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. 31 Table of Contents Management Overview Fiscal Year 2024 Financial Highlights: • Consolidated revenues increased by $10.4 million, or 18%, to $70.0 million for the fiscal year ended August 31, 2024, compared to $59.6 million for the fiscal year ended August 31, 2023 • Consolidated gross profit decreased by $4.8 million, or 10%, to $43.2 million for the fiscal year ended August 31, 2024, compared to $47.9 million for the fiscal year ended August 31, 2023 • Income from operations decreased by $2.6 million, or 30%, to $6.1 million for the fiscal year ended August 31, 2024, from $8.7 million for the fiscal year ended August 31, 2023 • Net income remained unchanged at $10.0 million for the fiscal year ended August 31, 2024, compared to $10.0 million for the fiscal year ended August 31, 2023 • Diluted earnings per share remained unchanged at $0.49 for the fiscal year ended August 31, 2024, compared to $0.49 for the fiscal year ended August 31, 2023 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 exceptional 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 2024 was a successful year for the Company on several fronts. 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. Acquisitions Immunetrics On June 16, 2023, the Company completed the acquisition of Immunetrics for an estimated consideration of $15.3 million. The Company made the first cash earnout payment issuable pursuant to the Merger Agreement entered into in connection with the Immunetrics acquisition, in the aggregate amount of $2.5 million, to the former equity holders and employees of Immunetrics in 2023. The Company has a remaining earnout obligation related to the Immunetrics acquisition for up to $5.5 million, as well as $1.8 million holdback liability, which are expected to be paid out and released, to the extent earned and less any applicable deductions, in early calendar year 2025. Pro-ficiency 32 Table of Contents On June 11, 2024, the Company entered into a Stock Purchase Agreement, pursuant to which it acquired Pro-ficiency for an estimated consideration of $100.2 million. At closing, an aggregate of $1.0 of the purchase price was placed in escrow to fund payment obligations of the sellers with respect to post-closing purchase price adjustments and post-closing indemnification obligations of the sellers. The primary purpose of this acquisition was to bring together two businesses, each with complementary expertise and services that are grounded in science and focused on applying advanced technologies like AI to enhance actionable data analytics. Results of Operations Comparison of fiscal years 2024 and 2023 (in thousands) Years ended % of Revenue August 31, 2024 August 31, 2023 August 31, 2024 August 31, 2023 $ Change % Change Revenue $ 70,013 $ 59,577 100 % 100 % $ 10,436 18 % Cost of revenue 26,862 11,630 38 % 20 % 15,232 131 % Gross profit 43,151 47,947 62 % 80 % (4,796) (10) % Research and development 5,754 4,504 8 % 8 % 1,250 28 % Sales and marketing 8,915 6,558 13 % 11 % 2,357 36 % General and administrative 22,351 28,160 32 % 47 % (5,809) (21) % Total operating expenses 37,020 39,222 53 % 66 % (2,202) (6) % Income from operations 6,131 8,725 9 % 15 % (2,594) (30) % Other income, net 6,280 2,970 9 % 5 % 3,310 111 % Income before income taxes 12,411 11,695 18 % 20 % 716 6 % Provision for income taxes (2,457) (1,734) (4) % (3) % (723) 42 % Net income $ 9,954 $ 9,961 14 % 17 % $ (7) — % Revenues Revenues increased by $10.4 million, or 18%, to $70.0 million for the fiscal year ended August 31, 2024, compared to $59.6 million for the fiscal year ended August 31, 2023. This increase is due to an increase of $4.5 million, or 12%, in software-related revenue primarily driven by higher revenues from Monolix™ of $1.3 million, higher revenues from GastroPlus® of $1.0 million, higher revenues from QSP of $0.5 million, higher revenues from ADMET Predictor® of $0.4 million, and incremental revenues from ALI of $1.1 million. $5.9 million, or 26%, of the overall increase in revenues is due to an increase in service-related revenues, primarily driven by higher revenues from QSP services of $3.2 million, higher revenues from CPP services of $2.0 million, offset by lower revenues from PBPK services of $0.4 million. Cost of revenues Cost of revenues increased by $15.2 million, or 131%, for the fiscal year ended August 31, 2024, compared to the fiscal year ended August 31, 2023. This corresponds to an 18% increase in cost of revenue as a percentage of revenue. $6.8 million of the increase in cost of revenues is due to the reorganization of our internal structure from divisions based on prior acquisitions to business units organized around key product and service offerings. As part of this reorganization, we evaluated our departmental structure with a focus on continuing to improve operational performance and profitability while providing our investors improved visibility to our progress. Accordingly, we moved all services personnel into cost of revenues departments, moved all research and development personnel into research and development expense departments, moved all sales and marketing personnel into sales and marketing expense departments, and moved all general and administrative personnel into general and administrative (“G&A”) expense departments. These movements completed the final step toward consolidating the Company from the various acquired company divisions to a company-wide business unit structure. $6.8 million of the increase in cost of revenues corresponds to a $6.8 million decrease in G&A expenses discussed below from the reorganization reclassification. $3.0 million of the increase in cost of revenues is due to the acquisition of Pro-ficiency. $1.6 million of the increase in cost of revenues is due to a full year's recognition of expenses associated with the acquisition of Immunetrics in June 2023. $2.8 million of the increase is due to compensation-related increases, primarily attributable to the addition of scientific headcount as well as general annual salary adjustments for existing employees. 33 Table of Contents Gross profit Gross profit decreased by $4.8 million, or 10%, to $43.2 million for the fiscal year ended August 31, 2024, compared to $47.9 million for the fiscal year ended August 31, 2023. The decrease in gross profit is primarily due to a decrease in gross profit for our services business of $6.5 million, or 43%, primarily resulting from the reorganization of our internal structure as well as additional services headcount from the Pro-ficiency acquisition, partially offset by an increase in gross profit for our software business of $1.7 million, or 5%, reflecting the strong revenue growth and operating leverage of our software business. Overall gross margin percentage was 62% and 80% for the fiscal year ended August 31, 2024, and 2023 , respectively. Research and development We incurred $9.0 million of R&D costs during the fiscal year ended August 31, 2024. Of this amount, $3.2 million was capitalized as a part of capitalized software development costs and $5.8 million was expensed. We incurred $7.8 million of research and development costs during the fiscal year ended August 31, 2023. Of this amount, $3.3 million was capitalized and $4.5 million was expensed. R&D spend increased by $1.2 million, or 16% , for the fiscal year ended August 31, 2024, compared to the fiscal year ended August 31, 2023. The increase is mainly due to an increase of $0.5 million from the acquisition of Immunetrics, and an increase of $0.3 million from the acquisition of Proficiency. R&D spend as a percentage of revenue is consistent at 13% for both periods. Sales and marketing expenses Sales and marketing expenses increased by $2.4 million, or 36% , to $8.9 million for the fiscal year ended August 31, 2024, compared to $6.6 million for the fiscal year ended August 31, 2023. This corresponds to a 2% increase in sales and marketing expense as a percentage of revenue. The increase was primarily due to an increase of $0.9 million of compensation-related increases driven by an increase in stock compensation expense of $0.3 million, the addition to our team of a Chief Revenue Officer, sales commissions on the strong revenue growth year over year, and general annual salary adjustments for existing employees. Additionally, the acquisitions of Pro-ficiency and Immunetrics, increased sales and marketing expenses by $0.6 million and $0.3 million, respectively. General, and administrative expenses G&A expenses decreased $5.8 million, or 21%, to $22.4 million for the fiscal year ended August 31, 2024, compared to $28.2 million for the fiscal year ended August 31, 2023. This corresponds to 15% decrease in G&A expense as a percentage of revenue. The decrease is primarily driven by a $6.8 million shift from G&A expense to cost of revenues, as referenced above, due to the reorganization of our internal structure from divisions based on prior acquisitions to business units organized around key product and service offerings and a decrease of $1.1 million in mergers and acquisition expense, offset by an increase of $0.7 million from the acquisition of Pro-ficiency, an increase of $0.5 million from the acquisition of Immunetrics, an increase of $1.0 million in compensation costs due to general annual salary adjustments for existing employees, an increase in professional fees of $0.3 million, an increase in software license costs of $0.2 million, and an increase in amortization of internal-use software of $0.1 million. Other income Total other income was $6.3 million for the fiscal year ended August 31, 2024, compared to total other income of $3.0 million for the fiscal year ended August 31, 2023. The increase is primarily due to a decrease of $2.3 million in the fair value of the earnout liability related to the Immunetrics acquisition. The decrease in the fair value of the earnout liability is attributable to a partial earnout attainment for the first earnout measurement period and more modest revenue projections for the second earnout measurement period. The earnout target for the first measurement period was $4.0 million, however, based on revenue attainment, we only paid $2.5 million in March 2024 for the first earnout measurement period. As a result of the partial attainment, there is a catch-up opportunity for the second measurement period's earnout payment to increase from the target of $4.0 million to $5.5 million. Additionally, part of the increase is due to a foreign currency exchange gain of $0.4 million for the fiscal year ended August 31, 2024 compared to a foreign currency exchange loss of $0.5 million for the fiscal year ended August 31, 2023, and an increase in interest income of $0.2 million from our investments in debt securities driven by an increase in interest rates. Provision for income taxes 34 Table of Contents The provision for income taxes was $2.5 million for the fiscal year ended August 31, 2024, compared to $1.7 million for the fiscal year ended August 31, 2023. Our effective tax rate increased to 20% for the fiscal year ended August 31, 2024 from 15% for the fiscal year ended August 31, 2023 primarily due to a larger return to provision adjustment in the fiscal year ended August 31, 2023 which lowered the effective tax rate in that year. This effect was partially offset by lower state income taxes during the fiscal year ended August 31, 2024. Comparison of fiscal years 2023 and 2022 (in thousands) Years ended % of Revenue August 31, 2023 August 31, 2022 August 31, 2023 August 31, 2022 $ Change % Change Revenue $ 59,577 $ 53,906 100 % 100 % $ 5,671 11 % Cost of revenue 11,630 10,822 20 % 20 % 808 7 % Gross profit 47,947 43,084 80 % 80 % 4,863 11 % Research and development 4,504 3,208 8 % 6 % 1,296 40 % Sales and marketing 6,558 4,879 11 % 9 % 1,679 34 % General and administrative 28,160 20,086 47 % 37 % 8,074 40 % Total operating expenses 39,222 28,173 66 % 52 % 11,049 39 % Income from operations 8,725 14,911 15 % 28 % (6,186) (41) % Other income, net 2,970 204 5 % — % 2,766 1,356 % Income before income taxes 11,695 15,115 20 % 28 % (3,420) (23) % Provision for income taxes (1,734) (2,632) (3) % (5) % 898 (34) % Net income $ 9,961 $ 12,483 17 % 23 % $ (2,522) (20) % Revenues Revenues increased by $5.7 million, or 11%, to $59.6 million for the fiscal year ended August 31, 2023, compared to $53.9 million for the fiscal 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 fiscal 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 fiscal year ended August 31, 2023, compared to the fiscal 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 fiscal year ended August 31, 2022. Gross profit Gross profit increased by $4.9 million, or 11%, to $47.9 million for the fiscal year ended August 31, 2023, compared to $43.1 million, for the fiscal 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 fiscal years ended August 31, 2023, and 2022, respectively. Research and development 35 Table of Contents We incurred $7.8 million of research and development costs during fiscal 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 fiscal 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 (“GPX®”), 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. Sales and marketing expenses Sales and marketing expenses increased by $1.6 million, or 34%, to $6.6 million for the fiscal year ended August 31, 2023, compared to $4.9 million for the fiscal year ended August 31, 2022. This corresponds to a 2% increase in sales and marketing expense as a percentage of revenue. This increase was primarily due to a $1.7 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 $1.7 million increase in personnel costs includes an increase in base salaries of $0.9 million, an increase in stock compensation of $0.5 million, and an increase in accrued bonuses of $0.2 million. General and administrative expenses G&A expenses increased by $8.1 million, or 40%, to $28.2 million for the fiscal year ended August 31, 2023, compared to $20.1 million for the fiscal year ended August 31, 2022. This corresponds to a 10% increase in G&A expense as a percentage of revenue. This increase was primarily due to a $3.8 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 of an external consulting firm, Arthur J. Gallagher & Co., during fiscal year 2022 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 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 $3.8 million increase in personnel costs includes an increase in base salaries of $0.7 million, an increase in accrued bonuses of $1.0 million, an increase in stock compensation of $1.1 million, and an increase in employee benefits of $0.4 million. Additionally, the overall increase in G&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, and an impairment charge of $0.5 million for the Cognigen trade name due to management strategy to no longer use the Cognigen trade name. In addition, G&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, and an increase of $0.1 million due to the newly required excise tax on share repurchases completed during fiscal year 2023. Other income Total other income was $3.0 million for the fiscal year ended August 31, 2023, compared to total other income of $0.2 for the fiscal 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 fiscal year ended August 31, 2022. Provision for income taxes 36 Table of Contents The provision for income taxes was $1.7 million for the fiscal year ended August 31, 2023, compared to $2.6 million for the fiscal year ended August 31, 2022. Our effective tax rate decreased to 15% mainly due to favorable foreign income tax rates for the fiscal year ended August 31, 2023, when compared to 17% for the fiscal year ended August 31, 2022. Liquidity and Capital Resources 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. We expect existing cash, cash equivalents, short-term investments, cash generated by ongoing operations, and working capital, will be sufficient to fund our operating activities and cash commitments for investing and financing activities, and material capital expenditures, for the next 12 months and beyond. We continue to seek opportunities for strategic acquisitions, investments and partnerships. If one or more strategic opportunities are identified, a substantial portion of our cash reserves may be required to complete it. 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 may consider financing options to complete the transaction, including obtaining loans or selling our securities. Additionally, our quest for strategic opportunities could result in a significant change to our liquidity position and/or our results of operations if any such opportunities are completed. 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. Cash, Cash Equivalents, and Investments At August 31, 2024, the Company had $10.3 million in cash and cash equivalents, $9.9 million in short-term investments, and working capital of $27.3 million. Short-term investments consist of highly liquid investment-grade fixed-income securities, diversified among industries and issuers. The investments are U.S. dollar-denominated securities. Our fixed-income investments are exposed to interest rate risk and credit risk. The settlement risk related to these investments is insignificant, given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities and can readily be converted to cash when needed. Restricted cash that was included within cash and cash equivalents as presented within our consolidated balance sheets as of August 31, 2024 and our consolidated statements of cash flows for the fiscal year ended August 31, 2024 was $0.1 million. The Company determined this to be immaterial. The restriction required us to maintain a minimum cash deposit in the Pro-ficiency bank account to collateralize an outstanding corporate credit card balance. The associated corporate credit card program was terminated as part of the integration of Pro-ficiency and the cash restriction was removed as of October 4, 2024. Cash Flows Operating Activities Net cash provided by operating activities was $13.3 million for the fiscal year ended August 31, 2024. 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, $4.2 million related to changes in balances of operating assets and liabilities was subtracted from net income and $7.6 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 $21.9 million for the fiscal year ended August 31, 2023. Our operating cash flows resulted primarily from our net income of $10.0 million. 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 noncash charges was added to net income to reconcile to cash flow from operations. Net cash provided by operating activities decreased by $8.5 million during the fiscal year ended August 31, 2024, compared to the fiscal year ended August 31, 2023. This decrease was driven by working capital changes. Investing Activities 37 Table of Contents Net cash used in investing activities during the fiscal year ended August 31, 2024, was $54.0 million, primarily due to the acquisition of Pro-ficiency of $98.8 million, purchase of short-term investments of $67.2 million and computer software development costs of $3.2 million, offset by proceeds from maturities of short-term investments of $71.1 million, and proceeds from sales of investments of $45.2 million. Net cash provided by investing activities during the fiscal 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, acquisition of Immunetrics of $8.2 million, and computer software development costs of $3.2 million. Financing Activities Net cash used in financing activities during the fiscal year ended August 31, 2024, was $6.6 million, primarily due to dividend payments totaling $4.8 million and the first cash earnout payments in the aggregate amount of $2.5 million to the former equity holders and employees of Immunetrics, partially offset by proceeds from the exercise of stock options totaling $0.7 million. Net cash used in financing activities during fiscal year ended August 31, 2023, was $23.2 million, primarily due to share repurchases of $20.0 million and dividend payments totaling $4.8 million, offset by proceeds from the exercise of stock options totaling $1.5 million. Pro-ficiency Acquisition On June 11, 2024, the Company entered into a Stock Purchase Agreement, by and among the Company, Pro-ficiency, each of the stockholders of Pro-ficiency (collectively, the “Sellers”) and WRYP Stockholders Services, LLC, solely in its capacity as the Sellers’ Representative (the “Purchase Agreement”). Pursuant to the Purchase Agreement, at closing on June 11, 2024 (the “Closing”), the Company purchased 100% of the issued and outstanding capital stock of Pro-ficiency (the “Acquisition”) from the Sellers for an aggregate purchase price of $100 million in cash, subject to post-closing adjustments for net working capital, closing cash, indebtedness, and transaction expenses (collectively, the “Purchase Price”). An aggregate of $1 million of the Purchase Price was placed in escrow to fund payment obligations of the Sellers with respect to post-Closing Purchase Price adjustments and post-Closing indemnification obligations of the Sellers, and another portion of the Purchase Price was deposited into an account to reimburse the Seller Representative for any fees and expenses incurred by the Seller Representative in performing its duties under the Purchase Agreement as the representative of the Sellers. As a result of the Acquisition, at Closing, Pro-ficiency became a wholly-owned subsidiary of the Company. The Purchase Agreement contains standard representations, warranties and covenants and other terms customary in similar transactions. Subject to the provisions of the Purchase Agreement, the Sellers have agreed to indemnify the Company and its affiliates for losses resulting from breaches of representations, warranties and covenants of the Sellers and Pro-ficiency in the Purchase Agreement and for certain other specified matters. The Sellers’ indemnification obligations are subject to various limitations, including, among other things, a deductible, caps, and time limitations. In connection with the Acquisition, the Company obtained a customary buyer’s representation and warranty insurance policy (the “R&W Insurance Policy”) providing for up to $10 million in coverage in the case of breaches of representations and warranties of the Sellers and Pro-ficiency contained in the Purchase Agreement, subject to certain exclusions and an initial $0.5 million retention. The Company, on the one hand, and the Sellers, on the other hand, each bore one-half of the cost of obtaining the R&W Insurance Policy. 38 Table of Contents Immunetrics Acquisition The Company has a remaining obligation for the Immunetrics acquisition for up to $5.5 million and $1.8 million hold back liability which are expected to be paid out and released, to the extent earned and less any applicable deductions, in early calendar year 2025. Dividends Refer to Note 6 – Shareholders’ Equity of the Notes to Financial Statements (Part I, Item 1 of this Report) for details regarding dividends. As discussed elsewhere in this Report, our Board of Directors has determined to discontinue the Company’s quarterly cash dividend after the dividend distribution on August 5, 2024, and reallocate these funds to our capital allocation strategy for investing in growth initiatives that are intended to generate long-term shareholder value. We do not expect to pay dividends to our stockholders at any time in the foreseeable future. Anyone considering investing in our stock should not rely on such investment to provide dividend income. Share Repurchases For the fiscal year ended August 31, 2024, we did not repurchase any shares of Company stock and for the fiscal year ending August 31, 2023, we repurchased 492,041 shares of Company common stock through our share repurchase program. All repurchases were made using cash resources. As of August 31, 2024, $30 million remains available for additional repurchases under our authorized repurchase program. However, we are not obligated to repurchase any additional shares, and the timing, manner, price, and actual amount of further share repurchases will depend on a variety of factors, including stock price, market conditions, other capital management needs and opportunities, and corporate and regulatory considerations. The share repurchase program has no expiration date but may be terminated at any time at our Board of Directors’ discretion. Critical Accounting 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, software 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 39 Table of Contents 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, $3.3 million, and $3.2 million for the fiscal years ended August 31, 2024, 2023, and 2022, 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 $2.1 million, $1.5 million, and $1.2 million, respectively for the fiscal years ended August 31, 2024, 2023, and 2022, 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 underperformance 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, 2024, after completion of the Company's internal reorganization, the Company determined that it had six reporting units: CHEM, PBPK, QSP, CPP, MC, and ALI. As of August 31, 2024, the entire balance of goodwill was attributed to four of the Company's reporting units, CPP, QSP, ALI, and MC. 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 fiscal years ended August 31, 2024, and 2022, respectively. Business Acquisitions The Company accounted for the acquisitions of Cognigen, DILIsym, Lixoft, Immunetrics, and Pro-ficiency 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 40 Table of Contents 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 costs, not including shares issued to directors for services, was $6.0 million, $4.3 million, and $2.7 million, for the fiscal years ending August 31, 2024, 2023, and 2022, respectively.