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SIGNIFICANT ACCOUNTING POLICIES (Policies)

9 Months Ended

May 31, 2022

Principles of ConsolidationThe accompanying consolidated financial statements include the accounts of Simulations Plus and its wholly owned subsidiaries as applicable for the periods presented. 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:

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, we satisfy a performance obligation

Remaining Performance Obligations

Transaction price allocated to remaining performance obligations represents contracted revenue that has not yet been recognized, which includes deferred revenue and unbilled amounts that will be recognized as revenue in future periods. As of May 31, 2022, remaining performance obligations were approximately $13.2 million. Approximately 89% of the remaining performance obligations are expected to be recognized over the next 12 months, with the remainder recognized thereafter. Remaining performance obligations estimates are subject to change and are affected by several factors, including contract terminations and changes in the scope of contracts.

Disaggregation of Revenue

The components of disaggregation of revenue for the three and nine months ended May 31, 2022 and 2021 were as follows:


(in thousands)	Three Months Ended May 31,				Nine Months Ended May 31,
	2022		2021		2022		2021
Software licenses:
Point in time	$	9,380	$	8,098	$	25,980	$	21,570
Over time	267		200		787		703

Consulting services:
Over time	5,312		4,479		15,405		14,352
Total revenue	$	14,959	$	12,777	$	42,172	$	36,625

Contract Balances

We receive payments from customers based upon contractual billing schedules, while we recognize revenue when, or as, we satisfy our performance obligations. This timing difference results in accounts receivable, contract assets, and contract liabilities. We record accounts receivable when the right to consideration becomes unconditional. We record a contract asset if the right to consideration is conditioned on something other than the passage of time, such as our future performance. Contract assets are included in prepaid expenses and other current assets on our condensed consolidated balance sheets. We record a contract liability when we have an obligation to transfer goods or services to a customer for which we have received consideration from a customer. We refer to contract liabilities as deferred revenue on our condensed consolidated balance sheets.

Contract asset balances as of May 31, 2022 and August 31, 2021 were $1.8 million and $3.2 million, respectively.

During the three and nine months ended May 31, 2022, we recognized $68 thousand and $608 thousand, respectively, of revenue that was included in contract liabilities as of August 31, 2021, and during the three and nine months ended May 31, 2021, we recognized $30 thousand and $430 thousand, respectively, of revenue that was included in contract liabilities as of August 31, 2020.

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. We apply the practical expedient as described in ASC 340-40-25-4 to expense costs as incurred for sales commissions, since the amortization period of the asset that we otherwise would have recognized is one year or less. This expense is included in the condensed consolidated statements of operations and comprehensive income as selling, general, and administrative expense.

Cash and Cash Equivalents

Cash and Cash EquivalentsFor 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 and Allowances for Credit Losses

Accounts Receivable and Allowances for Credit Losses The Company extends credit to its customers in the normal course of business. The Company evaluates its allowance for credit losses based on its estimate of the collectability of its trade accounts receivable. As part of this assessment, the Company considers various factors including the financial condition of the individual companies with which it does business, the aging of receivable balances, historical experience, changes in customer payment terms, current market conditions, and reasonable and supportable forecasts of future economic conditions. In times of economic turmoil, the Company’s estimates and judgments with respect to the collectability of its receivables is subject to greater uncertainty than in more stable periods. Accounts receivable balances will be charged off against the allowance for credit losses after all means of collection have been exhausted and the potential for recovery is considered remote.

Investments

The Company 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 within the parameters of our Investment Policy and Guidelines. The Company accounts for its investments 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 measured at amortized cost and are presented at the net amount expected to be collected. Any change in the allowance for credit losses during the period is reflected in earnings. Discounts and premiums to par value of the debt securities are amortized to interest income/expense over the term of the security.

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. For available-for-sale debt securities in an unrealized loss position, we evaluate as of the balance sheet date whether the unrealized losses are attributable to a credit loss or other factors. The portion of unrealized losses related to a credit loss is recognized in earnings, and the portion of unrealized loss not related to a credit loss is recognized in other comprehensive income.

We classify our investments in marketable debt securities based on the facts and circumstances present at the time of purchase of the securities. We subsequently reassess the appropriateness of that classification at each reporting date. During the quarter ended May 31, 2022, all of our investments were classified as held-to-maturity.

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 revenue, 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 $314 thousand and $344 thousand for the three months ended May 31, 2022 and 2021, respectively, and $938 thousand and $1.0 million for the nine months ended May 31, 2022 and 2021, respectively. We expect future amortization expense to vary due to increases in capitalized computer software development costs.

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

Property and Equipment

Property and equipment are recorded at cost, less accumulated depreciation and amortization. Depreciation and amortization are calculated 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

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 is classified as selling, general, and administrative expenses on the condensed consolidated statement of operations, and maintenance and minor upgrades are also charged to selling, general, and administrative expense as incurred.

Leases

Supplemental information related to operating leases was as follows as of May 31, 2022:


(in thousands)
Right-of-use assets	$	1,533
Lease liabilities, current	$	459
Lease liabilities, long-term	$	1,069
Operating lease costs	$	394
Weighted average remaining lease term	3.30 years
Weighted average discount rate	3.41		%

Intangible Assets and Goodwill

We perform valuations of assets acquired and liabilities assumed on each acquisition accounted for as a business combination and recognize 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 May 31, 2022, 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 May 31, 2022, the entire balance of goodwill was attributed to three of 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 and nine months ended May 31, 2022 and 2021.

Reconciliation of Goodwill as of May 31, 2022:


(in thousands)	Cognigen				DILIsym				Lixoft		Total
Balance, August 31, 2021	$	4,789	$	—	$	5,598	$	—	$	2,534	$	12,921
Addition	—		—		—		—		—		—
Impairments	—		—		—		—		—		—
Balance, May 31, 2022	$	4,789			$	5,598			$	2,534	$	12,921

Fair Value of Financial Instruments

Assets and liabilities recorded at fair value in the Condensed Consolidated 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 that 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, and accrued payroll and other expenses, the amounts approximate fair value due to their short maturities.

The following table summarizes fair value measurements at May 31, 2022 and August 31, 2021 for assets and liabilities measured at fair value on a recurring basis:


May 31, 2022:

(in thousands)	Level 1		Level 2		Level 3		Total
Cash and cash equivalents	$	42,353	$	—	$	—	$	42,353
Short-term investments	$	79,801	$	—	$	—	$	79,801
Acquisition-related contingent consideration obligations	$	—	$	—	$	—	$	—


August 31, 2021:

(in thousands)	Level 1		Level 2		Level 3		Total
Cash and cash equivalents	$	36,984	$	—	$	—	$	36,984
Short-term investments	$	86,484	$	—	$	—	$	86,484
Acquisition-related contingent consideration obligations	$	—	$	—	$	3,217	$	3,217

As of May 31, 2022, we had no liability for contingent consideration related to our acquisition of Lixoft, and as of August 31, 2021, 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. The liability is recorded as contracts payable on the condensed consolidated balance sheet, and changes in the value of the contingent consideration obligations are recorded as other income (expense), net in our Condensed Consolidated Statement of Operations and Comprehensive Income.

The following is a reconciliation of contingent consideration value:


(in thousands)
Value at August 31, 2021	$	3,217
Contingent consideration payments - cash	(2,334)
Contingent consideration payments - stock	(1,166)
Change in value of contingent consideration	283
Value at May 31, 2022	$	—

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 May 31, 2022:


(in thousands)	Amortization Period	Acquisition Value		Accumulated Amortization		Net Book Value
Royalty Agreement buy out-Enslein Research	Straight line 10 years	$	75	$	75	$	—
Termination/nonassertion agreement-TSRL Inc.	Straight line 10 years	6,000		4,825		1,175
Developed technologies–DILIsym acquisition	Straight line 9 years	2,850		1,583		1,267
Intellectual rights of Entelos Holding Corp.	Straight line 10 years	50		19		31
Developed technologies–Lixoft acquisition	Straight line 16 years	8,010		1,083		6,927
		$	16,985	$	7,585	$	9,400

The following table summarizes intellectual property as of August 31, 2021:


(in thousands)	Amortization Period	Acquisition Value				Accumulated Amortization		Net Book Value
Royalty Agreement buy out-Enslein Research	Straight line 10 years	$	75	$	—	$	71	$	4
Termination/nonassertion agreement-TSRL Inc.	Straight line 10 years	6,000		—		4,375		1,625
Developed technologies–DILIsym acquisition	Straight line 9 years	2,850		—		1,346		1,504
Intellectual rights of Entelos Holding Corp.	Straight line 10 years	50		—		15		35
Developed technologies–Lixoft acquisition	Straight line 16 years	8,010		—		709		7,301
		$	16,985			$	6,516	$	10,469

Amortization expense for intellectual property agreements for the three months ended May 31, 2022 and 2021 was $354 thousand and $358 thousand, respectively, and amortization expense for intellectual property agreements for the nine months ended May 31, 2022 and 2021 was $1.1 million and $1.1 million, respectively.

Other intangible assets

The following table summarizes our other intangible assets as of May 31, 2022:


(in thousands)	Amortization Period	Acquisition Value		Accumulated Amortization		Net Book Value
Simulations Plus
ERP	Straight line 15 years	$	1,702	$	52	$	1,650
Cognigen
Customer relationships	Straight line 8 years	1,100		1,065		35
Trade name	None	500		—		500
Covenants not to compete	Straight line 5 years	50		50		—
DILIsym
Customer relationships	Straight line 10 years	1,900		951		949
Trade name	None	860		—		860
Covenants not to compete	Straight line 4 years	80		80		—
Lixoft
Customer relationships	Straight line 14 years	2,550		394		2,156
Trade name	None	1,550		—		1,550
Covenants not to compete	Straight line 3 years	60		43		17
		$	10,352	$	2,635	$	7,717

The following table summarizes our other intangible assets as of August 31, 2021:


(in thousands)	Amortization Period	Acquisition Value		Accumulated Amortization		Net Book Value
Cognigen
Customer relationships	Straight line 8 years	$	1,100	$	963	$	137
Trade name	None	500		—		500
Covenants not to compete	Straight line 5 years	50		50		—
DILIsym
Customer relationships	Straight line 10 years	1,900		807		1,093
Trade name	None	860		—		860
Covenants not to compete	Straight line 4 years	80		80		—
Lixoft
Customer relationships	Straight line 14 years	2,550		258		2,292
Trade name	None	1,550		—		1,550
Covenants not to compete	Straight line 3 years	60		28		32
		$	8,650	$	2,186	$	6,464

Amortization expense for other intangible assets for the three months ended May 31, 2022 and 2021 was $160 thousand and $137 thousand, respectively, and amortization expense for other intangible assets for the nine months ended May 31, 2022 and 2021 was $449 thousand and $412 thousand, respectively. 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 outstanding. Diluted earnings per share is computed similarly 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 nine months ended May 31, 2022 and 2021 were as follows:


(in thousands)	Three Months Ended May 31,				Nine Months Ended May 31,
	2022		2021		2022		2021
Numerator:
Net income attributable to common shareholders	$	4,087	$	3,787	$	11,522	$	9,477

Denominator:
Weighted-average number of common shares outstanding during the period	20,212		20,105		20,180		20,014
Dilutive effect of stock options	556		697		551		736
Common stock and common stock equivalents used for diluted earnings per share	20,768		20,802		20,731		20,750

Stock-Based Compensation

Compensation costs related to stock options are determined in accordance with FASB ASC 718-10, “Compensation-Stock Compensation”. 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 related to stock options, not including shares issued to directors for services, was $679 thousand and $618 thousand for the three months ended May 31, 2022 and 2021, respectively, and $2.0 million and $1.8 million for the nine months ended May 31, 2022 and 2021, 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 nine months ended May 31, 2022 and 2021.

Recently Issued Accounting Pronouncements

In March 2020, the FASB issued ASU No. 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 consolidated financial statements or related disclosures.

In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers (“ASU 2021-08”). The amendment requires contract assets and contract liabilities acquired in a business combination to be recognized and measured in accordance with ASC 606, Revenue from Contracts with Customers, as if the acquirer had originated the contract. The amendment is intended to improve the accounting for acquired revenue contracts with customers in a business combination, related to the recognition of an acquired contract liability, and to payment terms and their effect on subsequent revenue recognized by the acquirer. The amendment also provides certain practical expedients when applying the guidance. ASU 2021-08 is effective for interim and annual periods beginning after December 15, 2022, on a prospective basis, with early adoption permitted. The Company expects to adopt ASU 2021-08 in the first quarter of fiscal year 2024. The Company is currently evaluating the potential impact of ASU 2021-08 to its consolidated financial statements.

In November 2021, the FASB issued ASU 2021-10, Government Assistance (Topic 832), which requires business entities to disclose information about transactions with a government that are accounted for by applying a grant or contribution model by analogy (for example, IFRS guidance in IAS 20 or guidance on contributions for not-for-profit entities in ASC 958-605). For transactions within scope, the new standard requires the disclosure of information about the nature of the transaction, including significant terms and conditions, as well as the amounts and specific financial statement line items affected by the transaction. The new guidance is effective for annual reporting periods beginning after December 15, 2021. The Company does not expect that the adoption of this standard will have a material impact on its condensed consolidated financial statements; however, the Company expects to increase its disclosures with respect to government assistance beginning in the first quarter of fiscal year 2023.