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. 37 Table of Contents Management Overview Fiscal Year 2023 Financial Highlights: • Consolidated revenues increased by $5.7 million, or 11%, to $59.6 million for the year ended August 31, 2023, compared to $53.9 million for the year ended August 31, 2022 • Consolidated gross profit increased by $4.9 million, or 11%, to $47.9 million for the year ended August 31, 2023, compared to $43.1 million for the year ended August 31, 2022 • Income from operations decreased by $6.2 million, or 41%, to $8.7 million for the year ended August 31, 2023, from $14.9 million for the year ended August 31, 2022 • Net income decreased by $2.5 million, or 20%, to $10.0 million for the year ended August 31, 2023, compared to $12.5 million for the year ended August 31, 2022 • Diluted earnings per share decreased by $0.11, or 18%, to $0.49 for the year ended August 31, 2023, compared to $0.60 for the year ended August 31, 2022 Strategy Going Forward: • Continue to invest in research and development to enhance and expand our scientific product functionality and service capabilities • Continue to pursue customer collaborations to support expansion of our products and services portfolio • Continue our aggressive marketing campaigns to open new market opportunities • Continue to expand our sales and marketing staff and distributor channels • Continue to recruit and retain 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 2023 was a successful year for the Company. We enhanced our leadership in modeling and simulation with the release of new technology. We expanded our collaborations with industry and regulatory leaders. We executed on our strategy to expand our business and market opportunity through acquisitions. We also grew our scientific staff through excellent retention and recruiting efforts. We believe the continued growth of our 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. 38 Table of Contents Results of Operations Comparison of fiscal years 2023 and 2022 (in thousands) Years ended August 31, 2023 2022 $ Change % Change Revenue $ 59,577 $ 53,906 $ 5,671 11 % Cost of revenue 11,630 10,822 808 7 % Gross profit 47,947 43,084 4,863 11 % Research and development 4,504 3,208 1,296 40 % Selling, general, and administrative 34,718 24,965 9,753 39 % Total operating expenses 39,222 28,173 11,049 39 % Income from operations 8,725 14,911 (6,186) (41) % Other income, net 2,970 204 2,766 1,356 % Income before income taxes 11,695 15,115 (3,420) (23) % Provision for income taxes (1,734) (2,632) 898 (34) % Net income $ 9,961 $ 12,483 $ (2,522) (20) % Revenues Revenues increased by $5.7 million, or 11%, to $59.6 million for the year ended August 31, 2023, compared to $53.9 million for the year ended August 31, 2022. This increase is primarily due to an increase of $3.9 million, or 12% in software-related revenue driven by timing of the software license renewals and foreign currency exchange rate fluctuations when comparing the years ended August 31, 2023, and 2022 and a $1.8 million, or 8%, increase in service-related revenue driven by addition of Immunetrics services revenue. Cost of revenues Cost of revenues increased by $0.8 million, or 7%, for the year ended August 31, 2023, compared to the year ended August 31, 2022. The increase is primarily due to an increase of $0.6 million, or 19%, in software-related cost of revenue and an increase of $0.2 million, or 3%, in service-related cost of revenue driven by addition of Immunetrics services cost when compared to the year ended August 31, 2022. Gross profit Gross profit increased by $4.9 million, or 11%, to $47.9 million for the year ended August 31, 2023, compared to $43.1 million, for the year ended August 31, 2022. The increase in gross profit is primarily due to an increase in gross profit for our software business of $3.3 million, or 11%, and an increase in gross profit for our services business of $1.6 million, or 12%. Overall gross margin percentage was 80% and 80% for the years ended August 31, 2023, and 2022, respectively. Research and development We incurred $7.8 million of research and development costs during year ended August 31, 2023. Of this amount, $3.3 million was capitalized as a part of capitalized software development costs and $4.5 million was expensed. We incurred $6.4 million of research and development costs during year ended August 31, 2022. Of this amount, $3.2 million was capitalized and $3.2 million was expensed. The overall increase in research and development costs is primarily due to development of the newest version of our MonolixSuite product, version 2023R1, which was released on February 28, 2023, the development of the newest version of our GastroPlus product, version X, and the development of the newest version of our ADMET Predictor, version 11, with significant enhancements to the AIDD module; as well as an increase in personnel costs from market compensation adjustments following the Company’s engagement during fiscal year 2022 of an external consulting firm, Arthur J. Gallagher & Co., to complete a full market study on the compensation payable to our employees compared to those of our “peers”. The Company rebuilt its career grading system based on the results of the compensation study to ensure competitive and equitable pay for all our employees across the organization in base salary, cash bonus, and stock option grants. We believe that the market study and resulting compensation adjustments were necessary in light of the highly competitive employment market to attract and retain superior talent. 39 Table of Contents Selling, general, and administrative expenses Selling, general, and administrative (“SG&A”) expenses increased by $9.8 million, or 39%, to $34.7 million for the year ended August 31, 2023, compared to $25.0 million for the year ended August 31, 2022. This increase was primarily due to a $5.4 million increase in employee and labor-related expenses from a 11% headcount increase to meet the robust and growing demand for our services, as well as market compensation adjustments following the Company’s engagement during fiscal year 2022 of an external consulting firm, Arthur J. Gallagher & Co., to complete a full market study on the compensation payable to our employees compared to those of our “peers”. The Company rebuilt its career grading system based on the results of the compensation study to ensure competitive and equitable pay for all our employees across the organization in base salary, cash bonus, and stock option grants. We believe that the market study and resulting compensation adjustments were necessary in light of the highly competitive employment market to attract and retain superior talent. The $5.4 million increase in personnel costs includes an increase in base salaries of $1.7 million, an increase in accrued bonuses of $1.2 million, an increase in stock compensation of $1.6 million, and an increase in employee benefits of $0.4 million. Additionally, the overall increase in SG&A expenses is due to an increase in one-time charges such as merger and acquisition costs of $3.0 million, including a $1.6 million bonus compensation charge for Immunetrics employees, an impairment charge $0.5 million for Cognigen trade name due to management strategy to no longer use Cognigen trade name. In addition, SG&A also increased due to an increase in director compensation of $0.2 million, an increase in accounting and tax fees of $0.2 million, an increase in commissions to distributors of $0.1 million, and an increase of $0.1 million due to the newly required excise tax on share repurchases completed during fiscal year 2023. As a percent of revenues, SG&A expense was 58% for the year ended August 31, 2023, compared to 46% for the year ended August 31, 2022. Other income Total other income was $3.0 million for the year ended August 31, 2023, compared to total other income of $0.2 for the year ended August 31, 2022. The increase is primarily due to an increase in interest income of $3.4 million driven by an increase in interest rates, partially offset by the change in the fair value of contingent consideration of $0.4 million mainly driven by increase in the fair value of contingent consideration by $0.7 million for the Immunetrics earnout, when compared to $0.2 million for the year ended August 31, 2022. Provision for income taxes The provision for income taxes was $1.7 million for the year ended August 31, 2023, compared to $2.6 million for the year ended August 31, 2022. Our effective tax rate decreased to 15% mainly due to favorable foreign income tax rates for the year ended August 31, 2023, when compared to 17% for the year ended August 31, 2022. Comparison of fiscal years 2022 and 2021 (in thousands) Years 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, 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 % 40 Table of Contents 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. 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 change in the value of contingent consideration by $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 $1.3 million for the year ended August 31, 2021. Our effective tax rate increased by 5% to 17% for the year ended August 31, 2022, from 12% for the year ended August 31, 2021. The effective rate differs from anticipated combined statutory rates of 25% due to R&D credits, foreign-tax-related items (tax credits and foreign-deemed intangible income deductions), and the tax effect for stock compensation and disqualifying dispositions. During the year ended August 31, 2021, as a result of an increase in the Company's stock price, a number of employees exercised and sold ISOs granted to them under their corporate incentive plans, creating corporate tax deductions that lowered the effective tax rate, whereas disqualifying dispositions were not as prevalent during the year ended August 31, 2022. 41 Table of Contents Results of Operations by Business Unit Comparison of fiscal years 2023 and 2022 Revenues (in thousands) Years ended August 31, 2023 2022 Change ($) Change (%) Software $ 36,517 $ 32,642 $ 3,875 12 % Services 23,060 21,264 1,796 8 % Total $ 59,577 $ 53,906 $ 5,671 11 % Cost of Revenues (in thousands) Years ended August 31, 2023 2022 Change ($) Change (%) Software $ 3,627 $ 3,060 $ 567 19 % Services 8,003 7,762 241 3 % Total $ 11,630 $ 10,822 $ 808 7 % Gross Profit (in thousands) Years ended August 31, 2023 2022 Change ($) Change (%) Software $ 32,890 $ 29,582 $ 3,308 11 % Services 15,057 13,502 1,555 12 % Total $ 47,947 $ 43,084 $ 4,863 11 % Software Business For the year ended August 31, 2023, the revenue increase of $3.9 million, or 12%, compared to the year ended August 31, 2022, was primarily due to higher revenue from GastroPlus® of $2.0 million, higher revenue from MonolixSuite of $0.9 million, and higher revenue from ADMET Predictor® of $0.4 million. Cost of revenues increased by $0.6 million, or 19%, during the same periods, and gross profit increased by $3.3 million, or 11%, for the year ended August 31, 2023, compared to the year ended August 31, 2022. Services Business For the year ended August 31, 2023, the revenue increase of $1.8 million, or 8%, compared to the year ended August 31, 2022, was primarily due to higher revenues from PKPD services of $1.0 million and an increase in revenues from PBPK services of $1.0 million, slight increase in revenues from QSP driven by addition of Immunetrics services revenue, partially offset by a decrease of $0.2 million from other revenues. Cost of revenues increased by $0.2 million, or 3%. Gross profit increased by $1.6 million, or 12%, for the same periods. 42 Table of Contents Comparison of fiscal years 2022 and 2021 Revenues (in thousands) Years ended August 31, 2022 2021 Change ($) 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) Years 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 % Gross Profit (in thousands) Years 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. 43 Table of Contents LIQUIDITY AND CAPITAL RESOURCES As of August 31, 2023, the Company had $57.5 million in cash and cash equivalents, $57.9 million in short-term investments, and working capital of $118.4 million. Our principal sources of capital have been a follow-on public offering in August 2020 for $107.7 million and cash flows from our operations. We have achieved continuous positive operating cash flow over the last fourteen fiscal years. On December 29, 2022, our Board of Directors authorized and approved a share repurchase program for up to $50 million of the outstanding shares of our common stock, including the repurchase of up to $20 million of our outstanding shares through an accelerated share repurchase transaction. Under the repurchase program, shares may be repurchased at our discretion based on ongoing assessment of the capital needs of our business, the market price of shares of our common stock, and general market conditions. Repurchases may be made pursuant to certain SEC regulations, which permit common shares to be repurchased when we would otherwise be prohibited from doing so under insider trading laws. There is no time limit in place for the completion of our share repurchase program, and the program may be suspended or discontinued at any time. Except as was required by the ASR Agreement, we are not obligated to repurchase any shares under the repurchase program. We have funded share repurchases to date, and will fund future repurchases, if any, through cash on hand and cash generated from operations. On January 11, 2023, the Company entered into the ASR Agreement with Morgan Stanley to repurchase an aggregate of $20 million of our outstanding shares of common stock. The ASR Agreement was executed as part of our existing $50 million share repurchase program. Pursuant to the terms of the ASR Agreement, we made an initial payment, using available cash balances, of $20 million to Morgan Stanley and received an initial delivery of 408,685 shares of Company common stock from Morgan Stanley. These 408,685 shares were retired and are treated as authorized, unissued shares. At final settlement on May 20, 2023, based on the volume-weighted average price of our common stock during the term of the ASR Agreement, Morgan Stanley delivered an additional 83,356 shares of Company common stock to the Company, which shares were also retired and treated as authorized, unissued shares. On June 16, 2023, the Company acquired Immunetrics through a reverse triangular merger, pursuant to which Immunetrics became a wholly owned subsidiary of the Company. As consideration for the acquisition, at closing, the Company paid the equity holders of Immunetrics a cash payment in the aggregate amount of approximately $13.7 million, and also paid the representative of the Immunetrics stockholders $250,000 as an expense fund to cover expenses that it incurs in its role as such (collectively, the “Closing Payments”). In addition to the Closing Payments, the Company held back $1.8 million to cover any negative working capital adjustments (if any) and Immunetrics’ indemnification obligations under the Merger Agreement (the “Holdback Amount”), the balance of which, less any deductions, if any, will be distributed to the Immunetrics stockholders after expiration of the applicable hold back period. Furthermore, the Company agreed to pay the Immunetrics equity holders an aggregate amount of up to $8.0 million in earnout payments if Immunetrics achieves certain revenue milestones for the calendar years 2023 and 2024 (the “Earnout Payments,” and together with the Closing Payments and Holdback Amount, the “Merger Consideration”). 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, including to complete the remaining repurchases available under our $50 million share repurchase program, if we so choose. Thereafter, if cash generated from operations is insufficient to satisfy our capital requirements, we may have to sell additional equity or debt securities. In the event that additional 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. We continue to seek opportunities for strategic acquisitions, investments, and partnerships. If one or more such strategic opportunities are identified, a substantial portion of our cash reserves may be required to complete it; however, we intend to maintain sufficient cash reserves to provide reasonable assurance that outside financing will not be necessary to continue operations. If we identify an attractive strategic opportunity 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 transaction, 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. 44 Table of Contents Cash Flows Operating Activities Net cash provided by operating activities was $21.9 million for the year ended August 31, 2023. Our operating cash flows resulted in part from our net income of $10.0 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, $5.1 million related to changes in balances of operating assets and liabilities was added to net income and $6.8 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 $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. Investing Activities Net cash provided by investing activities during the year ended August 31, 2023, was $7.4 million, primarily due to the proceeds from maturities of short-term investments of $114.9 million, offset by purchase of short-term investments of $95.0 million, $8.2 million for acquisition of Immunetrics, net of cash, and computer software development costs of $3.2 million. Net cash provided by investing activities during the year ended August 31, 2022, was $4.3 million, primarily due to the proceeds from maturities of short-term investments of $109.1 million, offset by purchase of short-term investments of $100.8 million and computer software development costs of $3.2 million. Financing Activities Net cash used in financing activities during the year ended August 31, 2023, was $23.3 million, primarily due to share repurchases of $20.0 million and dividend payments totaling $4.8 million, partially offset by proceeds from the exercise of stock options totaling $1.5 million. Net cash used in financing activities during the year ended August 31, 2022, was $7.6 million, primarily due to payments on contracts payable of $3.7 million related to the Lixoft acquisition, and dividend payments totaling $4.8 million, partially offset by proceeds from the exercise of stock options totaling $0.9 million. DIVIDENDS Refer to Note 6 – Shareholders’ Equity of the Notes to Financial Statements (Part II, Item 8 of this Report) for details regarding dividends. 45 Table of Contents 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. Should customer delay, 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 and consulting services such as those we provide. 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. The world has been affected by the ongoing conflict between Russia and Ukraine, the developing conflict between Israel and Hamas, other geopolitical instability, and general economic uncertainty, amongst other things. Inflation has risen, Federal Reserve interest rates have increased, and the general consensus among economists suggests that we should expect a recession risk to continue for the near future. These factors, amongst other things, could result in further economic uncertainty and volatility in the capital markets in the near term, and could negatively affect our operations. Historically, we have paid cash dividends of $0.06 per share to holders of shares of our common stock on a quarterly basis. The declaration of any future dividends will be determined by our Board of Directors each quarter and will depend on earnings, financial condition, capital requirements, and other factors. Our continued quest for strategic 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 in these new markets or determine that resources would be more efficiently used elsewhere. CONTRACTUAL OBLIGATIONS The following table provides aggregate information regarding our contractual obligations as of August 31, 2023: (in thousands) Payments due by period Contractual obligations: Total 1 year 2–3 years 4–5 years More than 5 years Contracts payable (1) $ 6,580 $ 3,250 $ 3,330 $ — $ — (1) Contracts payable are related to our Merger Agreement that the Company entered into with Immunetrics on June 16, 2023. Under the terms of the agreement, we agreed to pay the former stockholders of Immunetrics earnout payments up to an $8.0 million, consisting of two payouts of up to $4.0 million each, subject to a potential catch-up increase in certain circumstances. Additionally, a portion of the consideration, in an amount equal to $1.8 million, which was held-back by the Company at closing to cover any negative net working capital adjustments (if any) and Immunetrics’ indemnification obligations under the Merger Agreement. For further details regarding our contracts payable, refer to Note 11 to the “Notes to Consolidated Financial Statements” in Part II, Item 8 of this of this Report. 46 Table of Contents 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. 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. 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 $3.3 million, $3.2 million, and $2.9 million for the fiscal years ending August 31, 2023, 2022, and 2021, respectively. 47 Table of Contents 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 $1.5 million, $1.2 million, and $1.4 million for the fiscal years ending August 31, 2023, 2022, and 2021, 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. 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, 2023, the Company determined that it had five reporting units, Simulations Plus, Cognigen, DILIsym, Lixoft, and Immunetrics. As of August 31, 2023, the entire balance of goodwill was attributed to four of the Company's reporting units, Cognigen, DILIsym, Lixoft, and Immunetrics. 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. As of August 31, 2023, we recognized $0.5 million of impairment charge for the Cognigen trade name, as management determined we will no longer use the Cognigen trade name. Management determined that this impairment is immaterial and has no bearing on any other intangible assets including goodwill. No impairment losses were recorded during the years ended 2022 and 2021. Business Acquisitions The Company accounted for the acquisition of Cognigen, DILIsym, Lixoft, and Immunetrics 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. 48 Table of Contents 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 $4.3 million, $2.7 million and $2.4 million for the years ended August 31, 2023, 2022, and 2021, respectively, and is included in the statements of operations as Consulting, Salaries, and Research and Development expense.