Simulations Plus, Inc. 10-K

ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the Financial Statements and related notes included in this Annual Report on Form 10-K. 33 Management Overview Fiscal year 2020 highlights: · We acquired Lixoft of Paris, adding the Monolix Suite to our product offerings · We completed a follow-on public offering in August 2020; net proceeds from the offering were $107.7 million · Entered into several funded collaborations to enhance Gastro Plus to include an intra-articular delivery model, a virtual bioequivalence trial simulator; and expansion of Mechanistic Oral Absorption (ACAT) · Entered a funded collaboration with large pharmaceutical company to enhance PKPlus · Entered a collaboration agreement with Bayer AG to advance ADMET predictor, improving structure and tautomer handling capabilities supporting data integrity across their discovery platforms · Entered into an agreement with a large pharmaceutical company for a new component, a QSP (Quantitative Systems Pharmacology) model focused on treating heart failure, such as can occur after myocardial infarction · Entered a collaboration agreement to advance ADMET Predictor software for use within integrated drug discover workflows, by enhancing the HTPK Simulation Model that incorporates PBPK modeling into the partner’s discovery platform to support compound screening activities · Received notice of an FDA funded agreement to develop physiologically based pharmacokinetics/pharmacodynamics (PBPK/PD) approaches to support inter species translation for ocular drug delivery in GastroPlus · We released Version 4.3 of our KIWI™ Pharmacometric Communication and Collaboration Platform · Continued quarterly payment of dividend of 6 cents per share Fiscal Year 2020 Financial Summary: · Consolidated net revenues increased by $7.62 million, or 22.4%, to $42 million in fiscal year 2020 from $34 million in fiscal year 2019 · Consolidated gross margin increased $6.0 million or 24.0%, to $30.9 million in fiscal year 2020 from $24.9 million in fiscal year 2019 · Net income from operations increased $956,000, or 9.0%, to $11.6 million in fiscal year 2020 from $10.6 million in fiscal year 2019. Fiscal year 2020 includes one-time acquisition costs of $1.4 million related to Lixoft · Net income increased by $749,000, or 8.7%, to $9.33 million in fiscal year 2020 from $8.58 million in fiscal year 2019 · Diluted earnings per share increased by $0.02 or 4.2% to $0.50 in 2020 from $0.48 in 2019 Strategy Going Forward: · Continue to pursue funded and unfunded collaborations in support of improving our products and services · Continue our aggressive marketing and sales campaign, including numerous scientific conferences and meetings · Continue to expand our use of social media and advertising · Continue to expand our sales staff, both in-house and in the field · Continue to recruit scientific and other resources to support our product and scientific consulting services · Seek accretive acquisitions that complement our existing offerings and expand our markets · Expand infrastructure to support corporate growth 34 Fiscal year 2020 was yet another record year for the Company. We saw increased growth in the midst of a COVID-19 economic environment. 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 have received a continuing series of study contracts with pharmaceutical companies ranging from several of the largest in the world to a number of medium-sized and smaller companies in the U.S., Europe, and Japan. In August 2020 we completed a follow-on public offering that will enable an expedited approach to potential acquisitions, continue our research and development activities, and invest in staffing and infrastructure to meet the needs of a wider customer base and the growth of the business. We do not have any stock repurchase programs currently in place or pending; however, our Board of Directors may consider such programs from time to time. Results of Operations FY20 COMPARED WITH FY19 The following sets forth selected items from our statements of operations (in thousands) and the percentages that such items bear to net sales for the fiscal years ended August 31, 2020 (FY20) and August 31, 2019 (FY19) (Because of rounding, numbers may not foot.) Fiscal year ended 8/31/20 8/31/19 Net revenues $ 41,589 100.00% $ 33,970 100.00% Cost of revenues 10,649 25.6 9,025 26.6 Gross margin 30,940 74.4 24,945 73.4 Selling, general and administrative 16,360 39.3 11,796 34.6 Research and development 2,975 7.2 2,500 7.4 Total operating expenses 19,335 46.5 14,296 42.1 Income from operations 11,605 27.9 10,649 31.4 Other income (expense) (218 ) (0.5 ) (92 ) (0.3 ) Net income before taxes 11,387 27.4 10,556 31.2 (Provision) for income taxes (2,055 ) (4.9 ) (1,973 ) (5.8 ) Net income $ 9,332 22.4% $ 8,583 25.4% Net Revenues Consolidated net revenues increased by 22.4% or $7.6 million to $41.59 million in FY20 from $33.97 million in FY19. Our Lancaster, California division increased revenues by $2.4 million or 12.1%, to $22.0 million in FY20 from $19.6 million in FY19. $1.78 million was an increase from revenues generated by our Buffalo subsidiary (Cognigen), an increase of 19.1%. DILIsym Services, Inc. (DILIsym) increased revenues by $1.88 million or 37.2%. $1.58 million of revenue was generated by our French subsidiary (Lixoft), which was acquired April 1, 2020. FY20 software and software-related revenues increased $3.1 million or 16.8% while consulting revenues increased by $4.5 million or 29.1% compared to FY19. 35 Cost of Revenues Consolidated cost of revenues increased by $1.6 million or 18.0% to $10.6 million in FY20 from $9.0 million in FY19. Labor-related cost incurred increased by $1.6 million, mainly in support of increased consulting revenues. Cost of revenues for direct contract-related cost increased by $274,000, offset by a decrease of approximately $217,000 of royalty expenses as well as $212,000 in training-related expenses in FY2020. A significant portion of cost of revenues for pharmaceutical software products is the systematic amortization of capitalized software development costs, which is an independent fixed cost rather than a variable cost related to revenues. This amortization cost of $2.36 million in FY20 increased by approximately $103,000 as compared to FY19. Cost of revenues as a percentage of revenue remained fairly consistent at 25.6% in FY20 as compared to 26.6% in FY19, a decrease of 1.0% year over year. Gross Margin Consolidated gross margin increased $6.0 million or 24.0%, to $30.9 million in FY20 from $24.9 million in FY19. $2.7 million of this increase is from the California division, which showed an 86.7% gross margin. The Buffalo Division gross margin increased $959,000 or 19% with margins of 53.3%. DILIsym of North Carolina recorded a $997,000 increase, a 67.3% margin, versus a 72.7% margin in FY19. Lixoft recorded a margin of $1.3 million or 83.1%. Overall gross margin has increased to 74.4% in FY20 as compared to 73.4% in FY19 an increase of 1.0% year over year. Selling, General and Administrative Expenses Selling, general, and administrative (SG&A) expenses increased $4.56 million, or 38.7% to $16.4 million in FY20 from $11.80 million in FY19. As a percent of revenues, SG&A was 39.3% for FY20, compared to 34.7% in FY19. The major increases in SG&A expense were: · During the year the Company incurred approximately $1,416,000 of costs associated with the acquisition of Lixoft. These fees included legal and accounting, due diligence, and M&A related consulting. · Commission expenses were up $226,000, this increase is related to increased sales in Asia as well as domestic sales · Contract labor increased $152,000 for other temporary labor and consulting costs related to various corporate initiatives · G&A salaries and wages increased by $1.49 million; this increase is a combination of increased headcount both from acquisitions and salaries in support of corporate growth · Insurance expense increased $259,000; $136,000 was health-related medical costs from increased headcount and rate increases · Payroll tax expense increased $478,000, the effect of higher employee count and salary expense · Director compensation increase by $394,000, based on an increase in the number of paid directors and compensation increases · 401k expense increased $52,000 due to increased staffing The major decreases in SG&A expense were: · Trade show and travel related costs decreased by $145,000 mainly due to lower attendance and less travel costs due to COVID-19 · Recruiting fees decreased by $86,000 36 Research and Development We incurred approximately $5,328,000 of research and development costs during FY20. Of this amount, $2,353,000 was capitalized and $2,975,000 was expensed. We incurred approximately $4,268,000 of research and development costs during FY19. Of this amount, $1,768,000 was capitalized and $2,500,000 was expensed. The increase of $1,060,000, or 24.8%, in total research and development expenditures from FY19 to FY20 was mainly from increased costs in the Lancaster and DILIsym divisions. Provision for Income Taxes The provision for income taxes was $2.05 million for FY20 compared to $1.97 million for FY19. Our effective tax rate decreased slightly to 18.0% in FY20 from 18.7% in FY19. The effective rate differs from anticipated combined statutory rates of approximately 25.7% 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. In the last part of FY20, as occurred also in FY19, 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. Net Income Net income increased by $749,000 or 8.7%, to $9.3 million in FY20 from $8.6 million in FY19. FY19 COMPARED WITH FY18 The following sets forth selected items from our statements of operations (in thousands) and the percentages that such items bear to net sales for the fiscal years ended August 31, 2019 (FY19) and August 31, 2018 (FY18) (Because of rounding, numbers may not foot.) Fiscal year ended 8/31/19 8/31/18 Net revenues $ 33,970 100.00% $ 29,667 100.00% Cost of revenues 9,025 26.6 7,994 26.9 Gross margin 24,945 73.4 21,672 73.1 Selling, general and administrative 11,796 34.6 9,584 32.3 Research and development 2,500 7.4 1,791 6.0 Total operating expenses 14,296 42.1 11,375 38.3 Income from operations 10,649 31.4 10,298 34.7 Other income (expense) (92 ) (0.3 ) (159 ) (0.5 ) Net income before taxes 10,556 31.2 10,139 34.2 (Provision) for income taxes (1,973 ) (5.8 ) (1,204 ) (4.1 ) Net income $ 8,583 25.4% $ 8,935 30.1% Net Revenues Consolidated net revenues increased by 14.5% or $4.3 million to $33.97 million in FY19 from 29.67 million in FY18. Our Lancaster, California division increased revenues by $2.03 million or 11.6%, to $19.6 million in FY19 from $17.6 million in FY18. $1.46 million of this increase was from revenues generated by our Buffalo subsidiary (Cognigen), an increase of 18.6%. DILIsym Services, Inc. (DILIsym) increased revenues by $807,000 or 19%. FY19 software and software-related revenues increased $1.8 million or 11.0% while consulting revenues increased by $2.5 million or 19.0% compared to FY18. 37 Cost of Revenues Consolidated cost of revenues increased by $1.03 million or 12.9% to $9.0 million in FY19 from $8.0 million in FY18. Labor-related cost incurred by our Lancaster and Buffalo divisions increased by $190,000 and $1.06 million, respectively mainly in support of increased consulting revenues. This was offset by a $380,000 decrease in cost of revenues for direct contract expenses paid for testing at DILIsym. We saw a decrease of approximately $52,000 in training-related expenses in FY2019. A significant portion of cost of revenues for pharmaceutical software products is the systematic amortization of capitalized software development costs, which is an independent fixed cost rather than a variable cost related to revenues. This amortization cost of $1.33 million in FY19 increased by approximately $31,000 in FY19. Cost of revenues as a percentage of revenue remained fairly consistent at 26.6% in FY19 as compared to 26.9% in FY18, a decrease of 0.3% year over year. Gross Margin Consolidated gross margin increased $3.27 million or 15.1%, to $24.94 million in FY19 from $21.67 million in FY18. $1.8 million of this increase is from the California division, which showed an 83.3% gross margin. The Buffalo Division gross margin increased $325,000 or 7% with a margin of 53.2%. DILIsym of North Carolina recorded a $1.14 million increase, a 72.7% margin, versus a 59.6% margin in FY18. Overall gross margin has remained fairly consistent at 73.4% in FY19 as compared to 73.1% in FY18, an increase of 0.3% year-over-year. Selling, General and Administrative Expenses Selling, general, and administrative (SG&A) expenses increased $2.22 million, or 23.1% to $11.80 million in FY19 from $9.58 million in FY18. As a percent of revenues, SG&A was 34.6% for FY19, compared to 32.3% in FY18. The major increases in SG&A expense were: · Commission expenses were up $122,000, mainly related to increased sales through representatives in Asia · Accounting and audit fees increased by $73,000, associated with costs of consolidated audits and other compliance-related expenses · Contract labor increased $172,000 due to increased director fees and consulting related to various corporate initiatives · G&A salaries and wages increased by $939,000; this increase is a combination of increased headcount and salaries in support of corporate growth · Insurance expense increased $218,000; $174,000 was health-related medical costs from increased headcount and rate increases · Payroll tax expense increased $116,000, the effect of higher salary expense · 401k expense increased $78,000 due to the increased staffing · Recruiting and hiring costs increased $214,000 mainly due to recruiting fees of scientific personnel · Software licenses costs increased $87,000 mainly due to sales volume related license fee increases The major decreases in SG&A expense were: · Trade-show-related costs decreased by $52,000 mainly due to lower attendance costs 38 Research and Development We incurred approximately $4,268,000 of research and development costs during FY19. Of this amount, $1,768,000 was capitalized and $2,500,000 was expensed. We incurred approximately $3,936,000 of research and development costs during FY18. Of this amount, $2,145,000 was capitalized and $1,791,000 was expensed. The increase of $332,000, or 8.4%, in total research and development expenditures from FY18 to FY19 was mainly from $316,000 of costs incurred by DILIsym Services Inc. Provision for Income Taxes The provision for income taxes was $1.97 million for FY19, compared to $1.20 million for FY18. Our effective tax rate increased to 18.7% in FY19 from 11.9% in FY18. This increase results mainly from a second quarter 2018 assessment of deferred taxes based on the new tax rates enacted under the Tax Cuts and Jobs Act of 2017 (the “2017 Tax Act”). Financial Accounting Standards Board (“FASB”) Accounting Standards Codification Topic 740, Income Taxes (“ASC 740”) requires that the company recognize the effects of changes in tax laws or tax rates in the financial statements for the period in which such changes were enacted. Among other things, changes in tax laws or tax rates can affect the amount of taxes payable for the current period, as well as the amount and timing of deferred tax liabilities and deferred tax assets. Based on the assessment, the Company posted a one-time tax benefit in the amount of $1,500,000 in the second fiscal quarter of 2018, the result of estimating future deferred liabilities at the lower tax rates under the newly enacted tax laws. The effective rate differs from anticipated combined statutory rates of approximately 25.4% due to R&D credits and the tax effect of disqualifying dispositions. In the last part of FY19, as a result of 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 rate. Net Income Net income decreased by $351,000 or 3.9%, to $8.6 million in FY19 from $8.93 million in FY18. The decrease in income was substantially effected by the deferred tax benefit of $1.5 million discussed above in the note on Provision for Income Taxes, which reduced taxes in FY18. SEASONALITY Our sales exhibit some seasonal fluctuations, with the fourth fiscal quarter (June-August) generally having the lowest sales due to summer vacations and reduced activities at our customers’ sites. This unaudited quarterly sales information has been prepared on the same basis as the annual information presented elsewhere in this Annual Report on Form 10-K and, in the opinion of management, reflects all adjustments (consisting of normal recurring entries) necessary for a fair presentation of the information presented. Net sales for any quarter are not necessarily indicative of sales for any future period; however, because our pharmaceutical software is licensed on an annual basis, renewals are usually within the same quarter year after year. (Numbers may not foot because of rounding.) Net Sales (in thousands of dollars) FY First Quarter Second Quarter Third Quarter Fourth Quarter Total 2020 $ 9,401 $ 10,350 $ 12,298 $ 9,540 $ 41,589 2019 $ 7,536 $ 8,472 $ 9,937 $ 8,026 $ 33,971 2018 $ 7,069 $ 7,357 $ 8,553 $ 6,688 $ 29,667 2017 $ 5,418 $ 5,706 $ 6,748 $ 6,265 $ 24,138 2016 $ 4,839 $ 5,164 $ 6,011 $ 3,958 $ 19,972 2015 $ 4,086 $ 4,574 $ 5,942 $ 3,712 $ 18,314 2014 $ 2,641 $ 3,081 $ 3,741 $ 1,998 $ 11,461 2013 $ 2,290 $ 3,118 $ 3,095 $ 1,568 $ 10,071 2012 $ 2,248 $ 2,789 $ 2,772 $ 1,640 $ 9,449 2011 $ 2,050 $ 2,622 $ 2,640 $ 1,427 $ 8,739 39 LIQUIDITY AND CAPITAL RESOURCES Our principal sources of capital have been cash flows from our operations. We have achieved continuous positive operating cash flow over the last eleven fiscal years. In August 2020, the company closed an underwritten public offering of 2,090,909 shares of its common stock to the public at $55.00 per share, which included the full exercise of the underwriters’ option to purchase 272,727 additional shares of common stock. The aggregate gross proceeds to the company from this offering were approximately $115 million, before deducting underwriting discounts and commissions; net proceeds were approximately $107.7 million. The company intends to use the net proceeds from the offering for strategic mergers and acquisitions (although the company has no present commitments or agreements to enter into any such mergers or acquisitions), working capital requirements, and other general corporate purposes, including investing in enhanced information and accounting systems, and personnel in support of corporate growth. As of August 31, 2020, the Company had $49.2 million in cash and cash equivalents and $66.8 million in short-term investments. 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 draw from our revolving line of credit with the bank, or we may have to sell additional equity or debt securities or obtain expanded credit facilities. 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 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. On March 31, 2020, the Company entered into a Stock Purchase and Contribution Agreement (the “Agreement”) with Lixoft, a French société par actions simplifiée (“Lixoft”). On April 1, 2020, the Company consummated the acquisition of all outstanding equity interests of Lixoft pursuant to the terms of the Agreement, with Lixoft becoming a wholly owned subsidiary of the Company. Under the terms of the Agreement, the Company will pay the former shareholders of Lixoft total consideration of up to $16,500,000, consisting of two-thirds cash and one-third newly issued, unregistered shares of the Company’s common stock. In addition, the Company paid $3,456,029 of excess working capital based on the March 31, 2020 financial statements of Lixoft. As part of the total consideration, the agreement calls for earnout payments up to an additional $5,500,000, two-thirds cash and one-third newly issued, unregistered shares of the Company’s common stock based on a revenue growth formula each year for the two years subsequent to April 1, 2020. The former shareholders can earn up to $2,000,000 the first year and $3,500,000 in year two. See Note 14 for a further description of the Agreement. On May 1, 2017 we signed a stock acquisition agreement with DILIsym Services, Inc. of Research Triangle Circle, North Carolina, and on June 1, 2017 consummated the acquisition of all the outstanding capital stock of DILIsym Services, Inc. pursuant to a Stock Purchase Agreement. DILIsym became a wholly-owned subsidiary of Simulations Plus. Under the terms of the Agreement, the Company: (1) paid to the DILIsym Shareholders Five Million Dollars, $4,515,982 payable at the closing of the Acquisition subject to certain adjustments and holdbacks. As part of the consideration there were certain earnout provisions in the agreement, subject to those provisions the company paid $5,000,000 in payments over the 3 years ended August 31, 2020 based on earnings of DILIsym before income taxes. We will 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. 40 Quarterly dividend payments made in FY19 and FY20 are listed in the following table. Fiscal Year Record Date Distribution Date # of Shares Outstanding on Record Date Dividend per Share Total Amount 2019 11/01/2018 11/08/2018 17,417,875 $ 0.06 $ 1,045,073 1/25/2019 2/01/2019 17,481,450 $ 0.06 $ 1,048,887 4/24/2019 5/01/2019 17,515,228 $ 0.06 $ 1,050,914 7/25/2019 8/01/2019 17,536,454 $ 0.06 $ 1,052,181 2020 10/25/2019 11/01/2019 17,606,314 $ 0.06 $ 1,056,379 1/27/2020 2/03/2020 17,645,639 $ 0.06 $ 1,058,740 4/24/2020 5/01/2020 17,769,134 $ 0.06 $ 1,066,148 7/27/2020 8/03/2020 17,820,057 $ 0.06 $ 1,069,203 The Board of directors has indicated its intention to pay $0.06 quarterly dividends; however, there can be no assurances that our Board of Directors will continue the dividend distributions as the decision is made on a quarterly basis based on current financial conditions and strategic plans. In October 2020, our Board of Directors declared a dividend distribution of $0.06 per share. The dividend was paid in November 2020. KNOWN TRENDS OR UNCERTAINTIES Although we have not seen any significant reduction in revenues to date, we have seen some consolidation in the pharmaceutical industry during economic downturns. These consolidations have not had a negative effect on our total sales to that industry; however, should consolidations and downsizing in the industry continue to occur, those events could adversely impact our revenues and earnings going forward. As discussed in the risk section of this 10-K, the world has been affected due to the COVID-19 pandemic. Though there has not been a substantial impact on sales revenues, until the pandemic has passed, there remains uncertainty as to the effect on our business in both the short and long-term. 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 the 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 sales or determine that resources would be more efficiently used elsewhere. INFLATION We have not been affected materially by inflation during the periods presented, and no material effect is expected in the near future. 41 OFF-BALANCE SHEET ARRANGEMENTS As of August 31, 2020, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not materially exposed to any financing, liquidity, market, or credit risk that could arise if we had engaged in such relationships. We do not have relationships or transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties. CONTRACTUAL OBLIGATIONS The following table provides aggregate information regarding our contractual obligations as of August 31, 2020 (in thousands). Payments due by period Contractual obligations: Total 1 year 2–3 years 4–5 years More than 5 years Operating lease obligations $ 961 $ 486 $ 389 $ 86 $ – Contracts Payable 6,064 2,000 4,064 – – Total $ 7,025 $ 2,486 $ 4,453 $ 86 $ – RECENTLY ISSUED OR NEWLY ADOPTED ACCOUNTING STANDARDS In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09 and its related amendments regarding Accounting Standards Codification Topic 606 (ASC Topic 606), Revenue from Contracts with Customers. The standard provides principles for recognizing revenue for the transfer of promised goods or services to customers with the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also provides guidance on the recognition of incremental costs related to obtaining customer contracts. We adopted ASC Topic 606, effective September 1, 2018, utilizing the modified retrospective method. This approach was applied to contracts that were in process as of September 1, 2018, and the corresponding incremental costs of obtaining those contracts, which resulted in a cumulative effect adjustment of $493,279 to the opening balance of retained earnings at the date of adoption. The adoption of this ASU primarily impacts the timing of our revenue recognition for certain sales contracts, the capitalization and amortization of incremental costs of obtaining a contract, and related disclosures. The reported results for fiscal year 2019 reflect the application of ASC Topic 606. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which supersedes existing guidance on accounting for leases in "Leases (Topic 840)" and generally requires all leases to be recognized in the consolidated balance sheet. ASU 2016-02 is effective for annual and interim reporting periods beginning after December 15, 2018. The Company adopted this ASU on September 1, 2019. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606), which amends certain aspects of the Board's new revenue standard, ASU 2014-09, Revenue from Contracts with Customers. The standard was adopted concurrently with the adoption of ASU 2014-09 which is effective for annual and interim periods beginning after December 15, 2017. 42 SIGNIFICANT ACCOUNTING POLICIES 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 The Company adopted Topic 606 effective September 1, 2018 using the modified retrospective method applying this guidance to all open contracts at the date of initial application, which resulted in an adjustment to retained earnings for the cumulative effect of applying this guidance. The most significant impact of Topic 606 on revenue to the Company relates to the timing of revenue recognition for one of its payment contracts. Under 606 the revenues under the contract are being recognized as time is expended and costs are being expensed as incurred. Under ASC 605 revenues were recognized as invoiced and certain costs were capitalized as development. 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. Cash and Cash Equivalents For purposes of the statements of cash flows, we consider all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. Accounts Receivable We analyze the age of customer balances, historical bad-debt experience, customer creditworthiness, and changes in customer payment terms when making estimates of the collectability of the Company’s trade accounts receivable balances. If we determine that the financial conditions of any of our customers deteriorated, whether due to customer-specific or general economic issues, an increase in the allowance may be made. Accounts receivable are written off when all collection attempts have failed. 43 Capitalized Computer Software Development Costs Software development costs are capitalized in accordance with FASB 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 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 computer software development costs are comprised primarily of salaries and direct payroll-related costs and the purchase or licensing of existing software to be used in the Company’s software products. Total capitalized computer software development costs were $2,353,000, $1,768,000 and $2,145,000 for the fiscal years ending August 31, 2020, 2019 and 2018, 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 $1,225,544, $1,331,753 and $1,300,434 for the fiscal years ending August 31, 2020, 2019 and 2018, 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. Property and Equipment Property and equipment are recorded at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method over the estimated useful lives as follows: Equipment 5 years Computer equipment 3 to 7 years Furniture and fixtures 5 to 7 years Leasehold improvements Shorter of life of asset or lease Maintenance and minor replacements are charged to expense as incurred. Gains and losses on disposals are included in the results of operations. 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. 44 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, 2020, the Company determined that it has four reporting units, Simulations Plus, Cognigen Corporation, DILIsym Services, Inc. and Lixoft. When testing goodwill for impairment, the Company first performs a qualitative assessment to determine whether it is necessary to perform step one of a two-step annual goodwill impairment test for each reporting unit. The Company is required to perform step one only if it concludes that it is more likely than not that a reporting unit's fair value is less than its carrying value. Should this be the case, the first step of the two-step process is to identify whether a potential impairment exists by comparing the estimated fair values of the Company's reporting units with their respective book values, including goodwill. If the estimated fair value of the reporting unit exceeds book value, goodwill is considered not to be impaired, and no additional steps are necessary. If, however, the fair value of the reporting unit is less than book value, then the second step is performed to determine if goodwill is impaired and to measure the amount of impairment loss, if any. The amount of the impairment loss is the excess of the carrying amount of the goodwill over its implied fair value. The estimate of implied fair value of goodwill is primarily based on an estimate of the discounted cash flows expected to result from that reporting unit, but may require valuations of certain internally generated and unrecognized intangible assets such as the Company's software, technology, patents and trademarks. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess. As of August 31, 2020, 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 recognized any impairment charges during FY20, FY19 and FY18. Reconciliation of Goodwill for FY20, FY19 and FY18: Cognigen DILIsym Lixoft Total Balance, August 31, 2017 $ 4,789,248 $ 5,597,950 $ – $ 10,387,198 Addition – – – – Impairments – – – – Balance, August 31, 2018 4,789,248 5,597,950 – 10,387,198 Addition – – – – Impairments – – – – Balance, August 31, 2019 4,789,248 5,597,950 – 10,387,198 Addition – – 2,533,987 2,533,987 Impairments – – – – Balance, August 31, 2020 $ 4,789,248 $ 5,597,950 $ 2,533,987 $ 12,921,185 Other Intangible Assets The following table summarizes other intangible assets as of August 31, 2020: Amortization Period Acquisition Value Accumulated Amortization Net book value Customer relationships-Cognigen Straight line 8 years $ 1,100,000 $ 825,000 $ 275,000 Trade Name-Cognigen None 500,000 – 500,000 Covenants not to compete-Cognigen Straight line 5 years 50,000 50,000 – Covenants not to compete-DILIsym Straight line 4 years 80,000 65,000 15,000 Trade Name-DILIsym None 860,000 – 860,000 Customer relationships-DILIsym Straight line 10 years 1,900,000 617,500 1,282,500 Customer relationships-Lixoft Straight line 14 years 2,550,000 75,892 2,474,108 Trade Name-Lixoft None 1,550,000 – 1,550,000 Covenants not to compete-Lixoft Straight line 3 years 60,000 8,333 51,667 $ 8,650,000 $ 1,641,725 $ 7,008,275 Amortization expense for FY20, FY19, and FY18 was $431,725, $357,500, and $357,500, respectively. 45 Business Acquisitions The Company accounted for the acquisition of Cognigen, DILIsym Services Inc., and Lixoft using the purchase 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. Fair Value of Financial Instruments Assets and liabilities recorded at fair value in the Condensed Balance Sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The categories, as defined by the standard are as follows: Level Input: Input Definition: Level I Inputs are unadjusted, quoted prices for identical assets or liabilities in active markets at the measurement date. Level II Inputs, other than quoted prices included in Level I, that are observable for the asset or liability through corroboration with market data at the measurement date. Level III Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. For certain of our financial instruments, including accounts receivable, accounts payable, contract payable, accrued payroll, and other expenses, and accrued bonus to officer, the amounts approximate fair value due to their short maturities. Research and Development Costs Research and development costs are charged to expense as incurred until technological feasibility has been established. 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 the 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 using the modified prospective method in accordance with FASB ASC 718-10, “Compensation-Stock Compensation” . Under this method, compensation costs include estimated grant date fair value of the awards amortized over the options’ vesting period. Stock-based compensation was $1,286,625, $865,848 and $562,079 for the fiscal years ended August 31, 2020, 2019 and 2018, respectively, and is included in the statements of operations as Consulting, Salaries, and Research and Development expense. 46