at the current level, and if no additional financing was obtained, then management would restructure the Company in a way to preserve its pharmaceutical business while maintaining expenses within operating cash flows. We continue to seek opportunities for strategic acquisitions. If one or more such acquisitions is identified, a substantial portion of our cash reserves may be required to complete it; however, we intend to maintain sufficient cash reserves after any acquisition to provide reasonable assurance that outside financing will not be necessary to continue operations. If we identify an attractive acquisition that would require more cash to complete than we are willing or able to use from our cash reserves, we will consider financing options to complete the acquisition, including obtaining loans and issuing additional securities. Except as discussed elsewhere in this Report, we are not aware of any trends or demands, commitments, events, or uncertainties that are reasonably likely to result in a decrease in liquidity of our assets. The trend over the last ten years has been increasing cash deposits from our operating cash flows, and we expect that trend to continue for the foreseeable future. Cash Flows Operating Activities Net cash provided by operating activities was $17.9 million for the year ended August 31, 2022. Our operating cash flows resulted primarily from our net income of $12.5 million, which was generated by cash received from our customers, offset by cash payments we made to third parties for their services and employee compensation. In addition, $2.6 million related to changes in balances of operating assets and liabilities was subtracted from net income and $8.0 million related to non-cash charges was added to net income to reconcile to cash flow from operations. Net cash provided by operating activities was $19.2 million for the year ended August 31, 2021. Our operating cash flows resulted primarily from our net income of $9.8 million, which was generated by cash received from our customers, offset by cash payments we made to third parties for their services and employee compensation. In addition, $1.0 million related to changes in balances of operating assets and liabilities was added to net income and $8.4 million related to non-cash charges was added to net income to reconcile to cash flow from operations. Investing Activities Net cash provided by investing activities during the year ended August 31, 2022, was $4.3 million, primarily due to the proceeds from the sale of short-term investments of $109.1 million, offset by the purchase of short-term investments of $100.8 million and computer software development costs of $3.2 million. Net cash used for investing activities during the year ended August 31, 2021, was $26.7 million, primarily due to the purchase of short-term investments of $122.4 million and computer software development costs of $2.9 million, offset by proceeds from the sale of short-term investments totaling $100.2 million. Financing Activities Net cash used in financing activities during the year ended August 31, 2022, was $7.6 million, primarily due to dividend payments totaling $4.8 million and a $3.7 million earnout payment to the former shareholders of Lixoft, partially offset by proceeds from the exercise of stock options totaling $0.9 million. Net cash used in financing activities during the year ended August 31, 2021, was $4.7 million, primarily due to dividend payments totaling $4.8 million and a $1.3 million earnout payment to the former shareholders of Lixoft, partially offset by proceeds from the exercise of stock options totaling $1.5 million. 39 Table of Contents DIVIDENDS Refer to Note 8 – Shareholders’ Equity of the Notes to Financial Statements (Part II, Item 8 of this Report) for details regarding dividends. KNOWN TRENDS OR UNCERTAINTIES We have seen some consolidation in the pharmaceutical industry during economic downturns, although these consolidations have not had a negative effect on our total revenues to that industry. Should customer delays, holds, program cancellations, or consolidations and downsizing in the industry continue to occur, those events could adversely impact our revenues and earnings going forward. We believe that the need for improved productivity in the research and development activities directed toward developing new medicines will continue to result in increasing adoption of simulation and modeling tools such as those we produce. New product developments in our pharmaceutical business segments could result in increased revenues and earnings if they are accepted by our markets; however, there can be no assurances that new products will result in significant improvements to revenues or earnings. For competitive reasons, we do not disclose all of our new product development activities. Our continued quest for acquisitions could result in a significant change to revenues and earnings if one or more such acquisitions are completed. The potential for growth in new markets (e.g., healthcare) is uncertain. We will continue to explore these opportunities until such time as we either generate revenues or determine that resources would be more efficiently used elsewhere. RECENTLY ISSUED OR NEWLY ADOPTED ACCOUNTING STANDARDS In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers (“ASU 2021-08”). The amendment requires contract assets and contract liabilities acquired in a business combination to be recognized and measured in accordance with ASC 606, Revenue from Contracts with Customers, as if the acquirer had originated the contract. The amendment is intended to improve the accounting for acquired revenue contracts with customers in a business combination, related to the recognition of an acquired contract liability, and to payment terms and their effect on subsequent revenue recognized by the acquirer. The amendment also provides certain practical expedients when applying the guidance. ASU 2021-08 is effective for interim and annual periods beginning after December 15, 2022, on a prospective basis, with early adoption permitted. The Company expects to adopt ASU 2021-08 in the first quarter of fiscal year 2024. The Company is currently evaluating the potential impact of ASU 2021-08 to its consolidated financial statements. In November 2021, the FASB issued ASU 2021-10, Government Assistance (Topic 832), which requires business entities to disclose information about transactions with a government that are accounted for by applying a grant or contribution model by analogy (for example, IFRS guidance in IAS 20 or guidance on contributions for not-for-profit entities in ASC 958-605). For transactions within scope, the new standard requires the disclosure of information about the nature of the transaction, including significant terms and conditions, as well as the amounts and specific financial statement line items affected by the transaction. The new guidance is effective for annual reporting periods beginning after December 15, 2021. The Company does not expect that the adoption of this standard will have a material impact on its consolidated financial statements; however, the Company expects to increase its disclosures with respect to government assistance beginning in the first quarter of fiscal year 2023. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Estimates Our financial statements and accompanying notes are prepared in accordance with GAAP. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management’s application of accounting policies. Actual results could differ from those estimates. Significant accounting policies for us include revenue recognition, accounting for capitalized software development costs, valuation of stock options, and accounting for income taxes. 40 Table of Contents Revenue Recognition We generate revenue primarily from the sale of software licenses and providing consulting services to the pharmaceutical industry for drug development. The Company determines revenue recognition through the following steps: i. Identification of the contract, or contracts, with a customer ii. Identification of the performance obligations in the contract iii. Determination of the transaction price iv. Allocation of the transaction price to the performance obligations in the contract v. Recognition of revenue when, or as, the Company satisfies a performance obligation The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance, and collectability of consideration is probable. Contracts generally have fixed pricing terms and are not subject to variable pricing. The Company considers the nature and significance of each specific performance obligation under a contract when allocating the proceeds under each contract. Accounting for contracts includes significant judgement in the estimation of estimated hours/cost to be incurred on consulting contracts, and the di minimis nature of the post-sales costs associated with software sales. Capitalized Computer Software Development Costs Software development costs are capitalized in accordance with ASC 985-20, “Costs of Software to Be Sold, Leased, or Marketed”. Capitalization of software development costs begins upon the establishment of technological feasibility and is discontinued when the product is available for sale. The establishment of technological feasibility and the ongoing assessment for recoverability of capitalized computer software development costs require considerable judgment by management with respect to certain external factors including, but not limited to, technological feasibility, anticipated future gross revenues, estimated economic life, and changes in software and hardware technologies. Capitalized software development costs are comprised primarily of salaries and direct payroll-related costs and the purchase of existing software to be used in the Company’s software products. Total capitalized computer software development costs were $3.2 million, $2.9 million, and $2.4 million for the fiscal years ending August 31, 2022, 2021, and 2020, respectively. Amortization of capitalized computer software development costs is calculated on a product-by-product basis on the straight-line method over the estimated economic life of the products, not to exceed five years. Amortization of software development costs amounted to $1.2 million, $1.4 million, and $1.2 million for the fiscal years ending August 31, 2022, 2021, and 2020, respectively. We expect future amortization expense to vary due to increases in capitalized computer software development costs. We test capitalized computer software development costs for recoverability whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Intangible Assets and Goodwill The Company performs valuations of assets acquired and liabilities assumed on each acquisition accounted for as a business combination and recognizes the assets acquired and liabilities assumed at their acquisition date fair value. Acquired intangible assets include customer relationships, software, trade name, and noncompete agreements. The Company determines the appropriate useful life by performing an analysis of expected cash flows based on historical experience of the acquired businesses. Intangible assets are amortized over their estimated useful lives using the straight-line method, which approximates the pattern in which the majority of the economic benefits are expected to be consumed. 41 Table of Contents Goodwill represents the excess of the cost of an acquired entity over the fair value of the acquired net assets. Goodwill is not amortized, instead it is tested for impairment annually or when events or circumstances change that would indicate that goodwill might be impaired. Events or circumstances that could trigger an impairment review include, but are not limited to, a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, a loss of key personnel, significant changes in the manner of the Company's use of the acquired assets or the strategy for the Company's overall business, significant negative industry or economic trends, or significant under-performance relative to expected historical or projected future results of operations. Goodwill is tested for impairment at the reporting unit level, which is one level below or the same as an operating segment. As of August 31, 2022, the Company determined that it had four reporting units, Simulations Plus, Cognigen, DILIsym, and Lixoft. As of August 31, 2022, the entire balance of goodwill was attributed to three of the Company's reporting units, Cognigen, DILIsym, and Lixoft. Intangible assets subject to amortization are reviewed for impairment whenever events or circumstances indicate that the carrying amount of these assets may not be recoverable. The Company did not recognize any impairment charges during the periods ended August 31, 2022, 2021, or 2020. Business Acquisitions The Company accounted for the acquisition of Cognigen, DILIsym, and Lixoft using the acquisition method of accounting where the assets acquired and liabilities assumed are recognized based on their respective estimated fair values. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. Determining the fair value of certain acquired assets and liabilities is subjective in nature and often involves the use of significant estimates and assumptions, including, but not limited to, the selection of appropriate valuation methodology, projected revenue, expenses, and cash flows, weighted average cost of capital, discount rates, and estimates of terminal values. Business acquisitions are included in the Company's consolidated financial statements as of the date of the acquisition. Research and Development Costs Research and development costs are charged to expense as incurred until technological feasibility has been established, or when the costs are for maintenance and minor modification of existing software products that do not add significant new capabilities to the products. These costs include salaries, laboratory experiment, and purchased software that was developed by other companies and incorporated into, or used in the development of, our final products. Income Taxes The Company accounts for income taxes in accordance with ASC 740-10, “Income Taxes”, which requires the recognition of deferred tax assets and liabilities for expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period and the change during the period in deferred tax assets and liabilities. Stock-Based Compensation The Company accounts for stock options in accordance with ASC 718-10, “Compensation-Stock Compensation” . Under this method, compensation costs include the estimated grant-date fair value of awards amortized over the options’ vesting period. Stock-based compensation expense, not including shares issued to Directors for services, was $2.7 million, $2.4 million and $1.3 million for the years ended August 31, 2022, 2021, and 2020, respectively, and is included in the statements of operations as Consulting, Salaries, and Research and Development expense. 42 Table of Contents