Simulations Plus, Inc. - Quarter Report: 2021 February (Form 10-Q)

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

Commission file number: 001-32046

Simulations Plus, Inc.

(Name of registrant as specified in its charter)

42505 10th Street West

Lancaster, CA 93534-7059

(Address of principal executive offices including zip code)

(661) 723-7723

(Registrant’s telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filings requirements for the past 90 days.     Yes ☒     No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒     No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐   No ☒

The number of shares outstanding of the registrant’s common stock, par value $0.001 per share, as of April 12, 2021 was 20,107,895; no shares of preferred stock were outstanding.

Simulations Plus, Inc.

FORM 10-Q

For the Quarterly Period Ended February 28, 2021

Table of Contents

Part I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

SIMULATIONS PLUS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

SIMULATIONS PLUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

For the three and six months ended February 28, 2021 and February 29, 2020

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

SIMULATIONS PLUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

For the three and six months ended February 28, 2021 and February 29, 2020

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

SIMULATIONS PLUS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

SIMULATIONS PLUS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1: GENERAL

This report on Form 10-Q for the quarter ended February 28, 2021, should be read in conjunction with the our Annual Report on Form 10-K for the year ended August 31, 2020, filed with the Securities and Exchange Commission (“SEC”) on November 16, 2020. As contemplated by the SEC under Article 8 of Regulation S-X, the accompanying consolidated financial statements and footnotes have been condensed and therefore do not contain all disclosures required by generally accepted accounting principles. The interim financial data are unaudited; however, in the opinion of Simulations Plus, Inc. ("we", "our", "us"), the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the results for the interim periods. Results for interim periods are not necessarily indicative of those to be expected for the full year.

Organization

Simulations Plus, Inc. (“Simulations Plus”) was incorporated on July 17, 1996. In September 2014, Simulations Plus acquired all of the outstanding equity interests of Cognigen Corporation (“Cognigen”) and Cognigen became a wholly owned subsidiary of Simulations Plus, Inc. In June 2017, Simulations Plus acquired DILIsym Services, Inc. (“DILIsym”) as a wholly owned subsidiary. In April 2020, Simulations Plus, Inc. acquired Lixoft, a French société par actions simplifiée (“Lixoft”) as a wholly owned subsidiary pursuant to a stock purchase and contribution agreement. (Collectively, “Company”, “we”, “us”, “our”).  

Lines of Business

We are a premier developer of drug discovery and development software for modeling and simulation, and for the prediction of molecular properties utilizing artificial intelligence and machine learning based technology. We also provide consulting services ranging from early drug discovery through preclinical and clinical trial data analysis and for submissions to regulatory agencies. Our software and consulting services are provided to major pharmaceutical, biotechnology, agrochemical, cosmetics, food industry companies, and to regulatory agencies worldwide for use in the conduct of industry-based research.

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Simulations Plus, Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated upon consolidation.

Use of Estimates

Our financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America. 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 computer software development costs, valuation of stock options, and accounting for income taxes.

Reclassifications

Certain numbers in the prior year have been reclassified to conform to the current year's presentation.

Revenue Recognition

We generate revenue primarily from the sale of software licenses and by providing consulting services to the pharmaceutical industry for drug development.

In accordance with Accounting Standards Codification Topic 606 (ASC Topic 606), “Revenue from Contracts with Customers”, we determine revenue recognition through the following steps:

Deferred Commissions

Sales commissions earned by our sales force and our commissioned sales representatives are considered incremental and recoverable costs of obtaining a contract with a customer. Sales commissions for new contracts are deferred and then amortized on a straight-line basis over a period of benefit. We determined the period of benefit by taking into consideration our customer contracts, our technology, and other factors. Sales commissions for renewal contracts are deferred and then amortized on a straight-line basis over the related contractual renewal period. Amortization expense is included in sales and marketing expenses on the condensed consolidated statements of operations.

We apply the practical expedient in ASC Topic 606 to expense costs as incurred for sales commissions when the period of benefit would have been one year or less. Most of our contracts are of a duration of one year or less, while few, if any of the longer-term contracts have commissions associated with them.

Practical Expedients and Exemptions

We have elected the following additional practical expedients in applying Topic 606:

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 our trade accounts receivable balances. If we determine that the financial conditions of any of our customers have 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.

Investments

We may invest excess cash balances in short-term and long-term marketable debt securities. Investments may consist of certificates of deposit, money market accounts, government-sponsored enterprise securities, corporate bonds and/or commercial paper. We account for our investment in marketable securities in accordance with Financial Accounting Standards Board (FASB) ASC 320, Investments – Debt and Equity Securities. This statement requires debt securities to be classified into three categories:

Held-to-maturity—Debt securities that the entity has the positive intent and ability to hold to maturity are reported at amortized cost. Discounts and premiums to par value of the debt securities are amortized to interest income/expense over the term of the security. No gains or losses on investment securities are realized until they are sold or a decline in fair value is determined to be other-than-temporary.

Trading Securities—Debt securities that are bought and held primarily for the purpose of selling in the near term are reported at fair value, with unrealized gains and losses included in earnings.

Available-for-Sale—Debt securities not classified as either securities held-to-maturity or trading securities are reported at fair value with unrealized gains or losses excluded from earnings and reported as a separate component of shareholders’ equity.

We classify our investments in marketable debt securities based on the facts and circumstances present at the time of purchase of the securities. During the quarter ended February 28, 2021, all of our investments were classified as held-to-maturity.

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 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 our software products.

Amortization of capitalized 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 $365 thousand and $314 thousand for the three months ended February 28, 2021 and February 29, 2020, respectively and $690 thousand and $628 thousand for the six months ended February 28, 2021 and February 29, 2020, respectively. We expect future amortization expense to vary due to increases in capitalized computer software development costs.

We test capitalized computer software development costs for recoverability whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

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:

Internal-use Software

We have a service contract related to the implementation of internally used software. In accordance with ASC 350-40 “Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract”, we have capitalized certain internal-use software which are included in long-term assets.

The amortization will be classified as selling, general, and administrative expenses on the condensed consolidated statement of operations and maintenance and minor upgrades are charged to expense as incurred. Gains and losses on disposals are included in the results of operations. No amortization has been expensed for the project as it is still in progress.

Leases

Supplemental balance sheet information related to operating leases was as follows as of February 28, 2021:

Intangible Assets and Goodwill

We perform 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 names, and noncompete agreements. We determine 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 our use of the acquired assets or the strategy for our 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 February 28, 2021, we determined that we have four reporting units: Simulations Plus, Cognigen, DILIsym and Lixoft. When testing goodwill for impairment, we first perform 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. we are 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 our 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 our 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 February 28, 2021, the entire balance of goodwill was attributed to three of the our 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. We did not recognize any impairment charges during the three months and six months ended February 28, 2021 and February 29, 2020.

Reconciliation of Goodwill as of February 28, 2021:

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:

For certain of our financial instruments, including accounts receivable, accounts payable, accrued payroll and other expenses, accrued bonuses to officers, and accrued warranty and service costs, the amounts approximate fair value due to their short maturities.

The following table summarizes fair value measurements at February 28, 2021 and August 31, 2020 for assets and liabilities measured at fair value on a recurring basis: 

August 31, 2020:

As of February 28, 2021 and August 31, 2020, we had a liability for contingent consideration related to our acquisition of Lixoft. The fair value measurement of the contingent consideration obligations is determined using Level 3 inputs. The fair value of contingent consideration obligations is based on a discounted cash flow model using a probability-weighted income approach. These fair value measurements represent Level 3 measurements as they are based on significant inputs not observable in the market. Significant judgment is employed in determining the appropriateness of these assumptions as of the acquisition date and for each subsequent period. Accordingly, changes in assumptions could have a material impact on the amount of contingent consideration expense we record in any given period. Changes in the value of the contingent consideration obligations are recorded in our Consolidated Statement of Operations.

The following is a reconciliation of contingent consideration value:

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 experiments, and purchased software that was developed by other companies and incorporated into, or used in the development of, our final products.

Income Taxes

We account 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.

Intellectual property

The following table summarizes intellectual property as of August 31, 2020:

Total amortization expense for intellectual property agreements for the three months ended February 28, 2021 and February 29, 2020 was $357 thousand and $232 thousand, respectively, and total amortization expense for the six months ended February 28, 2021 and February 29, 2020 was $714 thousand and $465 thousand, respectively.

Other intangible assets

The following table summarizes the Company’s other intangible assets as of August 31, 2020:

Total amortization expense for other intangible assets for the three months ended February 28, 2021 and February 29, 2020 was $138 thousand and $87 thousand, respectively, and total amortization expense for the six months ended February 28, 2021 and February 29, 2020 was $275 thousand and $174 thousand, respectively. According to policy in addition to normal amortization, these assets are tested for impairment as needed.

Earnings per Share

We report earnings per share in accordance with FASB ASC 260-10. Basic earnings per share is computed by dividing income available to common shareholders by the weighted-average number of common shares available. Diluted earnings per share is computed similar to basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. The components of basic and diluted earnings per share for the three and six months ended February 28, 2021 and February 29, 2020 were as follows:

Stock-Based Compensation

Compensation costs related to stock options are determined in accordance with FASB ASC 718-10, “Compensation-Stock Compensation”, using the modified prospective method. Under this method, compensation cost is calculated based on the grant-date fair value estimated in accordance with FASB ASC 718-10, amortized on a straight-line basis over the options’ vesting period. Stock-based compensation expense was $804 thousand and $417 thousand for the three months ended February 28, 2021 and February 29, 2020, respectively, and $1.3 million and $784 thousand for the six months ended February 28, 2021 and February 29, 2020, respectively. This expense is included in the condensed consolidated statements of operations as Selling, general, and administration and Research and development expense.

Impairment of Long-lived Assets

We account for the impairment and disposition of long-lived assets in accordance with ASC 350, “Intangibles – Goodwill and Other” and ASC 360, “Property and Equipment”. Long-lived assets to be held and used are reviewed for events or changes in circumstances that indicate that their carrying value may not be recoverable. We measure recoverability by comparing the carrying amount of an asset to the expected future undiscounted net cash flows generated by the asset. If we determine that the asset may not be recoverable, or if the carrying amount of an asset exceeds its estimated future undiscounted cash flows, we recognize an impairment charge to the extent of the difference between the fair value and the asset's carrying amount. No impairment losses were recorded during the six months ended February 28, 2021 and February 29, 2020.

Recently Issued Accounting Pronouncements

In March 2020, the FASB issued Accounting Standards Update (“ASU”) 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”). The amendments in ASU 2020-04 provide temporary optional expedients and exceptions for applying GAAP to contract modifications, hedging relationships and other transactions to ease the potential accounting and financial reporting burden associated with transitioning away from reference rates that are expected to be discontinued, including the London Interbank Offered Rate (“LIBOR”). This ASU is effective as of March 12, 2020 through December 31, 2022. The adoption of the new standard has not had and is not expected to have a material impact on our financial statements or related disclosures.

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. We adopted this ASU on September 1, 2019.

NOTE 3: REVENUE RECOGNITION

Contract Liabilities

During the three and six months ended February 28, 2021, we recognized $104 thousand and $400 thousand, respectively, of revenue that was included in contract liabilities as of August 31, 2020, and during the three and six months ended February 29, 2020, we recognized $338 thousand and $773 thousand, respectively, of revenue that was included in contract liabilities as of August 31, 2019.

Disaggregation of Revenues

The components of disaggregation of revenue for the three and six months ended February 28, 2021 and February 29, 2020 were as follows:

Remaining Performance Obligations

Remaining performance obligations that do not fall under the expedients require us to perform various consulting and software development services of approximately $3.8 million. It is anticipated that a majority of these revenues will be recognized within the next twelve months.

NOTE 4: PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

NOTE 5: INVESTMENTS

We invest a portion of our excess cash balances in short-term debt securities. Investments at February 28, 2021 consisted of corporate bonds with maturities remaining of less than 12 months. We may also invest excess cash balances in certificates of deposit, money market accounts, government-sponsored enterprise securities, corporate bonds and/or commercial paper. We account for investments in accordance with FASB ASC 320, Investments – Debt and Equity Securities. At February 28, 2021, all investments were classified as held-to-maturity securities.

The following tables summarize our short-term investments as of February 28, 2021 and August 31, 2020:

August 31, 2020

NOTE 6: CONTRACTS PAYABLE

DILIsym Acquisition Liabilities:

On June 1, 2017, we acquired DILIsym. The agreement provided for a working capital adjustment, an eighteen-month $1.0 million holdback provision against certain representations and warranties, and an earnout agreement of up to an additional $5.0 million in earnout payments based on earnings over three years following acquisition. The earnout liability has been recorded at an estimated fair value. Payments under the earnout liability started in fiscal year 2019. In September 2018, $1.6 million was paid out under the first earnout payment, a second earnout payment was made in August 2019 in the amount of $1.7 million. The final payment of $1.8 million was paid in August 2020. In addition, no claims were made against the holdback and the $1.0 million holdback provision was released eighteen months after June 1, 2017.

Lixoft Acquisition Liabilities:

On April 1, 2020, we acquired Lixoft. The agreement provided for a 24 month $2.0 million holdback escrow provision against certain representations and warrantees, comprised of $1.3 million of cash and shares of stock valued at $667 thousand issued at the date of the agreement. In addition, based on a revenue growth formula for the two years subsequent to April 1, 2020, the agreement calls for earnout payments of up to $5.5 million (two-thirds cash and one-third newly issued, restricted shares of our common stock). The former shareholders of Lixoft can earn up to $2.0 million the first year and $3.5 million in year two.

As of February 28, 2021 and August 31, 2020 the following liabilities have been recorded:

NOTE 7: COMMITMENTS AND CONTINGENCIES

Leases

We lease approximately 9,255 square feet of space in Lancaster, California. The original lease had a five-year term with two, three-year options to extend. The initial five-year term expired in February 2011, and we extended the lease to February 2, 2014. In June 2013, the lease was amended to extend the term to February 2, 2017. The amended lease also provides for an annual base rent increase of 3% per year and two, two-year options to extend. In May 2016, we exercised the two, two-year options extending the term of the lease through February 2, 2021 at a fixed rate of $25 thousand per month. In December 2020, the lease was amended to extend the term to January 31, 2026. The amendment decreased the leased square footage from 13,500 sq. ft to 9,255 sq. ft, and correspondingly reduced the base rent from $25 thousand per month to $16.7 thousand per month. The amended lease also allows us to opt out of the last 4 years of the lease upon 180-day notice to the landlord with no penalty.

Our Cognigen subsidiary leases approximately 12,623 square feet of space in Buffalo, New York. The initial five-year term expired in October 2018 and was renewed for a three-year option extending it to November 2021. The new base rent is $16 thousand per month.

DILIsym leases approximately 2,700 square feet of space in Research Triangle Park, North Carolina. The initial three-year term was due to expire October 2020. An amendment to the initial lease became effective April 1, 2020, which added 686 square feet and extended the term of the lease to September 30, 2023. The new base rent is approximately $8 thousand per month with an annual 3% adjustment.

In Paris, France, Lixoft leases approximately 2,300 square feet of office space, which as of April 1, 2020, had minimum payments equaling $288 thousand. The lease is for a 9-year term, with an option to terminate every 3 years, and expires in November of 2024. The rent is $16 thousand per quarter (approximately $5.3 thousand per month) and can be adjusted each December based on a consumer price index.

Rent expense, including common area maintenance fees for the three months ended February 28, 2021, and February 29, 2020 was $147 thousand and $150 thousand, respectively, and $332 thousand and $295 thousand for the six months ended February 28, 2021 and February 29, 2020, respectively.

Future minimum lease payments under noncancelable operating leases with remaining terms of one year or more at February 28, 2021 were as follows:

Line of Credit

On March 31, 2020, we entered into a Credit Agreement with Wells Fargo Bank, N.A. The Credit Agreement provides us with a credit facility of $3.5 million through April 15, 2022. As of February 28, 2021, there were no amounts drawn against the line of credit.

Employment Agreements

In the normal course of business, we have entered into employment agreements with certain of our key management personnel that may require compensation payments upon termination.

License Agreement

We had a royalty agreement with Dassault Systèmes Americas Corp. for access to their Metabolite Database for developing our Metabolite Module within ADMET Predictor™. The module was renamed the Metabolism Module when we released ADMET Predictor version 6 on April 19, 2012. Under this agreement, we paid a royalty of 25% of revenue derived from the sale of the Metabolism/Metabolite module. This agreement was renegotiated, and we do not bear any royalty obligations towards Dassault Systèmes Americas Corp. effective as of June 30, 2019. In addition, the license agreement terminated on September 5, 2020. We have not experienced any adverse impact on revenue since terminating the license agreement.

We are in the process of making arrangements to replace the database, which is expected to be completed by the end of fiscal year 2021.

Income Taxes

We follow guidance issued by the FASB with regard to our accounting for uncertainty in income taxes recognized in the financial statements. Such guidance prescribes a recognition threshold of more likely than not and a measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In making this assessment, a company must determine whether it is more likely than not that a tax position will be sustained upon examination, based solely on the technical merits of the position and must assume that the tax position will be examined by taxing authorities. Our policy is to include interest and penalties related to income tax expense. We file income tax returns with the IRS and various state jurisdictions as well as with the countries of India and France. Our federal income tax returns for fiscal year 2017 thru 2019 are open for audit, and our state tax returns for fiscal year 2016 through 2019 remain open for audit.

Our review of prior year tax positions using the criteria and provisions presented in guidance issued by FASB did not result in a material impact on our financial position or results of operations.

Legal Proceedings

We may be subject to litigation, claims, investigations and audits arising from time to time in the ordinary course of our business; however, at this time, we are not a party to any legal proceedings and are not aware of any pending, threatened, or unasserted legal proceedings of any kind.

NOTE 8: SHAREHOLDERS’ EQUITY

Dividends

Our Board of Directors declared cash dividends during fiscal years 2021 and 2020. The details of the dividends paid are in the following tables:

Stock Option Plans

On February 23, 2007, the Board of Directors adopted and the shareholders approved the 2007 Stock Option Plan under which a total of 1.0 million shares of common stock were reserved for issuance. On February 25, 2014 the shareholders approved an additional 1.0 million shares increasing the total number of shares available to be granted under the 2007 Stock Option Plan to 2.0 million. This plan terminated in February 2017 by its term.

On December 23, 2016 the Board of Directors adopted, and on February 23, 2017 the shareholders approved, the 2017 Equity Incentive Plan under which a total of 1.0 million shares of common stock were reserved for issuance. This plan will terminate in December 2026 by its term.

On November 20, 2020, the Board of Directors adopted an amendment to the 2017 Equity Incentive Plan to, subject to shareholder approval, increase the number of shares reserved for issuance under the plan from 1.0 million shares of common stock to 1.75 million shares of common stock. The amendment, which was submitted for shareholder approval at our 2021 annual shareholder meeting, was not approved by the shareholders. As a result, we expect to submit a new equity plan for adoption by the Board of Directors and shareholders in May 2021. If approved, the new equity incentive plan will replace the 2017 Equity Incentive Plan, except that outstanding awards granted prior to the adoption of the new equity incentive plan will continue to be governed by the 2017 Equity Incentive Plan.

As of February 28, 2021, employees and directors hold Qualified Incentive Stock Options (“ISOs”) and Non-Qualified Stock Options (“NQSOs) to purchase 1.3 million shares of common stock at exercise prices ranging from $6.85 to $61.84.

The following table summarizes information about stock options: 

The weighted-average remaining contractual life of options outstanding issued under the Plan, both ISOs and NQSOs, was 6.88 years at February 28, 2021. The total fair value of nonvested stock options as of February 28, 2021 was $20.1 million and is amortizable over a weighted average period of 3.73 years.

The fair value of these options was estimated at the date of grant using the Black-Scholes option-pricing model. The Black-Scholes option-valuation model was developed for use in estimating the fair value of traded options, which do not have vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility.

The following table summarizes the fair value of the options, including both ISOs and NQSOs, granted during the six months ended February 28, 2021 and fiscal year 2020: 

The exercise prices for the options outstanding at February 28, 2021 ranged from $6.85 to $61.84, and the information relating to these options is as follows:

(in thousands except prices)

During the three and six months ended February 28, 2021 we issued 1,105 and 2,380 shares of stock valued at $87 and $170 thousand to our nonmanagement directors as compensation for services rendered to us.

In August 2020, we closed an underwritten public offering of approximately 2.1 million shares of our common stock to the public at $55.00 per share, which included the full exercise of the underwriters’ option to purchase approximately 273 thousand 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 offering was made pursuant to our automatic shelf registration statement on Form S-3 filed with the SEC on July 9, 2020.

The balance of par value common stock and additional paid in capital as of February 28, 2021 was $10 thousand and $130.7 million, respectively.

NOTE 9: CONCENTRATIONS AND UNCERTAINTIES

Financial instruments that potentially subject us to concentration of credit risk consist principally of cash, cash equivalents, trade accounts receivable and short-term investments. We hold cash and cash equivalents at banks located in California and North Carolina with balances that often exceed FDIC-insured limits. In addition, we hold cash at a bank in France that is not FDIC-insured. Historically, we have not experienced any losses in such accounts. However, considering the current banking environment, we are investigating alternative ways to minimize our exposure to such risks. While we may be exposed to credit losses due to the nonperformance of our counterparties, we do not expect the settlement of these transactions to have a material effect on our results of operations, cash flows, or financial condition. We maintain cash at financial institutions that may, at times, exceed federally insured limits. As of February 28, 2021 we had cash and cash equivalents exceeding insured limits by $12.7 million.

Revenue concentration shows that international sales accounted for 34% and 33% of net sales for the six months ended February 28, 2021 and February 29, 2020, respectively. Two customers accounted for 13% and 5% of net sales during the six months ended February 28, 2021. Three customers accounted for 7%, 6% (a dealer account in Japan representing various customers), and 6% of net sales during the six months ended February 29, 2020.

Accounts receivable concentration shows that four customers comprised 15%, 10%, 6%, and 5% (a dealer account in Japan representing various customers) of accounts receivable at February 28, 2021. Accounts receivable concentration shows that four customers comprised 10% (a dealer account in Japan representing various customers), 5%, 5% and 5% at February 29, 2020.

We operate in the computer software industry, which is highly competitive and changes rapidly. Our operating results could be significantly affected by our ability to develop new products and find new distribution channels for new and existing products.

The majority of our customers are in the pharmaceutical industry. During economic downturns, we have seen consolidations in the pharmaceutical industry. The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous factors we cannot reliably predict, including the duration and scope of the pandemic; businesses and individuals' actions in response to the pandemic; and the impact on economic activity including the possibility of recession or financial market instability. These factors may adversely impact consumer, business, and government spending as well as customers' ability to pay for our products and services on an ongoing basis. As a result, our growth rate could be affected by consolidation and downsizing in the pharmaceutical industry.

NOTE 10: SEGMENT AND GEOGRAPHIC REPORTING

We account for segments and geographic revenues in accordance with guidance issued by the FASB. Our reportable segments are strategic business units that offer different products and services.

Results for each segment and consolidated results are as follows for the three and six months ended February 28, 2021 and February 29, 2020:

*Lixoft was purchased on April 1, 2020.

*Lixoft was purchased on April 1, 2020.

In addition, we allocate revenues to geographic areas based on the locations of our customers. Geographical revenues for the three and six months ended February 28, 2021 and February 29, 2020 were as follows:

NOTE 11: EMPLOYEE BENEFIT PLAN

We maintain a 401(k) Plan for all eligible employees, and we make matching contributions equal to 100% of the employee’s elective deferral, not to exceed 4% of total employee compensation. We can also elect to make a profit-sharing contribution. Our contributions to this Plan amounted to $131 thousand and $109 thousand for the three months ended February 28, 2021 and February 29, 2020, respectively and $252 thousand and $202 thousand for the six months ended February 28, 2021 and February 29, 2020, respectively.

NOTE 12: ACQUISITION

On March 31, 2020, we entered into a Stock Purchase and Contribution Agreement (the “Agreement”) with Lixoft. On April 1, 2020, we completed the acquisition of all outstanding equity interests of Lixoft pursuant to the terms of the Agreement, with Lixoft becoming our wholly owned subsidiary. We believe the combination of Simulations Plus and Lixoft provides substantial potential based on the complementary strengths of each of the companies.

Under the terms of the Agreement, as described below, we will pay the former shareholders of Lixoft total consideration of up to $16.5 million, consisting of two-thirds cash and one-third newly issued, unregistered shares of our common stock. In addition, we will pay $3.5 million of excess working capital based on the March 31, 2020 financial statements of Lixoft.

On April 1, 2020, we paid the former shareholders of Lixoft a total of $10.8 million, comprised of cash in the amount of $9.5 million and the issuance of 111,682 shares of our common stock valued at $3.7 million, net of adjustments and a holdback for representations and warranties. Under the terms of the Agreement a price of approximately $32.15 dollars per share was used based upon the volume-weighted average closing price of our shares of common stock for the 30-consecutive-trading-day period ending two trading days prior to April 1, 2020. A total of 9,669 shares are held in an escrow account for potential offset for representations and warrantees. Within three business days following the two-year anniversary of March 31, 2020 (the date of the Agreement) and subject to any offsets for representations and warrantees, we will pay the former shareholders of Lixoft a total of $2.0 million, comprised of $1.3 million of cash and shares released from escrow valued at $666 thousand issued at the date of the Agreement. The Agreement provides for a two-year market standoff period in which the newly issued shares may not be sold by the recipients thereof.

In addition, the Agreement calls for earnout payments up to an additional $5.5 million, two-thirds cash and one-third newly issued, unregistered shares of our common stock based on a revenue growth formula each year for the two years subsequent to April 1, 2020. The former shareholders can earn up to $2.0 million the first year and $3.5 million in year two. The earnout liability has been recorded at fair value.

Under the acquisition method of accounting, the total purchase price reflects Lixoft’s tangible and intangible assets and liabilities based on their estimated fair values at the date of the completion of the acquisition (April 1, 2020). The following table summarizes the preliminary allocation of the purchase price for Lixoft:

Goodwill was provided in the transaction based on estimates of future earnings of this subsidiary including anticipated synergies associated with the positioning of the combined company as a leader in Model-Based Drug Development.

Consolidated supplemental Pro Forma information

The following unaudited consolidated supplemental pro forma information assumes that the acquisition of Lixoft took place on September 1, 2019 for the income statement for the three and six months ended February 28, 2021. These amounts have been calculated after applying our accounting policies and adjusting the results of Lixoft to reflect the same expenses in the three and six months ended February 29, 2020. The adjustments include costs of acquisition, and amortization of intangibles and other technologies acquired during the merger, assuming the fair value adjustments applied on September 1, 2019, together with consequential tax effects.

NOTE 13: SUBSEQUENT EVENTS

On Friday, April 9, 2021, our Board of Directors declared a quarterly cash dividend of $0.06 per share to our shareholders. The dividend amount of $1.2 million will be distributed on Monday, May 3, 2021, for shareholders of record as of Monday, April 26, 2021.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This document and the documents incorporated in this document by reference contain forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact contained in this document and the materials accompanying this document are forward-looking statements.

The forward-looking statements are based on the beliefs of our management, as well as assumptions made by and information currently available to our management. Frequently, but not always, forward-looking statements are identified by the use of the future tense and by words such as “believes,” expects,” “anticipates,” “intends,” “will,” “may,” “could,” “would,” “projects,” “continues,” “estimates” or similar expressions. Forward-looking statements are not guarantees of future performance and actual results could differ materially from those indicated by the forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause our or our industry’s actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by the forward-looking statements.

The forward-looking statements contained or incorporated by reference in this document are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (“Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”) and are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. These statements include declarations regarding our plans, intentions, beliefs, or current expectations.

Among the important factors that could cause actual results to differ materially from those indicated by forward-looking statements are the risks and uncertainties described under “Risk Factors” in our Annual Report on Form 10-K for the year ended August 31, 2020 filed with the Securities and Exchange Commission (“SEC”) on November 16, 2020 and elsewhere in this document and in our other filings with the SEC.

Forward-looking statements are expressly qualified in their entirety by this cautionary statement. The forward-looking statements included in this document are made as of the date of this document and we do not undertake any obligation to update forward-looking statements to reflect new information, subsequent events, or otherwise.

General

BUSINESS

OVERVIEW

Simulations Plus, Inc., incorporated in 1996, is a premier developer of modeling and simulation software for drug discovery and development, including the prediction of properties of molecules utilizing artificial-intelligence- and machine-learning-based technology. We also provide consulting services ranging from early drug discovery through preclinical and clinical trial development to regulatory submissions in support of product approval. Our software and consulting services are provided to major pharmaceutical, biotechnology, agrochemical, cosmetics, and food industry companies and to academic and regulatory agencies worldwide for use in the conduct of industry-based research. SLP is headquartered in Southern California, with offices in Buffalo, NY, Research Triangle Park, NC, and Paris, France. Our common stock trades on the Nasdaq Capital Market under the symbol “SLP”.

We are a global leader focused on improving the ways scientists use knowledge and data to predict the properties and outcomes of pharmaceutical and biotechnology agents by providing a wide range of early discovery, preclinical, and clinical consulting services and software. Our innovations in integrating new and existing science in medicinal and computational chemistry, pharmaceutical science, biology, physiology, and machine learning into our software have enabled us to be a leading software provider for physiologically based pharmacokinetics “(PBPK”) modeling and simulation, pharmacometric modeling and simulation, prediction of molecular properties from structure, and prediction of the propensity of drugs to induce liver injury or to treat nonalcoholic fatty liver disease. Our scientific consulting staff draw upon extensive experience across multiple therapeutic areas and a full range of modeling and simulation techniques to assist our clients across the full spectrum of drug development.

We generate revenue by delivering relevant, cost-effective software and creative and insightful consulting services. Pharmaceutical and biotechnology companies use our software programs and scientific consulting services to guide early drug discovery (molecule design screening and lead optimization), preclinical, and clinical development programs, including using our software products and services to enhance their understanding of the properties of potential new medicines and to use emerging data to improve formulations, select and justify dosing regimens, support the generics industry, optimize clinical trial designs, and simulate outcomes in special populations, such as in elderly and pediatric patients.

Simulations Plus acquired Cognigen Corporation (Cognigen) as a wholly owned subsidiary in September 2014. Cognigen was originally incorporated in 1992. Through the integration of Cognigen into Simulations Plus, Simulations Plus became a leading provider of population modeling and simulation contract research services for the pharmaceutical and biotechnology industries. Our clinical-pharmacology-based consulting services include pharmacokinetic and pharmacodynamic modeling, clinical trial simulations, data programming, and technical writing services in support of regulatory submissions. We have also developed software for harnessing cloud-based computing in support of modeling and simulation activities and secure data archiving, and we provide consulting services to improve interdisciplinary collaborations and research and development productivity.

Simulation Plus acquired DILIsym Services, Inc. (DILIsym) as a wholly owned subsidiary in June 2017. The acquisition of DILIsym positioned us as the leading provider of Drug Induced Liver Injury (DILI) modeling and simulation software and related scientific consulting services. In addition to the DILIsym® software for analysis of potential drug-induced liver injury, DILIsym also has developed a simulation program for analyzing nonalcoholic fatty liver disease (NAFLD) called NAFLDsym™. Both the DILIsym and NAFLDsym software programs require outputs from PBPK software as inputs. Outputs generated by the GastroPlus™ PBPK software that are required by DILIsym software can be automatically mapped to DILIsym applications; thus, the integration of these technologies provides a seamless capability for analyzing the potential for drug-induced liver injury for new drug compounds and for investigating the potential for new therapeutic agents to treat NAFLD. Since the acquisition, DILIsym has applied its mechanistic modeling resources in other disease areas including idiopathic pulmonary fibrosis (IPF).

Simulations Plus acquired Lixoft as a wholly owned subsidiary on April 1, 2020. Lixoft brings to Simulations Plus its powerful software products, Monolix, Simulx and PKanalix, which can take modeling projects from data exploration to clinical trial simulations. In addition, Lixoft provides training and focused consulting services which can accelerate pharmacometric studies. Lixoft’s technologies were developed as a result of a research program led by the French national research institute for digital science and technology (Inria), on nonlinear mixed effect models for advanced population analysis, pharmacometrics, pre-clinical, and clinical trial modeling and simulation. Lixoft continues to work with Inria.

PRODUCTS

General

We currently offer eleven software products for pharmaceutical research and development: five simulation programs that provide time-dependent results based on solving large sets of differential equations: GastroPlus; DDDPlus™ MembranePlus™ DILIsym; and NAFLDsym^®; three programs that are based on predicting and analyzing static (not time-dependent) properties of chemicals: ADMET Predictor; MedChem Designer™ and MedChem Studio™ (the combination of ADMET Predictor, MedChem Designer, and MedChem Studio is called our ADMET Design Suite); a program which is designed for rapid clinical trial data analysis and regulatory submissions called PKPlus™ a cloud-based communication and collaboration platform for exploratory data analysis, population PK/PD modeling and reporting called KIWI^TM; and in April 2020 with the acquisition of Lixoft, we added the Monolix Suite of products – a modeling and simulation solution that allows nonparametric analyses, population PKPD analyses, and modeling and clinical trial simulation.

Software business

Our software business represented 59% of our total revenue during the first six months of fiscal year 2021, and was primarily generated by the following products:

GastroPlus^®

Our flagship product, originally introduced in 1998, and currently our largest single source of software revenue, is GastroPlus. GastroPlus mechanistically simulates the absorption, pharmacokinetics, pharmacodynamics, and drug-drug interactions (DDI) of compounds administered to humans and animals and is currently one of the most widely used commercial software of its type by industry, the U.S. Food and Drug Administration (FDA), the U.S. National Institutes of Health (NIH), and other government agencies in the U.S. and around the world. In February 2021, GastroPlus version 9.8.1, which included new mechanisms and updated documentation for key DDI standards models, was released.

ADMET Predictor^®

ADMET Predictor is a top-ranked, chemistry-based computer program that takes molecular structures (i.e., drawings of molecules represented in various formats) as inputs and uses artificial intelligence/machine learning technologies to predict approximately 175 different properties for them at an average rate of over 200,000 compounds per hour on a modern laptop computer. This capability allows chemists to generate estimates for a large number of important molecular properties without the need to synthesize and test the molecules, as well as to generate estimates of unknown properties for molecules that have been synthesized, but for which only a limited number of experimental properties have been measured. In September 2020, ADMET Predictor® Version 10.0 (APX), which integrates Artificial Intelligence-driven Drug Design (AIDD) with PBPK, was released.

DILIsym^®

The DILIsym software is a quantitative systems pharmacology (“QSP”) program that was introduced in 2011. QSP software models are based on the fundamental understanding of complex biological pathways, disease processes, and drug mechanisms of action, integrating information from experiments and forming hypotheses for the next experimental model. DILIsym deals with the propensity for some drug molecules to induce temporary or permanent changes in biological functions within liver cells (hepatocytes) that can result in damage to the liver (i.e., drug-induced liver injury or DILI).

Monolix Suite^™

The Monolix Suite is a unique solution for modeling and simulation for pharmaceutical companies, biotechs, and hospitals. It supports nonparametric analyses, population PKPD analyses and modeling, and clinical trial simulation. The extended MonolixSuite contains three main products: Monolix, Simulx, and PKanalix. These products are interconnected and interoperable, i.e., allowing users to go from one application to another one without changing anything in terms of data set or of biological models. Monolix 2020R1 was released in November 2020, which combines the most advanced algorithms with unique ease of use.

Consulting Services

Our consulting business represented 41% of our total revenue during the first six months of fiscal year 2021, and was primarily generated by the following services:

PKPD

Our clinical-pharmacology-based consulting services include population pharmacokinetic and pharmacodynamic modeling, exposure-response analyses, clinical trial simulations, data programming, and technical writing services in support of regulatory submissions. In addition to modeling and simulation consulting services, we provide expertise and assistance with development-related decision making and support for regulatory interactions related to dose selection, clinical trial design, and understanding of the determinants of safety and efficacy for new medicines.

QSP/QST

We provide creative and insightful consulting services to support our QSP/QST modeling focused on heart failure, liver safety, and radiation syndrome, as well as other areas. Pharmaceutical and biotechnology companies use our scientific consulting services to guide early drug discovery (molecule design screening and lead optimization), preclinical, and clinical development programs. This includes using our software products and services to enhance their understanding of the properties of potential new medicines and to use emerging data to improve formulations, select and justify dosing regimens, support the generics industry, optimize clinical trial designs, and simulate outcomes in special populations, such as in elderly and pediatric patients.

PBPK

Beginning in 2014, the FDA and other regulatory agencies began to emphasize the need to encourage mechanistic PBPK modeling and simulation in clinical pharmacology, with final guidance documents completed in 2018. New draft guidance documents were released in October 2020 focused on additional applications for biopharmaceuticals. This has resulted in an increased need for us to provide consulting-related services to support this sophisticated technique. We support Model Informed Drug Discovery and Development throughout the entire product lifecycle: from discovery through translation research and clinical development when an organization does not have the time or resources to use our software, directly. More specifically, our clients seek out our consulting services to acquire scientific, therapeutic-area-related modeling and simulation expertise that they do not have in-house.

Summary Results of Operations

Three Months Ended February 28, 2021 compared with Three Months Ended February 29, 2020:

Revenues

Consolidated revenues increased by $2.8 million or 27% to $13.1 million for the three months ended February 28, 2021 compared to consolidated revenue of approximately $10.3 million for the three months ended February 29, 2020. This increase is primarily due to a $2.4 million or 45% increase in consolidated software-related revenue, and a $0.4 million or 7% increase in consolidated consulting and analytical study revenues when comparing the three months ended February 28, 2021 and February 29, 2020.

Cost of Revenues

Consolidated cost of revenues increased by $0.2 million, or 9%, to $2.9 million for the three months ended February 28, 2021 compared to $2.7 million for the three months period ended February 29, 2020. The increase is primarily due to a $0.2 million or 9% increase in labor-related contract research organization fees for the DILIsym division.

Gross Margin

Consolidated gross margin increased by approximately $2.5 million or 33% to $10.2 million for the three months ended February 28, 2021 compared to $7.7 million for the three months ended February 29, 2020. The higher gross margin is primarily due to the addition of the Lixoft division, which contributed $1.4 million to the increase, as well as the Simulations Plus division’s gross margin increase of $0.8 million or 16%. The gross margin for the Cognigen and DILIsym Divisions both increased by approximately $0.2 million, respectively, for the quarter.

Overall gross margin percentage increased by 4% to 78% for the three months ended February 28, 2021 from 74% for the three months period ended February 29, 2020.

Selling, General and Administrative Expenses

Selling, general, and administrative expenses increased by approximately $1.4 million, or 33% to $5.5 million for the three months period ended February 28, 2021 from $4.1 million for the three months period ended February 29, 2020. As a percent of revenues, Selling, general, and administrative expense increased from 40% to 42% for the same comparative periods.

The increase in Selling, General, and Administrative expense was primarily due to the following:

Research and Development Costs

Total research and development costs increased by $0.7 million for the three months ended February 28, 2021 compared to the three months ended February 29, 2020. During the second quarter of fiscal year 2021, we incurred approximately $2.0 million of research and development costs; of this amount, $0.7 million was capitalized and $1.3 million was expensed. For the three months ended February 29, 2020, we incurred approximately $1.3 million of research and development costs; of this amount, approximately $0.6 million was capitalized and approximately $0.7 million was expensed.

Other Income (Expense)

Total other expense was $63 thousand for the three months ended February 28, 2021 compared to total other income of $10 thousand for the three months ended February 29, 2020. The variance of $73 thousand is primarily due to a change in the valuation of contingent consideration, partially offset by an increase in interest income resulting from short-term investments.

Provision for Income Taxes

The provision for income taxes was $0.2 million for the three months ended February 28, 2021 compared to $0.7 million for the same period in the previous year. Our effective tax rate decreased 18.0% to 6.2% for the three months ended February 28, 2021 from 24.2% during the same period of the previous year primarily due to the disqualified disposition of options exercised.

Six Months Ended February 28, 2021 compared with Six Months Ended February 29, 2020: