SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-KSB
[x] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended August 31, 2005 or
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _________ to _________
Commission file number: 001-32046
SIMULATIONS PLUS, INC.
(Name of small business issuer in its charter)
CALIFORNIA 95-4595609
(State or other jurisdiction) (I.R.S. Employer Identification No.)
1220 W. AVENUE J
LANCASTER, CA 93534 (661) 723-7723
(Address of principal executive (Issuer's telephone number,
offices including zip code) including area code)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE ACT: NONE.
SECURITIES REGISTERED UNDER SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $0.001 PER SHARE
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. Yes
[X] No [ ]
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of Exchange Act.) Yes [ ] No [X]
The issuer had revenues of approximately $4,874,000 for the fiscal year
ended August 31, 2005.
As of December 7, 2005, the aggregate market value of the common equity
held by non-affiliates of the issuer (1,633,048 shares) was approximately
$6,123,930 based upon the December 7, 2005 closing price ($3.75) of one share on
such date.
As of December 7, 2005, the issuer had outstanding 3,650,048 shares of
common stock and no share of preferred stock.
SIMULATIONS PLUS, INC.
FORM 10-KSB
FOR THE FISCAL YEAR ENDED AUGUST 31, 2005
Table of Contents
Page
----
PART I
Item 1. Description of Business 1
Item 2. Description of Property 10
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 11
PART II
Item 5. Market for Common Equity and Related Stockholder Matters 12
Item 6. Management's Discussion and Analysis or Plan of Operation 13
Item 7. Financial Statements 18
Item 8. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure 18
Item 8A. Controls and Procedures 18
Item 8B. Other Information 18
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act 19
Item 10. Executive Compensation 21
Item 11. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 24
Item 12. Certain Relationships and Related Transactions 25
Item 13. Exhibits 25
Item 14. Principal Accounting Fees and Services 27
Signatures 29
Financial Statements F-1
Exhibits
FORWARD-LOOKING STATEMENTS
--------------------------
CERTAIN STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-KSB, OR THE "REPORT," ARE
"FORWARD-LOOKING STATEMENTS." THESE FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE
NOT LIMITED TO, STATEMENTS ABOUT THE PLANS, OBJECTIVES, EXPECTATIONS AND
INTENTIONS OF SIMULATIONS PLUS, INC., A CALIFORNIA CORPORATION AND OTHER
STATEMENTS CONTAINED IN THIS REPORT THAT ARE NOT HISTORICAL FACTS.
FORWARD-LOOKING STATEMENTS IN THIS REPORT OR HEREAFTER INCLUDED IN OTHER
PUBLICLY AVAILABLE DOCUMENTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION,
OR THE "COMMISSION," REPORTS TO OUR SHAREHOLDERS AND OTHER PUBLICLY AVAILABLE
STATEMENTS ISSUED OR RELEASED BY US INVOLVE KNOWN AND UNKNOWN RISKS,
UNCERTAINTIES AND OTHER FACTORS WHICH COULD CAUSE OUR ACTUAL RESULTS,
PERFORMANCE (FINANCIAL OR OPERATING) OR ACHIEVEMENTS TO DIFFER FROM THE FUTURE
RESULTS, PERFORMANCE (FINANCIAL OR OPERATING) OR ACHIEVEMENTS EXPRESSED OR
IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. SUCH FUTURE RESULTS ARE BASED UPON
MANAGEMENT'S BEST ESTIMATES BASED UPON CURRENT CONDITIONS AND THE MOST RECENT
RESULTS OF OPERATIONS. WHEN USED IN THIS REPORT, THE WORDS "EXPECT,"
"ANTICIPATE," "INTEND," "PLAN," "BELIEVE," "SEEK," "ESTIMATE" AND SIMILAR
EXPRESSIONS ARE GENERALLY INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS,
BECAUSE THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES. THERE
ARE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
THOSE EXPRESSED OR IMPLIED BY THESE FORWARD-LOOKING STATEMENTS, INCLUDING OUR
PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS AND OTHER FACTORS.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
BUSINESS
--------
Simulations Plus, Inc. (the "Company" or "Simulations Plus", or "we" or "our")
and its wholly owned subsidiary, Words+, Inc. ("Words+") produce different types
of products: (1) Simulations Plus, incorporated in 1996, develops and produces
modeling and simulation software for use in pharmaceutical research and for
education, and also provides contract research services to the pharmaceutical
industry, and (2) Words+, founded in 1981, produces computer software and
specialized hardware for use by persons with disabilities, as well as a personal
productivity software program called Abbreviate! for the retail market. For the
purposes of this document, we sometimes refer to the two businesses as
"Simulations Plus" when referring to the business that is primarily
pharmaceutical software and services, and "Words+" when referring to the
business that is primarily assistive technologies for persons with disabilities.
SIMULATIONS PLUS
----------------
PRODUCTS
--------
We currently offer five software products for pharmaceutical research:
GastroPlus(TM), ADMET Predictor(TM), ADMET Modeler(TM), and ClassPharmer(TM).
Just before the end of the fiscal year, we acquired the assets of Sage
InformatIcs, LLC ("Sage") of Santa Fe, New Mexico, including three products:
ChemTK(TM), ChemTK Lite(TM), and ChemTKX(TM), and The CEO of Sage joined
Simulations Plus as a Senior Scientist and Product Manager for this business
area.
1
GASTROPLUS
----------
GastroPlus is a computer program for the simulation of the absorption and
pharmacokinetics of drugs in the human gastrointestinal tract as well as in a
number of standard laboratory animals. This sophisticated simulation has
equations for the movement of the drug through the gastrointestinal tract, how
fast it dissolves or precipitates along the way, whether it is converted to a
different molecular form in the gastrointestinal tract prior to absorption, and
how fast it is absorbed through various regions of the intestinal wall into the
blood stream. With additional inputs, it also simulates the concentration of
drug in the blood plasma versus time. With an optional module called PDPlus(TM),
the program can also simulate how a drug affects the body, such as reducing
pain, reducing blood pressure, reducing depression, and adverse side effects.
GastroPlus is used from early drug discovery through development and into early
clinical trials. The information provided through these simulations guides
project decisions in various ways. Among the kinds knowledge gained through such
simulation are: (1) whether a potential new drug compound is likely to be
absorbed at high enough levels to achieve the desired blood concentrations
needed for effective therapy, (2) whether the absorption process is affected by
certain transporter proteins in the intestinal tract that may cause absorption
to be very different from one region to another, (3) when certain properties of
a new compound can be adequately estimated through computer ("in silico")
predictions or simple experiments rather than through more expensive and
time-consuming experiments, (4) what the likely variations in blood
concentration levels would be in a large population, in different age groups or
in different ethnic groups, and (5) whether a new generic formulation for an
existing approved drug is likely to demonstrate "bioequivalence" (equivalent
blood concentration versus time) to the currently marketed dosage form in a
human trial.
Our marketing intelligence indicates that GastroPlus is the industry "gold
standard" for this type of simulation, enjoying a dominant position in the
number of users worldwide. In addition to virtually every major pharmaceutical
company, licenses include a number of generic drug companies and drug delivery
companies (companies that design the tablet or capsule for a drug compound that
was developed by another company). Although these companies are considerably
smaller than the pharmaceutical giants, they can also save considerable time and
money using our software tools. We believe this part of the industry, which
includes hundreds of companies, represents major growth potential for
GastroPlus.
We are aware that other companies have developed competitive software; however,
based on customer feedback, we believe that the competitive threat to GastroPlus
is limited. The PBPKPlus(TM) module in final development during this reporting
period will further extend the utility of GastroPlus. Our recognized expertise
in oral absorption and pharmacokinetics is evidenced by the fact that our staff
members have been speakers or presenters at over 40 prestigious scientific
meetings worldwide in the past three years. We conduct contracted studies for
customers who prefer to have studies run by our scientists rather than to
license our software and train someone to use it.
ADMET PREDICTOR
---------------
In addition to simulation software, we produce software that consists of
statistically significant numerical models that predict a variety of properties
of chemical compounds from just their molecular structures. This kind of
predictive capability means a chemist can merely draw a molecule diagram and get
reasonable estimates of these properties, even though the molecule has never
existed. When drug companies try to find new drugs, they search through
thousands or millions of such molecular structures. The vast majority of these
are not suitable as medicines. Some have such low solubility that they will not
dissolve well, some have such low permeability through the intestinal wall that
they will not be absorbed well enough to reach the required concentration in
blood, some degrade so quickly that they are not stable enough to have a useful
shelf life, some bind to proteins in blood (like albumin) to such a high extent
that little unbound drug is available to reach the target, and some will be
toxic in various ways. Identification of such properties as early as possible
enables researchers to eliminate poor compounds without spending time and money
to run experiments to identify these weaknesses. Today, many molecules are
eliminated on the basis of computer predictions, such as those provided by ADMET
Predictor.
2
ADMET Predictor provides estimates for approximately 50 properties of new
drug-like molecules from their structures. Recent product improvements included
a state-of-the-art prediction of ionization constants ("pKa's") for molecules,
which tells chemists whether the molecules will ionize (add or give up hydrogen
atoms) at different pH levels in the body. Ionization is especially important
because it has a major effect on many other properties, like solubility,
permeability, and binding to various proteins. ADMET Predictor is now one of the
few programs available in the world that provides accurate prediction of pKas,
and we believe the predictive accuracy of the pKa model in ADMET Predictor is
unsurpassed.
During this reporting period, we have added a series of toxicity predictions to
ADMET Predictor. Toxicity prediction was identified as one of the critical needs
for pharmaceutical research and development in a white paper called the
"Critical Path Initiative" issued by the U.S. Food and Drug Administration in
March 2004. At the end of this reporting period, ADMET Predictor included six
toxicity predictions. Identifying likely failure modes for potential new drug
molecules can help to reduce the high cost and long development time for new
drugs.
With these new capabilities, we believe ADMET Predictor combines the most
comprehensive and accurate set of predictions for Absorption, Distribution,
Metabolism, Excretion and Toxicity (ADMET) available today.
ADMET MODELER
-------------
Our third core product, ADMET Modeler was released in July of 2003. This
powerful program is used to generate the predictive models used in ADMET
Predictor in a small fraction of the time once required to build these models.
For example, the six toxicity models in our new ADMET Predictor Toxicity Module
were developed in a matter of a few weeks. Most of that time was spent in
cleaning up the databases (which seem to always contain a number of errors).
Prior to the availability of ADMET Modeler, we would have needed as much as
three months after cleaning the databases for each of the six models to obtain
similar results.
Pharmaceutical companies spend enormous amounts of money conducting a wide
variety of experiments on new molecules each year. Using such data to build
predictive models provides a second return on this investment; however, in the
past, model-building has traditionally been a tedious activity that required a
specialist. With ADMET Modeler, scientists without model-building experience can
use their own experimental data to create very high quality predictive models.
For example, if a company runs solubility experiments for 500 molecules out of
50,000 new similar potential drug molecules (called a "chemical series"), it can
then use ADMET Modeler to generate a predictive solubility model for the other
49,500 molecules in the same series. In the past, a modeling specialist might
have needed 2-3 months to produce equivalent models. With ADMET Modeler, the
time to generate a predictive model for 500 molecules has been reduced to
minutes for a person with minimal training in modeling.
DDDPLUS
-------
We announced the release of our fourth core product, DDDPlus (Dose
Disintegration and Dissolution Plus), in February 2005. DDDPlus simulates how
different tablets and capsules disintegrate and dissolve during IN VITRO
(laboratory) dissolution experiments. The program also simulates the effects of
changing formulation excipients (additives that are not the active drug), and
changing the experimental apparatus and fluids used in the experiment. We
believe this tool will be a valuable asset for formulation scientists as they
search for optimum formulations that provide desirable properties at minimum
cost, as well as optimum experimental conditions under which to measure
disintegration and dissolution to best predict what will happen in human. The
market for this tool includes hundreds of drug delivery companies as well as all
pharmaceutical and biotech companies.
3
Over 60 companies have evaluated DDDPlus. This is an indication of the strong
interest and business potential in this area. However, few licenses were sold
through the end of the fiscal year. Through the evaluation process, we received
valuable feedback on what would be required for various customers to license the
software, and we are now incorporating those improvements. We remain confident
that sales of DDDPlus licenses will take place. The initial release has served
us well to stimulate interest in this first-of-its-kind software and to get
formulation scientists thinking about how to use such a capability in their
work.
CHEMTK
------
In August 2005 we acquired all of the assets of Sage Informatics, LLC, ("Sage")
and the CEO of Sage joined Simulations Plus as a senior scientist. The software
assets acquired from Sage were the software programs ChemTK, ChemTK Lite, and
ChemTKX. ChemTK program takes as input a set of molecular structures and one or
more measured properties for each of those structures (typically activity
against a target protein from high throughput screening, but any property can be
used). The program then constructs classes or clusters of molecules that have
common substructures. This involves complex graph theory and sophisticated
mathematical algorithms to identify structural elements that various molecules
have in common. These common substructures are then used to group molecules into
classes. Classes can then be compared to find those with consistently high
activity. The substructures for those classes provide chemists with valuable
information regarding the structural characteristics that produce good
properties.
Subsequent to the end of the fiscal year ended August 31, 2005, we acquired
certain secured assets of Bioreason, Inc. from its former creditors, including
two patents governing classification algorithms and a software package called
ClassPharmer(TM). ClassPharmer is also a classification software program,
similar in nature to ChemTK, but with the more sophisticated and patented
classification algorithms and various convenience features. ClassPharmer was
programmed in a combination of programming languages that make it run much more
slowly than ChemTK, and certain elements of the ChemTK user interface are more
user-friendly and visually pleasing than ClassPharmer.
Our strategy for acquiring Sage was to eventually acquire both products and to
integrate them into a single package, which will become ClassPharmer 4.0 (our
current version is ClassPharmer 3.5).
EDUCATIONAL SOFTWARE
--------------------
In addition to our pharmaceutical software, we also produce a set of
award-winning science experiment simulations (computer programs for Windows and
Macintosh computers) for middle school and high school students under the
umbrella name of FutureLab(TM). These simulations incorporate the equations of
chemistry and physics for each experiment (optics, electrical circuits, gravity,
universal gravitation, and ideal gases), and allow students to design and
conduct their own experiments in a virtual laboratory environment. Although
development of FutureLab software was discontinued in 1998, low-level sales have
continued through distributors in the U.S., U.K., Australia, and New Zealand.
CONTRACT RESEARCH SERVICES
--------------------------
We offer contract research services to the pharmaceutical industry in the area
of gastrointestinal absorption, pharmacokinetics, structure-property model
building, and related technologies. These studies provide us an additional
source of revenue, as well as a means to introduce our software products to new
customers. Such studies are also beneficial to us to validate and enhance our
products by studying actual data in the pharmaceutical industry. The business of
contracted studies is growing, and we believe it could contribute significantly
to our revenues and earnings; however, we plan to control growth in this area
such that it does not adversely impact our product development stream.
4
PHARMACEUTICAL SIMULATIONS SOFTWARE PRODUCT DEVELOPMENT
-------------------------------------------------------
Although all of our development work cannot be disclosed for competitive
reasons, some of our development efforts during this reporting period included:
(1) PBPKPlus(TM) Module
-----------------------
PBPK (physiologically based pharmacokinetics) simulations enable researchers to
predict the amount of drug that reaches different body tissues and organs. This
is an important new capability because it is one of the most promising
technologies for predicting human pharmacokinetics from animal data
(pharmacokinetics refers to what happens to the drug after it enters the body).
This capability enables scientists to estimate the concentration of drug in
various body tissues, which contributes to a better understanding of both
therapeutic and adverse effects. Without the ability to predict these effects,
clinical trial costs can soar when trials must be repeated to determine proper
dosing levels.
The development of this new module, which included a major upgrade to almost all
other aspects of our flagship GastroPlus software, extended through the end of
the fiscal year. We had expected release of this capability much earlier;
however, the complexity of the changes to the program exceeded our estimates,
and additional time was required to ensure that the release of this new version
would meet the needs of our customers.
(2) Multiple Particle Size Dissolution Model
--------------------------------------------
The current dissolution model in GastroPlus uses a single "effective" particle
size. While this has adequately represented the dissolution of most tablets,
capsules, and suspensions to date, formulation researchers know that real dosage
forms do not consist of particles that are all one size. Instead, there is a
distribution of particle sizes from smaller than average to larger than average.
Smaller particles dissolve faster than larger particles. For some drugs, this
results in dissolution behavior that is not well-modeled with a single effective
particle size. This new model will allow formulation researchers to assess the
effects of different particle size distributions on dissolution and absorption.
The multiple particle size model has already been demonstrated in our DDDPlus
software. We plan to incorporate it into GastroPlus as part of a Formulation
Module in calendar 2006.
(3) DDDPlus
-----------
The DDDPlus (Dose Disintegration and Dissolution Plus) software is being
improved by incorporating additional functionality in accordance with comments
and suggestions received from approximately 60 companies who evaluated the
initial release. A number of enhancements have been incorporated at this time
and several more are in progress. We expect to release a much-enhanced version
of DDDPlus in early calendar year 2006.
(4) ADMET Predictor upgrades
----------------------------
The initial toxicity predictions in ADMET Predictor were released during fiscal
year 2005, and we have continued to add new toxicity models steadily. At this
time, we are working on additional such models, but we are not revealing their
nature for competitive reasons.
(5) MembranePlus(TM)
--------------------
MembranePlus is a computer program that simulates IN VITRO experiments that
measure the permeability of new drug-like molecules through a layer of living
cells or through an artificial membrane. These experiments are conducted in
order to estimate the permeability of new drug compounds through the human
intestinal wall and into the blood. However, such experiments do not produce
results that are easily translated into human permeabilities. We believe that a
detailed mechanistic simulation of these IN VITRO experiments will provide the
insight and understanding needed to provide reasonably accurate estimates of
permeability in different regions of the human intestinal tract from IN VITRO
data.
5
This development effort has accelerated with the hiring of a new Ph.D. scientist
who has focused on this program. We have now progressed to the point where the
simulation is predicting the movement of drug molecules through the bulk fluid,
into the membranes at the surface of a cell layer, through the surface membrane,
through the interior of the cell, into the opposite surface membrane, and
through it to the bulk fluid on the opposite side of the cell layer. Although a
few technical issues remain to be resolved, we are optimistic that the
simulation will become a unique tool for the analysis of data from these
experiments, and will enable researchers to more accurately human intestinal
permeability from these IN VITRO experiments. We are not aware of any other
effort to produce a product of this nature.
MARKETING AND DISTRIBUTION
--------------------------
We market our pharmaceutical software and consulting services through attendance
and presentations at scientific meetings, exhibits at trade shows, seminars at
pharmaceutical companies and government agencies, through our web pages on the
Internet, and using various communication media to our compiled database of
prospect and customer names. Until recently, our scientific team has also been
our only sales and marketing team. We believe that this was more effective than
a separate sales team for several reasons: (1) customers appreciate talking
directly with developers who can answer a wide range of technical questions
about methods and features, (2) our scientists benefit from direct customer
contact through gaining an appreciation for the environment and problems of the
customer, and (3) the relationships we build through scientist-to-scientist
contact are stronger than through salesperson-to-scientist contacts. One of our
scientists recently moved to the marketing and sales department and is now a
full-time field sales representative. His strong familiarity with our product
line after over two years as a product scientist and software developer has
prepared him well for his new role. In addition, we added an in-house support
person during the fiscal year to improve our ability to follow up on leads
generated at scientist meetings, through our web site, and through our other
communication media.
We use our web pages on the Internet for such activities as providing product
information, providing software updates, and as a forum for user feedback and
information exchange. We have cultivated significant market share in North
America, Europe, and in Japan, and Internet and e-mail technologies have had a
strong positive influence on our ability to communicate with existing and
potential customers worldwide.
PRODUCTION
----------
Our pharmaceutical software products are designed and developed entirely by our
development team at our Lancaster, California facility. The chief materials and
components used in the manufacture of simulation software products include
CD-ROMs and instruction manuals, which are also produced in-house. Robotic CD
burner technology along with in-house graphic art and engineering talent enable
us to accomplish this production in a cost-efficient manner.
COMPETITION
-----------
In our pharmaceutical software and services business, we compete against a
number of established companies that provide screening, testing and research
services, and products that are not based on simulation software. There are also
software companies whose products do not compete directly, but are sometimes
closely related. Our competitors in this field include companies with financial,
personnel, research and marketing resources that are greater than ours. While
management believes there is currently no significant competitive threat to
GastroPlus, DDDPlus, or ClassPharmer. ADMET Predictor and ADMET Modeler operate
in a more competitive environment; however, independent product comparisons have
been very favorable toward our offerings. Several other companies presently
offer simulation or modeling software, or simulation-software-based services, to
the pharmaceutical industry.
6
Major pharmaceutical companies conduct drug discovery and development efforts
through their internal development staffs and through outsourcing some of this
work. Smaller companies need to outsource a greater percentage of this research.
Thus, we compete not only with other software suppliers, but also with the
in-house development teams at some pharmaceutical companies.
We are not aware of any significant competition in the area of gastrointestinal
absorption simulation. Although a few competitive products exist, both new
licenses and license renewals for GastroPlus have continued to grow in spite of
this competition. We enjoy a dominant market share in this segment. We believe
the completion of GastroPlus 5.0 with the PBPKPlus module will put GastroPlus
further ahead of its competitors.
We believe the key factors in competing in this field are our ability to develop
simulation and modeling software and related products and services to
effectively predict the ADMET-related behaviors of new drug-like compounds, our
ability to develop and maintain a proprietary database of results of physical
experiments that will serve as a basis for simulated studies and empirical
models, our ability to continue to attract and retain a highly skilled
scientific and engineering team, and our ability to develop and maintain
relationships with research and development departments of pharmaceutical
companies, universities and government agencies.
WORDS+
------
PRODUCTS
--------
Our wholly owned subsidiary, Words+, Inc. has been an industry pioneer and
technology leader for over 24 years in introducing and improving augmentative
and alternative communication and computer access software and devices for
disabled persons and intends to continue to be at the forefront of the
development of new products. We will continue to enhance our major software
products, E Z Keys and Say-it! SAM, as well as our growing line of hardware
products. We will also consider acquisitions of other products, businesses and
companies that are complementary to our existing augmentative and alternative
communication and computer access business lines. We purchased the Say-it! SAM
technologies from SAM Communications, LLC of San Diego in December 2003. This
acquisition gave us our smallest, lightest augmentative communication system,
which is based on a Compaq iPAQ personal digital assistant (PDA). PDA-based
communication devices have been very successful in the augmentative
communication market, and this technology purchase has enabled us to move into
this market segment faster and at lower cost than developing the product
ourselves.
Since the acquisition of the Say-it! SAM technologies, we have continued to add
new functionality to SAM and to offer it on additional platforms. At the CSUN
conference in March 2005, we introduced the SAM Tablet XP1, our Windows XP-based
tablet. At the Closing The Gap conference in October 2005, we announced the
expected December release of our SAM for PC version, allowing SAM to be
distributed on virtually any Windows XP desktop or laptop computer. All received
enthusiastic responses from both potential customers and Words+ dealers alike.
MARKETING AND DISTRIBUTION
--------------------------
We market augmentative and alternative communication products through a network
of employee representatives and independent dealers and resellers.
At the present time we have 37 sales representatives worldwide: 1
salary/commission salesperson in California, 14 independent distributors and 6
independent resellers in the U.S., and 16 sales representatives overseas - 4 in
Australia, and 1 each in New Zealand, Canada, England, Norway, Finland, The
Netherlands, France, Italy, Israel, Japan, Korea, Mexico and Malaysia. We also
have 2 inside sales/support persons, who answer e-mails and telephone inquiries
on our toll-free telephone line and who provide technical support. Additional
outside sales persons and independent dealers and resellers are being actively
recruited.
7
We direct our marketing efforts to speech pathologists, occupational therapists,
rehabilitation engineers, special education teachers, disabled persons and
relatives of disabled persons. We maintain a mailing list of over 10,000 people
made up of these professionals, consumers and relatives, and we mail various
marketing materials to this list. These materials include our catalog of
products and announcements regarding new and enhanced products.
We participate in industry conferences held worldwide that are attended by
speech pathologists, occupational and physical therapists, special education
teachers, parents and consumers. We and others in the industry demonstrate our
products at these conferences and present technical papers that describe the
application of our technologies and research studies on the effectiveness of our
products. The Communication Aids Manufacturers Association (CAMA), co-founded by
our CEO over ten years ago, distributes sales literature to professionals,
consumers and parents in the field. We advertise in selected publications of
interest to persons in this market.
We estimate that for approximately 50% of our sales of augmentative and
alternative communication ("AAC") software and hardware, some or all of the
purchases are funded by third parties such as Medicaid, Medicare, school special
education budgets, private insurance or other governmental or charitable
assistance. Medicare provides coverage of augmentative communication devices.
Our personnel provide advice and assistance to customers and prospective
customers on obtaining third-party financial assistance for purchasing our
products. Third party funding has grown slowly but continuously for 20 years.
The addition of Medicare coverage for AAC devices was the largest single
increase in third party funding in our history. Our Medicare/Medicaid sales have
grown, and approximately 40% of total sales are funded by Medicare/Medicaid.
Such sales are subject to funding caps that limit the amounts paid for our
products, and payment by some agencies can be slow, making this market segment
somewhat more difficult than others.
PRODUCTION
----------
Disability software products are either loaded onto computer hard disk drives by
our employees or copied to diskettes, CD-ROM, or memory cards, which is
performed in-house. Most software customers also buy their notebook personal
computers from us, which we purchase at wholesale prices and resell at a markup.
We purchase microprocessors that are part of dedicated devices such as
MessageMates(TM). We design our cases, printed circuit boards, labels and other
components of products such as MessageMates and MicroCommPacs(TM). We outsource
the extrusion, machining and manufacturing of certain components. All final
assembly and testing operations are done by our employees at our facility.
Our products are shipped from our Lancaster, California facility either directly
to the customer or to the salesperson, dealer or reseller. For major products,
the outside salesperson, dealer or reseller either delivers the product or
visits the customer after delivery to provide training.
COMPETITION
-----------
The AAC industry in which we operate is highly competitive and some of our
competitors have greater financial and personnel resources than ours. The
industry is made up of about six major competitors including Words+, and a
number of smaller ones. Based on personal conversations with our outside dealers
and customers, we believe that the other major competitors each have revenues
ranging from $3 million to under $50 million, so that there are no large
companies in this industry.
8
We believe that the competition in this industry is based primarily on the
quality of products, quality of customer training and technical support, and
quality and size of sales forces. Price is a competitive factor but we believe
price is not as important to the customer as obtaining the product most suited
to the customer's needs, along with strong after-sale support. We believe that
we are a leader in the industry in developing and producing some of the most
technologically advanced products and in providing quality customer training and
technical support. The prices of our products are among the highest in the
industry and we have one of the smallest sales forces and dealer networks in the
industry. We believe that the potential exists for significant increases in the
sales of our disability products; however, there are few barriers to entry in
the form of proprietary or patented technology or trade secrets in this
industry. While we believe that cost of product development and the need for
specialized knowledge and experience in this industry would present some barrier
to entry for new competition, other companies may enter this industry, including
companies with substantially greater financial resources than ours. Furthermore,
companies already in this industry may increase their market share through
increased technology development and marketing efforts.
TRAINING AND TECHNICAL SUPPORT
------------------------------
We believe customer training and technical support are important factors in
customer satisfaction for both our pharmaceutical and disability products, and
we believe we are an industry leader in providing customer training and
technical support. For pharmaceutical software, we provide in-house seminars at
customers' sites. These seminars often serve as initial training in the event
the potential customer decides to license or evaluate our software. Technical
support is provided after the sale in the form of on-site training (at
customer's expense), telephone, fax, and e-mail assistance to users, as well as
software upgrades, if any, that may be released during the customer's license
period. Software licenses are on an annual basis, and include all maintenance
upgrades to the modules licensed by the customer during the license year. We
have also used Internet meetings extensively to provide demonstrations and
customer assistance, resulting in rapid response to requests worldwide and
reducing our travel time and expenses.
For Disability Products, our salesperson, dealer or reseller provides initial
training to the customer for major systems -- typically two to four hours. This
training is typically provided not only to the user of the product but also to
the person's speech pathologists, teachers, parents and others who will be
assisting the user. This initial training for the purchase of full systems is
often provided as a part of the price of the product. We and our dealers charge
a fee for additional training and service calls.
Technical support for both pharmaceutical software and disability products is
provided by our life sciences team and our inside sales and support staff based
at our headquarters facilities in Lancaster, California. We provide free
telephone support offering unlimited toll-free numbers in the U.S. and Canada,
and e-mail support for all of our pharmaceutical software and disability
products worldwide. Technical support for pharmaceutical software products is
minimal, averaging a few person-hours per month. Technical support for Words+
products varies from none for most customers to as much as several hours for
others. Words+ dealers usually train new customers at the customer's location,
which significantly reduces technical support demands on our staff.
RESEARCH AND DEVELOPMENT
------------------------
We believe that our ability to grow and remain competitive in our markets is
strongly dependent on significant investment into research and development
("R&D"). R&D activities include both enhancement of existing products and
development of new products. Development of new products is capitalized in
accordance with Financial Accounting Standards No. 86 and AICPA Statement of
Position 98-1. R&D expenditures were approximately $1,049,000 during fiscal year
2005, of which $524,000 was capitalized. R&D expenditures during fiscal year
2004 were approximately $736,000, of which $221,000 was capitalized. R&D
expenditures in fiscal year 2005 include the purchase of the assets of Sage.
9
Our pharmaceutical business R&D activities during fiscal year 2005 were focused
on improving our GastroPlus, ADMET Predictor, ADMET Modeler, and DDDPlus
products, and developing one new pharmaceutical software product,
MembranePlus(TM).
Our R&D activities for our Words+ subsidiary were focused on improvement of our
E Z Keys(TM) and Say-it! SAM(TM) software products, the development of the
Windows CE-based SAM Tablet(TM).
EMPLOYEES
---------
As of November 28, 2005, we employed twenty seven full-time and three part-time
employees, including eleven in research and development, five in marketing and
sales, eight in administration and accounting, five in production and one in
repair. Five current employees hold Ph.D.'s and one is a Ph.D. candidate in
their respective science or engineering disciplines and four additional
employees hold one or more Master's degrees. All but two of the senior
management team and Board of Directors hold graduate degrees. We believe that
our future success will depend, in part, on our ability to continue to attract,
hire and retain qualified personnel. The competition for such personnel in the
pharmaceutical industry and in the augmentative and alternative communication
device and computer software industry is intense. None of our employees is
represented by a labor union, and we have never experienced a work stoppage. We
believe that our relations with our employees are good.
PATENTS
-------
During fiscal year 2005, we owned no patents. We primarily protect our
intellectual property through copyrights and trade secrecy. Our intellectual
property consists primarily of source code for computer programs and data files
for various applications of those programs in both the pharmaceutical software
and the disability products businesses. In the disability products business,
electronic device schematics, mechanical drawings, and design details are also
intellectual property. The expertise of our technical staff is a considerable
asset closely related to intellectual property, and attracting and retaining
highly qualified scientists and engineers is essential to our business.
EFFECT OF GOVERNMENT REGULATIONS
--------------------------------
Our pharmaceutical software products are tools used in research and development
and are neither approved nor approvable by the Food and Drug Administration or
other government agency. Approximately 33% of our products for the disabled are
funded by Medicare or Medicaid programs. Changes in government regulations
regarding the allowability of augmentative communication aids and other
assistive technology under such funding could affect our business. On January 1,
2001, Medicare began funding augmentative communication devices for the first
time. Over our 24-year history, the trend has been toward increasing funding
from government agencies; however, there can be no assurance that government
funding for such devices will continue, or if it does continue, that our
products will continue to meet the requirements imposed for funding of such
devices.
10
ITEM 2. DESCRIPTION OF PROPERTIES
Our current office lease expired in August 2005, and we are now renting
on a month-to-month basis. We have signed a new lease for a building located
approximately two miles from the current office. The new building is under
construction, and is expected to be completed in January 2006. At the new
location, we will lease approximately 13,500 square feet of space under a
five-year term with two (2), three (3) year options to extend its lease. The new
lease will be effective within two weeks of the city of Lancaster final approval
of building. The base rent starts at the rate of $15,779 per month plus common
area maintenance fee. The base rental rate will increase at 4% annually. We
believe that this new facilities are sufficient for current needs and growth in
near future.
ITEM 3. LEGAL PROCEEDINGS
While we may from time to time be involved in various claims, lawsuits or
disputes with third parties, we are not currently a party to any significant
litigation and are not aware of any significant pending or threatened litigation
against us. In a subsequent event, we have been contacted by a former Bioreason
salesperson in France regarding his status and status of certain contracts after
our acquisition of certain secured assets of Bioreason from its creditors.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal year 2005.
11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Common Stock is currently traded on the American Stock Exchange (AMEX) under
the symbol "SLP". According to records of our transfer agent, we had about 66
stockholders of record and approximately 600 beneficial owners as of August 31,
2005. The following table sets forth the low and high sale prices for the Common
Stock for each of the last two fiscal years as listed on the AMEX for the
periods from March 17, 2004 to August 31, 2005, and as quoted on the OTCBB for
the periods prior to March 17, 2004, indicated below in each of the last two
fiscal years. The quotations quoted for the over-the-counter market reflect
inter-dealer prices, without retail mark-up, mark-down or commission, and may
not represent actual transactions. We have not paid cash dividends on our Common
Stock. We currently intend to retain our earnings for future growth, and
therefore do not anticipate paying cash dividends in the foreseeable future. Any
further determination as to the payment of dividends will be at the discretion
of our Board of Directors and will depend among other things, on our financial
condition, results of operations, capital requirements and such other factors as
the Board of Directors deems relevant.
LOW SALES PRICE HIGH SALES PRICE
--------------- ----------------
FY05:
Quarter ended August 31, 2005........ 3.32 4.49
Quarter ended May 31, 2005........... 3.25 4.80
Quarter ended February 28, 2005...... 4.15 6.70
Quarter ended November 30, 2004...... 3.21 5.20
FY04:
Quarter ended August 31, 2004........ 3.22 4.52
Quarter ended May 31, 2004........... 4.35 7.55
Quarter ended February 28, 2004...... 4.20 7.55
Quarter ended November 30, 2003...... 3.05 5.95
12
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS
REPORT.
RESULTS OF OPERATIONS
The following sets forth selected items from our statements of operations (in
thousands) and the percentages that such items bear to net sales for the fiscal
years ended August 31, 2005 ("FY05") and August 31, 2004 ("FY04").
FY05 FY04
---------------------------- --------------------------
Net sales $4,752 100.0% $5,207 100.0%
Cost of sales 1,508 31.7 1,557 29.9
--------------- ------------ ------------- ------------
Gross profit 3,244 68.3 3,650 70.1
--------------- ------------ ------------- ------------
Selling, general, and administrative 2,423 51.0 2,508 48.2
Research and development 525 11.0 515 9.9
--------------- ------------ ------------- ------------
Total operating expenses 2,948 62.0 3,023 58.1
--------------- ------------ ------------- ------------
Income from operations 296 6.2 627 12.0
--------------- ------------ ------------- ------------
Interest income 44 0.9 73 1.4
Interest expense, net (1) - (1) -
Gain on sale of assets 15 0.3 - -
Loss on currency exchange (6) (0.1) - -
--------------- ------------ ------------- ------------
Total other income 52 1.1 72 1.4
--------------- ------------ ------------- ------------
Net income before taxes 348 7.3 699 13.4
--------------- ------------ ------------- ------------
Benefit from (provision for) income taxes (86) (1.8) 138 2.7
--------------- ------------ ------------- ------------
Net income 262 5.5% 837 16.1%
--------------- ------------ ------------- ------------
FY05 COMPARED WITH FY04
-----------------------
NET SALES
---------
Our net sales for FY05 decreased by $455,000 or 8.7%, to $4,752,000 compared to
$5,207,000 for FY04. Sales from pharmaceutical and educational software
("Simulations Plus sales") decreased approximately $788,000, or 27.6%, however
Words+, Inc.'s sales increased approximately $333,000, or 14.2% for the year.
We attribute the decrease in consolidated net sales to a decrease in
pharmaceutical software in FY05 compared with FY04, which outweighed the
increase in Words+ sales. The largest changes in pharmaceutical software and
services revenues were due to three factors: (1) revenues of $860,000 from
multi-year software licenses with two customers in FY04 were recognized during
that fiscal year, resulting in no revenue recognized in FY05 for those licenses;
(2) three smaller customers did not renew their annual licenses, resulting in a
net decrease of $80,000, although this was well offset by eight new customers
that generated revenues of $259,000; and (3) income from study contracts
decreased by $65,000.
For Words+, our overall product sales were increased by sales of our Say-it!
SAM(TM) product which outweighed loweR sales for the Freedom(TM) product and
larger discounts taken by Medicare/Medicaid.
13
COST OF SALES
-------------
Our consolidated cost of sales for FY05 decreased by $49,000, or 3.2%, to
$1,508,000 from $1,557,000 in FY04. As a percentage of sales, cost of sales was
31.7% for FY05, compared to 29.9% for FY04, a 1.8% increase. For Simulations
Plus, cost of sales decreased $86,000, or 26.5%. We reassessed the estimated
life of our pharmaceutical software in FY05 based on our demonstrated product
lives, increasing the amortization of remaining capitalized software development
costs from 36 months to 60 months. If we amortized it using the same estimated
life in FY04, the amortization cost for FY05 would be $132,000, which would have
resulted in a decrease of $19,000, or 5.9%. A significant portion of cost of
sales is the systematic amortization of capitalized software development costs,
which decreased $69,000, or 51.3%, and royalty expense, which we pay to TSRL for
GastroPlus sales, which decreased $16,000, or 8.7%. As a percentage, costs of
sales for FY05 and FY04 are nearly identical, 11.5% and 11.4% respectively.
For our Words+ subsidiary, cost of sales for FY05 increased by $37,000, or 3.0%.
As a percentage of sales, cost of sales decreased to 47.3% in FY05, compared to
52.4% in FY04. Management attributes this decrease primarily due to our
restructuring of Words+ in the 4th quarter of FY04, which increased our profit
margin by increasing the prices on some products while maintaining the cost.
GROSS PROFIT
------------
Consolidated gross profit decreased $406,000, or 11.1%, to $3,244,000 in FY05
from $3,650,000 in FY04. Our gross profit margin decreased 1.8%, to 68.3% in
FY05, compared to 70.1% in FY04, primarily due to the lower sales of
pharmaceutical software, in spite of an increase in gross profit from Words+
operations, which improved in spite of an increase in Medicare/Medicaid orders,
which have a lower profit margin due to their required discounts, and a decrease
in sales of higher margin products such as MessageMate.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
--------------------------------------------
Selling, general and administrative ("SG&A") expenses for FY05 decreased by
$85,000, or 3.4%, to $2,423,000, compared to $2,508,000 for FY04. For
Simulations Plus, SG&A expenses increased $120,000, or 10.1%. The major
increases in expenses were in the categories of selling expenses such as
commissions and trade shows, equipment leases, investor relations fees, and
salary increases, along with payroll-related expenses such as health insurance,
payroll taxes and 401(k) matching contributions. These increases outweighed
decreases in legal and accounting fees, sales taxes to Japan (which are no
longer required by a new tax treaty between US and Japan), and annual bonuses to
our President and Secretary.
For Words+, expenses decreased $205,000, or 15.6%, due to reductions in salaries
and payroll-related expenses such as health insurance, payroll taxes and 401(k)
matching contributions, business insurance, telephone, travel expenses and
catalog expenses. These decreases outweighed increases in commissions, contract
labor, and equipment repair.
RESEARCH AND DEVELOPMENT
------------------------
We incurred approximately $1,049,000 of research and development costs for both
companies during FY05. Of this amount, $524,000 was capitalized and $525,000 was
expensed. For FY04, we incurred approximately $736,000 of research and
development costs, of which approximately $221,000 was capitalized and
approximately $515,000 was expensed. The 42.5% increase in research and
development expenditure from FY05 to FY04 was due primarily to our purchase of
the ChemTK(TM) software product line from Sage Informatics, LLC, as well as
increased R&D staff and increases in salaries and bonuses.
INCOME FROM OPERATIONS
----------------------
During FY05, we generated income from operations of $296,000, as compared to
$627,000 for FY04. We attribute this decrease to the decrease in sales in
pharmaceutical software and services from the previous year in which we obtained
the large two-year software licenses. Our Words+ subsidiary generated a
significant increase in income from operations; however, the decrease in
operating income from our pharmaceutical software and services business
outweighed the increase in Words+ operating income.
14
OTHER INCOME AND (EXPENSE)
--------------------------
The net of other income (expense) for FY05 decreased by $20,000, or 27.6%, to
$52,000, compared to $72,000 for FY04. Interest income decreased by $29,000, or
40.7%, due primarily to a decrease in the amortization of present value discount
on long-term receivables to $32,000 in FY05 from $70,000 in FY04, which
outweighed an increase in interest income on bank accounts. The minimal interest
expenses incurred in FY05 and FY04 were almost the same. We recognized a gain of
$15,000 on sale of equipment and a loss of $6,000 on currency exchange in FY05,
while there were no such items in FY04.
BENEFIT FROM (PROVISION FOR) INCOME TAXES
-----------------------------------------
For FY05 as well as FY04, because of our net operating loss ("NOL") carry
forward applicable to Federal tax, and multiple tax credits applicable to both
Federal and State, we accrued only the minimum Franchise tax of $1,600 in the
state of California for the two companies. Based on the reconciliation of the
expected income tax, the company made a provision of $86,000 for income taxes in
FY05 while the company recognized the tax benefit of $138,000 from income taxes
in FY04. Please refer to the notes to the financial statements for the details.
NET INCOME
----------
Net income for FY05 decreased by $575,000, or 68.9%, to $262,000, compared to
$835,000 for FY04. We attribute this decrease to three factors: (1) the lower
revenues from pharmaceutical software and services and other income, (2) the
increase in R&D expenses, and (3) the change in provision for income taxes from
a benefit of $138,000 in FY04 to an expense of $86,000 in FY05, resulting in a
decrease of $224,000. Shareholders' equity grew by 9.4%, from $4.446 million to
$4.862 million during FY05.
SEASONALITY
-----------
Sales of our pharmaceutical and disability products exhibit minimal seasonal
fluctuation. In the last two years, the highest quarters were in the 3rd and 4th
quarters, and the lowest quarters were in the 1st and 2nd quarters. This
unaudited net sales information has been prepared on the same basis as the
annual information presented elsewhere in this Annual Report on Form 10-KSB and,
in the opinion of management, reflects all adjustments (consisting of normal
recurring entries) necessary for a fair presentation of the information
presented. Net sales for any quarter are not necessarily indicative of sales for
any future period.
Prior to FY04, we believes sales of its Words+ products to schools are slightly
seasonal, with greater sales to schools during our third and fourth fiscal
quarter (March-May and June-August), as shown in the table below.
Net Words+ Sales
FY
First Second Third Fourth Total
Quarter Quarter Quarter Quarter
(in thousands)
------------------------------------------- ------- ------- ------- ------- -------
2005....................................... 543 622 762 757 2,684
2004....................................... 496 627 630 598 2,351
15
Sales of pharmaceutical simulations, which began in the first quarter of FY99,
are not expected to show significant seasonal behavior. Although a significant
portion of the pharmaceutical industry receives extended summer holidays, the
fourth quarter was the strongest quarter for fiscal year 2004, 2003 and 2002,
but was the second lowest in FY05 and the lowest in FY01. Although no consistent
seasonal trend is observed or expected, we believe that sales may show quarterly
spikes when large orders are received.
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
Our principal sources of capital have been cash flows from our operations. We
have achieved continuous positive operating cash flow in the last six fiscal
years. We believe that our existing capital and anticipated funds from
operations will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for the foreseeable future. Thereafter, if cash
generated from operations is insufficient to satisfy our capital requirements,
we may open the revolving line of credit with banks, or have to sell additional
equity or debt securities or obtain expanded credit facilities. In the event
such financing is needed in the future, there can be no assurance that such
financing will be available to us, or, if available, that it will be in amounts
and on terms acceptable to us. If cash flows from operations became insufficient
to continue operations at the current level, and if no additional financing was
obtained, then management would restructure the Company in a way to preserve its
pharmaceutical and disability businesses while maintaining expenses within
operating cash flows.
INFLATION
---------
We have not been affected materially by inflation during the periods presented,
and no material effect is expected in the near future.
RECENT ACCOUNTING ANNOUNCEMENTS
-------------------------------
In December 2004, the FASB issued Statement of Accounting Standard No. 123R,
"Share-Based Payment", a revision of SFAS No. 123, "Accounting for Stock-Based
Compensation." SFAS 123R supersedes APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and amends Statement of Accounting Standards No. 9,
"Statement of Cash Flows." SFAS 123R requires all companies to measure
compensation expense for all share-based payments (including employee stock
options and options issued pursuant to employee stock purchase plans) based upon
the fair value of the stock-based awards at the date of grant. SFAS 123R is
effective for the Company for fiscal year beginning after December 15, 2005.
Retroactive application of the requirements of FASB Statement No. 123 to the
beginning of the fiscal year that includes the effective date is permitted, but
not required. Early adoption of Statement 123R is encouraged. A component of
SFAS 123R includes one of the following options: 1) modified-prospective method,
2) the modified-retrospective method, restating all prior periods, or 3) the
modified-retrospective method, restating only the prior interim periods of 2005.
A determination as to which of the three options we will adopt will be made at a
later date. As permitted by SFAS 123, we currently account for share-based
payments to employees using APB25's intrinsic value method and, as such, we
generally recognize no compensation cost for employee stock options.
Accordingly, the adoption of SFAS 123R's fair value method will have a
significant impact on our results of operations, although it will have no impact
on our overall financial position. The impact of adoption of Statement 123R
cannot be predicted at this time because it will depend on levels of share-based
payments granted in the future.
16
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections." This statement applies to all voluntary changes in accounting
principles and requires retrospective application to prior periods' financial
statements of changes in accounting principles, unless this would be
impracticable. This statement also makes a distinction between "retrospective
application" of an accounting principle and the "restatement" of financial
statements to reflect the correction of an error. This statement is effective
for accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. The Company is evaluating the effect the adoption of
this interpretation will have on its financial position, cash flows and results
of operations.
CRITICAL ACCOUNTING POLICIES
----------------------------
Our consolidated 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. Critical accounting policies
for us include revenue recognition, accounting for capitalized software
development costs, and accounting for income taxes.
REVENUE RECOGNITION
-------------------
We account for the licensing of software in accordance with American Institute
of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2,
"SOFTWARE REVENUE RECOGNITION". The application of SOP 97-2 requires judgment,
including whether a software arrangement includes multiple elements, and if so,
whether vendor-specific objective evidence (VSOE) of fair value exists for those
elements.
The end users receive certain elements of our products over a period of time.
These elements include free post-delivery telephone and e-mail support and the
right to receive unspecified upgrades/enhancements. In accordance with SOP 97-2,
we have evaluated these agreements and we have recognized the entire license fee
on the date the software is delivered to and accepted by the customer. In order
to recognize the fee in this manner, we have met all the criteria required,
including:
o The Post Contract Customer Support ("PCS") fee is included in the
initial licensing fee,
o The PCS included with the license is for one year or less,
o The estimated cost of providing the PCS during the arrangement is
insignificant, and
o Unspecified upgrades/enhancements during the PCS arrangements have
been and are expected to continue to be minimal and infrequent.
Changes to the elements in a software arrangement, the ability to identify VSOE
for those elements, the fair value of the respective elements, the costs
associated with providing PCS and changes to a product's estimated life cycle
could materially impact the amount of earned and unearned revenue. Judgment is
also required to assess whether future releases of certain software represent
new products or upgrades and enhancements to existing products.
For the revenue generated by Words+ software which is mainly sold as a part of
an integrated communication package or sometimes sold as a perpetual license, we
recognize its revenue at the time of title transfer within the terms described
in the UCC.
CAPITALIZED SOFTWARE DEVELOPMENT COSTS
--------------------------------------
Computer software development costs are capitalized in accordance with SFAS No.
86, "Accounting for the Cost of Computer Software to be Sold, Leased, or
Otherwise Marketed". Capitalization of software development costs begins upon
the establishment of technological feasibility. The establishment of
technological feasibility and the ongoing assessment for recoverability of
capitalized software development costs require considerable judgment by
management including, but not limited to, technological feasibility, anticipated
future gross revenues, estimated economic life, and changes in software and
hardware technologies. Any changes to these estimates could materially impact
the amount of amortization expense, research and development expense recognized
in the consolidated statement of operations and the amount recognized as
capitalized software development costs in the consolidated balance sheet.
17
INCOME TAXES
------------
SFAS No. 109, "ACCOUNTING FOR INCOME TAXES", establishes financial accounting
and reporting standards for the effect of income taxes. The objectives of
accounting for income taxes are to recognize the amount of taxes payable or
refundable for the current year and deferred tax liabilities and assets for the
future tax consequences of events that have been recognized in an entity's
financial statements or tax returns. Judgment is required in assessing the
future tax consequences of events that have been recognized in our financial
statements or tax returns. Fluctuations in the actual outcome of these future
tax consequences could materially impact our financial position or our results
of operations.
ITEM 7. FINANCIAL STATEMENTS
The responses to this item are included elsewhere in this Form 10-KSB (see pages
F1 - F23) and incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 8A. CONTROLS AND PROCEDURES.
Our management, with the participation of its Chief Executive Officer and Chief
Financial Officer, has evaluated the effectiveness of our disclosure controls
and procedures as of August 31, 2005. Based on this evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective for gathering, analyzing and disclosing
the information we are required to disclose in the reports we file under the
Securities Exchange Act of 1934, within the time periods specified in the
Commission's rules and forms. Such evaluation did not identify any change in the
year ended August 31, 2005 that has materially affected, or is reasonable likely
to materially affect, our internal control over financial reporting.
ITEM 8B. OTHER INFORMATION.
Not applicable.
18
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; COMPLIANCE WITH
SECTION 16(a) OF THE EXCHANGE ACT
Our directors currently have terms which will end at our next annual meeting of
our shareholders or until their successors are elected and qualify, subject to
their prior death, resignation or removal. Officers serve at the discretion of
the Board of Directors. Except as set forth below, there are no family
relationships among any of our directors and executive officers. The following
sets forth certain biographical information concerning our directors and current
executive officers.
NAME AGE POSITION WITH THE COMPANY SINCE
---------------------------- --- ------------------------------------------------------ ------
Walter S. Woltosz 60 Chairman of the Board, Chief Executive Officer and 1996
President of the Company and Words+
Virginia E. Woltosz 54 Secretary, Treasurer and Director of the Company 1996
Dr. David Z. D'Argenio 56 Director 1997
Dr. Richard R. Weiss 72 Director 1997
Momoko A. Beran 53 Chief Financial Officer of the Company and Words+ 1996
Ronald F. Creeley 54 Vice President, Marketing and Sales of the Company and 1997
Words+
Jeffrey A. Dahlen 44 President, Words+ subsidiary 2003
Walter S. Woltosz is a co-founder of the Company and has served as its Chief
Executive Officer, President, a director and as Chairman of the Board of
Directors since its incorporation in July 1996. Mr. Woltosz is also a co-founder
of Words+ and has served as its Chief Executive Officer since its incorporation
in 1981. Mr. Woltosz was President of Words+ from its incorporation in 1981
until April 2004.
Virginia E. Woltosz is a co-founder of the Company and has served as Secretary
from its incorporation in July 1996 till January 31, 2003. Mrs. Woltosz is also
a co-founder of Words+ and served as its Vice President, Secretary and Treasurer
from its incorporation in 1981 until January 31, 2003. Mrs. Woltosz retired from
the position of Vice President as of January 31, 2003, but remains as Secretary
and Treasurer of Simulations Plus. Virginia E. Woltosz is the wife of Walter S.
Woltosz.
Dr. David Z. D'Argenio has served as a Director of the Company since June 1997.
He is currently Professor and former Chairman of the Biomedical Engineering
department at the University of Southern California ("USC"), and has been on the
faculty at USC since 1979. He also serves as the Co-Director of the Biomedical
Simulations Resource Project at USC, a project funded by the National Institutes
of Health since 1985.
19
Dr. Richard R. Weiss has served as a Director of the Company since June 1997.
From October 1994 to the present, Dr. Weiss acted as a consultant to a number of
aerospace companies and to the U.S. Department of Defense through his own
consulting entity, Richard R. Weiss Consulting Services. From June 1993 through
July 1994, Dr. Weiss was employed by the U.S. Department of Defense as its
Deputy Director, Space Launch & Technology.
Momoko A. Beran joined Words+ in June 1993 as Director of Accounting and was
named Chief Financial Officer of Simulations Plus in July 1996. Prior to joining
Words+, Ms. Beran had been Financial Controller at AB Component Systems, Inc.,
which had its headquarters in the United Kingdom. Since February 1, 2003, Ms.
Beran has also been our Director of Human Resources.
Ronald F. Creeley joined the Company in February 1997 as its Vice President,
Marketing and Sales. Prior to joining the Company, Mr. Creeley had been
Marketing Director at Union Pen Company, Time Resources, and New England
Business Services, Inc., with experience in marketing and research.
Jeffrey A. Dahlen rejoined the Company in April 2003 as Vice President of
Research and Development for Words+ after five years with iAT, a software
consulting firm he co-founded based in Pasadena, California. Mr. Dahlen was
promoted to President of Words+ in April 2004. He is a graduate of Stanford
University in Electrical Engineering and has 20 years' experience in both
software and hardware design, which includes development of extremely high speed
processing hardware with the Jet Propulsion Laboratory at the California
Institute of Technology, and over 10 years of software and hardware design and
development at Words+.
COMMITTEES OF THE BOARD OF DIRECTORS
------------------------------------
The Board of Directors has an Audit Committee and a Compensation Committee.
Audit Committee
---------------
The Audit Committee reviews, acts on and reports to the Board of Directors with
respect to various auditing and accounting matters, including selecting our
independent auditors, the scope of the annual audits, fees to be paid to the
auditors, the performance of our independent auditors and our accounting
practices. This committee is responsible for selecting the Company's independent
auditors, reviewing the Company's internal audit procedures, reviewing quarterly
and annual financial statements independently and with the Company's independent
auditors, reviewing the results of the annual audit and implementing and
monitoring the Company's cash investment policy. In addition, this committee
assists the Board in its oversight of corporate accounting and internal
controls, reporting practices and the quality and integrity of the financial
reports of the Company. The Audit Committee met four times during fiscal 2005.
AUDIT COMMITTEE FINANCIAL EXPERT
--------------------------------
Currently our two independent directors, Dr. Richard R. Weiss and Dr. David Z.
D'Argenio, are the members of the Audit Committee. Under the new rules of the
Securities and Exchange Commission brought about by the Sarbanes-Oxley Act,
companies are required to disclose whether their audit committees have an "audit
committee financial expert" as defined in Item 401(h) of Regulation S-B under
the Exchange Act and whether that expert is "independent" as that term is used
in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act. The Board of
Directors believes that the two members of the current audit committee are
qualified to read and understand financial reports, but it recognizes that they
do not meet the description of "audit committee financial expert" as defined in
the Regulation. At this time, we have not been able to locate an additional
board member who would satisfy the definition of "audit committee financial
expert".
20
Compensation Committee
----------------------
The Compensation Committee reviews and approves the compensation and benefits of
our key executive officers, administers our employee benefit plans and makes
recommendations to the Board of Directors regarding such matters. Dr. Richard R.
Weiss and Dr. David Z. D'Argenio are members of the Compensation Committee. The
Compensation Committee met once during fiscal 2005.
CODE OF ETHICS
--------------
Our Code of Ethics is posted on our web site: www.simulations-plus.com.
COMPLIANCE WITH SECTION 16 OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act") requires the Company's directors and executive officers and beneficial
holders of more than 10% of the Company's Common Stock to file with the
Commission initial reports of ownership and reports of changes in ownership of
the Company's equity securities.
Due to administrative errors, Richard R. Weiss, David Z. D'Argenio, and Jeffrey
A. Dahlen were each late in filing one report on Form 4s to report a grant of
stock options. Ronald F. Creeley was late in filing two reports on Form 4s to
report the exercise of a stock option and the sale of the underlying shares.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth certain information concerning compensation paid
or accrued for the fiscal year ended August 2005, 2004 and 2003 by the Company
to or for the benefit of the Company's CEO, President, Chief Financial Officer,
and Vice President, Sales and Marketing (the "named executive officers"). No
other executive officers of the Company received total annual compensation for
the fiscal year ended August 31, 2005, 2004 and 2003 that exceeded $100,000.
21
Long-Term
Annual Compensation Compensation
--------------------------------------------- --------------------
Securities (# shares)
Name and Principal Fiscal Bonus Accrued Other Underlying Options
Position Year Salary (2) Salary(1) (3) Granted during FY
----------------------------- ------ -------- ------- --------- -------- ---------------------
Walter S. Woltosz 2005 $165,000 $19,340 - - -
Chief Executive 2004 $165,000 $38,813 - - -
Officer 2003 $165,000 $73,538 $190,583 - -
Ronald F. Creeley 2005 $100,000 $4,951 - $4,000 5,000
Vice President, Sales 2004 $100,000 $6,596 - $3,679 -
and Marketing 2003 $100,000 $4,700 $35,519 $2,944 -
Momoko A. Beran 2005 $100,000 $6,010 - $4,000 5,000
Chief Financial Officer 2004 $100,000 $10,010 - $3,667 -
2003 $ 87,500 $3,130 $47,413 $3,208 -
(1) Amount represents deferred salary from previous years paid during the year.
(2) Amount represents bonus earned during the applicable year.
(3) Amount represents Company matching for 401(k) Plan.
EMPLOYMENT AND OTHER COMPENSATION AGREEMENTS
The Board of Directors renewed its employment agreement with Walter Woltosz
commencing September 1, 2005 for two years. The agreement provided for an annual
salary of $172,000. Pursuant to such agreement, Mr. Woltosz was entitled to such
health insurance and other benefits that are not inconsistent with that which we
customarily provide to our other management employees and to reimbursement of
customary, ordinary and necessary business expenses incurred in connection with
the rendering of services to the Company. The agreement also provides that we
may terminate the agreement without cause upon 30 days written notice, and that
our only obligation to Mr. Woltosz would be for a payment equal to the greater
of (i) 12 months of salary or (ii) the remainder of the term of the employment
agreement from the date of notice of termination. Further, the agreement
provides that we may terminate the agreement for cause (as defined) and that our
only obligation to Mr. Woltosz would be limited to the payment of Mr. Woltosz'
salary and benefits through and until the effective date of any such
termination.
As part of the agreement with the original underwriter and as partial
compensation for the sale of Words+ to Simulations Plus in 1996, commencing with
our fiscal year ending 1997 and for each fiscal year thereafter, Walter and
Virginia Woltosz are entitled to receive bonuses not to exceed $150,000 and
$60,000, respectively, equal to 5% of our net annual income before taxes. The
net income before tax for FY05 was $386,798, thus we accrued bonuses in the
total amount of $38,680: $19,340 for Walter Woltosz and $19,340 for Virginia
Woltosz. These bonuses are due and payable within 10 days after the filing of
this annual report.
DIRECTOR COMPENSATION
In accordance with the Company's bylaws, outside directors receive compensation
of $2,500 per year plus $500 per meeting. In addition, each outside director
receives options for 500 shares of our common stock per year at the fair market
value of the shares on the date of grant.
OPTION GRANTS/EXERCISES
OPTION GRANTS IN FY05
---------------------
The following table discloses information about option grants to the Named
Executive Officers during the year ended August 31, 2005, including hypothetical
gains or "option spreads" for the options at the end of their respective
ten-year terms, as calculated in accordance with the rules of the SEC. Each gain
is based on an arbitrarily assumed annualized rate of compound appreciation of
the market price at the date of the grant of 1% and 4% from the date the option
was granted to the end of the option term. Actual gains, if any, on option
exercises are dependent on the future performance of our common stock, overall
market conditions and continued employment.
22
Percent of
No. of Total Potential Realizable Value
Securities Options at Assumed Annual Rated
Underlying Granted to Exercise of Stock Price
Options Employees Price Per Expiration Appreciation for Option
Name Granted in FY05 Share Date Term
--------------------------- --------------- -------------- ------------- ------------- ---------------- --------------
1% 4%
--------------------------- --------------- -------------- ------------- ------------- ---------------- --------------
Walter S. Woltosz - 0% n/a n/a n/a n/a
--------------------------- --------------- -------------- ------------- ------------- ---------------- --------------
Virginia E. Woltosz - 0% n/a n/a n/a n/a
--------------------------- --------------- -------------- ------------- ------------- ---------------- --------------
Momoko A. Beran 5,000 7% $ 4.42 6/22/2015 $ 24,412 $ 32,713
--------------------------- --------------- -------------- ------------- ------------- ---------------- --------------
Ronald F. Creeley 5,000 7% $ 4.42 6/22/2015 $ 24,412 $ 32,713
--------------------------- --------------- -------------- ------------- ------------- ---------------- --------------
Jeffrey A. Dahlen 5,000 7% $ 4.42 6/22/2015 $ 24,412 $ 32,713
--------------------------- --------------- -------------- ------------- ------------- ---------------- --------------
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES
--------------------------------------------------------------------------------
The following table discloses certain information regarding the options held at
August 31, 2005 by the Chief Executive Officer and each other named executive
officer.
Shares
Acquired Value
on Realized Number of Options at Value of Options at
Exercise (2) August 31, 2005 August 31, 2005 (1)
------------------------------- -------------- ----------- -------------------------------- -----------------------------
Exercisable Unexercisable Exercisable Unexercisable
------------------------------- -------------- ----------- ------------------ ------------- --------------- -------------
Walter S. Woltosz - - 20,000 5,000 $37,200* $9,300*
------------------------------- -------------- ----------- ------------------ ------------- --------------- -------------
Virginia E. Woltosz - - 20,000 5,000 $37,200* $9,300*
------------------------------- -------------- ----------- ------------------ ------------- --------------- -------------
Momoko Beran - - 189,200 15,000 $270,123 $19,310
------------------------------- -------------- ----------- ------------------ ------------- --------------- -------------
Ronald F. Creeley 8,000 $28,880 182,000 15,000 $259,570 $19,310
------------------------------- -------------- ----------- ------------------ ------------- --------------- -------------
Dr. David Z. D'Argenio - - 3,653 950 $4,696 $152
------------------------------- -------------- ----------- ------------------ ------------- --------------- -------------
Dr. Richard R. Weiss - - 3,653 950 $4,696 $152
------------------------------- -------------- ----------- ------------------ ------------- --------------- -------------
Jeffrey Dahlen - - 10,000 45,000 - -
------------------------------- -------------- ----------- ------------------ ------------- --------------- -------------
(1) Based on a per share price of $3.40 at August 31, 2005 less applicable
option exercise prices.
(2) The value realized represents the difference between the aggregate closing
price of the shares on the date of exercise less the aggregate exercise
price paid.
* Granted at $1.54, 110% of market price of the issue date
OPTION PLANS
In September 1996, the Board of Directors adopted and the shareholders approved
the 1996 Stock Option Plan (the "Option Plan") under which a total of 250,000
shares of common stock had been reserved for issuance. In March 1999, the
shareholders approved an increase in the number of shares that may be granted
under the Option Plan to 500,000. In February 2000, the shareholders approved an
increase in the number of shares that may be granted under the Option Plan to
1,000,000. In December 2000, the shareholders approved an increase in number of
shares that may be granted under the Option Plan to 1,250,000. Furthermore, in
February 2005, the shareholders approved an additional 250,000 shares,
increasing the total number of shares that may be granted under the Option Plan
to 1,500,000. The Option Plan terminates in 2006, subject to earlier termination
by the Board of Directors.
23
DIRECTORS AND OFFICERS INSURANCE
At this time, we do not carry Directors and Officers insurance; however, we may
obtain such insurance in the future if such insurance can be purchased on
reasonable terms to us.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding beneficial
ownership of our Common Stock as of August 31, 2005 by (i) each person who is
known to own beneficially more than 5% of the outstanding shares of our Common
Stock, (ii) each of our directors and executive officers, and (iii) all
directors and executive officers of the Company as a group:
AMOUNT AND NATURE OF PERCENT
BENEFICIAL OWNER (1)(2) BENEFICIAL OWNERSHIP OF CLASS
----------------------- -------------------- --------
Walter S. and Virginia E. Woltosz (3) 2,057,000 50.45%
Momoko Beran (4) 190,500 4.67%
Ronald F. Creeley (5) 183,000 4.49%
Dr. David Z. D'Argenio (6) 4,653 *
Dr. Richard R. Weiss (7) 4,653 *
Jeffrey A. Dahlen (8) 10,000 *
All directors and officers as a group 2,449,806 60.08%
* Less than 1%
(1) Such persons have sole voting and investment power with respect to all
Shares of Common Stock shown as being beneficially owned by them, subject
to community property laws, where applicable, and the information contained
in the footnotes to this table.
(2) The address of each director and executive officer named is c/o the
Company, 1220 W. Avenue J, Lancaster, California 93534.
(3) Own an aggregate of 2,017,000 plus 40,000 shares of common stock underlying
an option exercisable within the next 60 days of the date of this Annual
Report. Does not include additional stock options for 10,000 shares, which
are not exercisable within the next 60 days of the date of this Annual
Report.
(4) Owns 1,300 shares of common stock acquired from the exercise of options
granted under the 1996 Stock Option plan, plus 189,200 shares of common
stock underlying an option exercisable within the next 60 days of the date
of this Annual Report. Does not include stock options for 15,000 shares,
which are not exercisable within the next 60 days of the date of this
Annual Report.
24
(5) Owns 1,000 shares of common stock, plus 182,000 shares of common stock
underlying an option exercisable within the next 60 days of the date of
this Annual Report. Does not include stock options for 15,000 shares, which
are not exercisable within the next 60 days of the date of this Annual
Report.
(6) Owns 1,000 shares of common stock, plus 3,653 shares of common stock
underlying an option exercisable within the next 60 days of the date of
this Annual Report. Does not include stock options for 950 shares, which
are not exercisable within the next 60 days of the date of this Annual
Report.
(7) Owns 1,000 shares of common stock, plus 3,653 shares of common stock
underlying an option exercisable within the next 60 days of the date of
this Annual Report. Does not include stock options for 950 shares, which
are not exercisable within the next 60 days of the date of this Annual
Report.
(8) 55,000 shares of common stock options were granted, of which 10,000 shares
are exercisable within the next 60 days of the date of this Annual Report.
Does not include stock options for 45,000 shares, which are no exercisable
within the next 60 days of the date of this Annual Report.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
As of August 31, 2005, included in accrued bonuses to officers was $38,680,
which represented 10% of the Company's net income before bonuses and taxes given
to the Company's CEO and President, Walter Woltosz and Corporate Secretary,
Virginia Woltosz as the annual bonuses.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as part of this report as required by
Item 601 of Regulation S-B:
EXHIBIT
NUMBER DESCRIPTION
------ -----------
3.1 Articles of Incorporation of the Registrant (1)
3.2 Amended and Restated Bylaws of the Registrant (1)
4.1 Articles of Incorporation of the Registrant (incorporated by
reference to Exhibit 3.1 hereof) and Bylaws of the Registrant
(incorporated by reference to Exhibit 3.2 hereof)
4.2 Form of Common Stock Certificate (1)
4.3 Share Exchange Agreement (1)
10.1 Simulations Plus, Inc. 1996 Stock Option Plan (the "Option Plan") and
terms of agreements relating thereto (1)+
10.2 Subscription Agreement with Patricia Ann O'Neil (1)
10.3 Security Agreement with Patricia Ann O'Neil (1)
10.4 Promissory Note made by the Registrant in favor of Patricia Ann
O'Neil (1)
10.5 Warrants to purchase 150,000 shares of Common Stock of the Registrant
issued to Patricia Ann O'Neil (1)
10.6 First Amendment to Agreement with Patricia Ann O'Neil (1)
10.7 Subscription Agreement with Fernando Zamudio (1)
10.8 Security Agreement with Fernando Zamudio (1)
10.9 Promissory Note made by the Registrant in favor of Fernando Zamudio
(1)
10.10 Warrant to purchase 100,000 shares of Common Stock of the Registrant
issued to Fernando Zamudio (1)
10.11 Employment Agreement by and between the Registrant and Walter S.
Woltosz (1) +
25
10.12 Performance Warrant Agreement by and between the Registrant and
Walter S. Woltosz + Virginia E. Woltosz (2) +
10.13 Software Acquisition Agreement by and Between the Registrant and
Michael B. Bolger (1)
10.14 Sublease Agreement dated May 7, 1993 by and between the Registrant
and Westholme Partners (along with Consent to Sublease and master
lease agreement) (1)
10.15 Lease Agreements dated August 22, 1996 by and between Words+, Inc.
and Abbey-Sierra LLC (1)
10.16 Form of 10% Amended and Restated Promissory Note issued in connection
with the Registrant's Private Placement (2)
10.17 Form of Subscription Agreement relative to the Registrant's Private
Placement (1)
10.18 Form of Lock-Up Agreement with Bridge Lenders (2)
10.19 Form of Indemnification Agreement (1)
10.20 Form of Lock-Up Agreement with the Woltosz' (2)
10.21 Letter of Intent by and between the Registrant and Therapeutic
Systems Research Laboratories (1)
10.22 Form of Representative's Warrant to be issued by the Registrant in
favor of the Representative (2)
10.23 Form of Warrant issued to Bridge Lenders (2)
10.24 License Agreement by and between the Registrant and Therapeutic
Systems Research Laboratories (3)
10.25 Grant Award Letter from National Science Foundation (4)
10.26 Distribution Agreement with Teijin Systems Technology LTD. (4)
10.27 Lease Agreements by and between Simulations Plus, Inc. and Martin
Properties, Inc. (4)
10.28 Software OEM Agreement for Assistive Market Developer by and between
Words+, Inc. and Digital Equipment Corporation. (4)
10.29 Purchase Agreement by and between Words+, Inc. and Epson America,
Inc. (4)
10.30 License Agreement with Absorption Systems, LP. (5)
10.31 Service contract with The Kriegsman Group. (5)
10.32 Letter of Engagement with Banchik & Associates. (5)
10.33 Letter of Intent for Cooperative Alliance with Absorption Systems,
LP. (5)
10.34 OEM/Remarketing Agreement between Words+, Inc. and Eloquent
Technology, Inc. (6)
10.35 Lease Option Agreement by and between Simulations Plus, Inc. and
Martin Properties, Inc. (8)
10.36 Auto Rental Lease Agreement by and between Simulations Plus, Inc. and
Walter and Virginia Woltosz (8)
10.37 Registration Statement - 1,250,000 shares of the Company's 1966 Stock
Options. (9)
10.38 Employment Agreement by and between the Company and Walter S. Woltosz
(10)
10.39 An addendum to Lease Agreement (11)
10.40 Business Lending Agreement with Wells Fargo Bank (11)
10.41 Technology Transfer Agreement with Sam Communications, LLC. (12)
10.42 Employment Agreement by and between the Company and Walter S. Woltosz
(14)
31.1 Section 302 - Certification of Chief Executive Officer. (14)
31.2 Section 302 - Certification of Chief Financial Officer. (14)
32.1 Section 906 - Certification of Chief Executive Officer. (14)
32.1 Section 906 - Certification of Chief Financial Officer. (14)
--------------------------------------------------------------------------------
26
(1) Incorporated by reference to the Company's Registration Statement on
Form SB-2 (Registration No. 333-6680) filed on March 25, 1997 (the
"Registration Statement").
(2) Incorporated by reference to Pre-Effective Amendment No. 1 to the
Registration Statement filed on May 27, 1997.
(3) Incorporated by reference to the Company's Form 10-KSB for the fiscal
year ended August 31, 1997.
(4) Incorporated by reference to the Company's Form 10-KSB for the fiscal
year ended August 31, 1998.
(5) Incorporated by reference to the Company's Form 10-KSB for the fiscal
year ended August 31, 1999.
(6) Incorporated by reference to the Company's Form 10-KSB for the fiscal
year ended August 31, 2000.
(7) Incorporated by reference to the Company's Form 8-K filed on March 1,
2001.
(8) Incorporated by reference to the Company's Form 10-KSB for the fiscal
year ended August 31, 2001.
(9) Incorporated by reference to the Company's Registration Statement on
Form S-8 (Registration No. 333-91592) filed on June 28, 2002 (the
"Registration Statement").
(10) Incorporated by reference to the Company's Form 10-KSB for the fiscal
year ended August 31, 2002.
(11) Incorporated by reference to the Company's Form 10-KSB for the fiscal
year ended August 31, 2003.
(12) Incorporated by reference to the Company's Form 8-K filed on December
29, 2003.
(13) Incorporated by reference to the Company's Form 10-KSB for the fiscal
year ended August 31, 2004.
(14) Filed herewith.
(b) Reports on Form 8-K
None.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The Company incurred the following fees to Rose, Snyder & Jacobs, CPAs for
services rendered during the fiscal year ended August 31, 2005:
Fee Category FY05 Fees
------------ ---------
Audit fees $ 51,803
Audit-related fees -
Tax fees 13,467
All other fees -
-------------------------
Total fees $ 69,270
-------------------------
The Company incurred the following fees to Singer Lewak Greenbaum & Goldstein,
LLP for services rendered during the fiscal year ended August 31, 2004:
Fee Category FY04 Fees (1)
------------ -------------
Audit fees $ 62,514
Audit-related fees -
Tax fees 9,474
All other fees -
-------------------------
Total fees $ 71,988
-------------------------
27
(1) Includes fees billed and estimated adjustments by Singer Lewak
Greenbaum & Goldstein, LLP in 2004 for the 2004 audit and tax returns.
AUDIT FEES - Consists of fees incurred for professional services
rendered for the audit of Simulations Plus, Inc.'s consolidated
financial statements and for reviews of the interim consolidated
financial statements included in our quarterly reports on Form 10-QSB
and consents for filings with the SEC.
AUDIT-RELATED FEES - Consists of fees billed for professional services
that are reasonably related to the performance of the audit or review
of Simulations Plus, Inc.'s consolidated financial statements, but are
not reported under "Audit fees."
TAX FEES - Consists of fees billed for professional services relating
to tax compliance, tax reporting, and tax advice.
ALL OTHER FEES - Consists of fees billed for all other services.
28
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Lancaster, State of California, on
December 9, 2005.
SIMULATIONS PLUS, INC.
By /s/ MOMOKO A. BERAN
-------------------------
Momoko A. Beran
Chief Financial Officer
In accordance with Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the Registrant and in the capacities
indicated on December 9, 2004.
SIGNATURE TITLE
/s/ WALTER S. WOLTOSZ Chairman of the Board of Directors
------------------------------ and Chief Executive Officer
Walter S. Woltosz
/s/ VIRGINIA E. WOLTOSZ Secretary and Director of the Company
------------------------------
Virginia E. Woltosz
/s/ DR. DAVID Z. D'ARGENIO Director
------------------------------
Dr. David Z. D'Argenio
DR. RICHARD R. WEISS Director
------------------------------
Dr. Richard R. Weiss
/s/ MOMOKO A. BERAN Chief Financial Officer of the Company
------------------------------
Momoko A. Beran
29
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONTENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
Page
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM F2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheet F3 - F4
Consolidated Statements of Operations F5
Consolidated Statements of Shareholders' Equity F6
Consolidated Statements of Cash Flows F7 - F8
Notes to Consolidated Financial Statements F9 - F23
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Simulations Plus, Inc.
Lancaster, California
We have audited the accompanying consolidated balance sheet of
Simulations Plus, Inc (a California corporation) and Subsidiary as of August 31,
2005 and the related consolidated statements of operations, shareholders' equity
and cash flows for the years ended August 31, 2005 and 2004. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards established by
the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the consolidated financial statements are free of material misstatement.
An audit also includes examining, on a test basis, evidence supporting the
amounts and disclosures in the consolidated financial statements. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Simulation Plus and Subsidiary as of August 31, 2005, and the consolidated
results of their operations and their cash flows for the years ended August 31,
2005 and 2004 in conformity with accounting principles generally accepted in the
United States of America.
Rose, Snyder & Jacobs
A Corporation of Certified Public Accountants
Encino, California
November 9, 2005
F2
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
August 31, 2005
--------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents (note 3) $1,754,042
Accounts receivable, net of allowance for doubtful
accounts of $22,237 (note 4) 1,097,531
Inventory 281,400
Prepaid expenses and other current assets 81,004
Deferred tax 60,000
----------
Total current assets 3,273,977
CAPITALIZED COMPUTER SOFTWARE DEVELOPMENT COSTS,
net of accumulated amortization of $2,140,370 936,615
PROPERTY AND EQUIPMENT, net (note 5) 87,318
DEFERRED TAX 1,251,800
OTHER ASSETS 11,150
----------
TOTAL ASSETS $5,560,860
==========
The accompanying notes are an integral part of these financial statements.
F3
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
August 31, 2005
--------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 91,041
Accrued payroll and other expenses 398,657
Accrued bonuses to officers 38,680
Accrued income taxes 1,600
Accrued warranty and service costs 27,739
Current portion of deferred revenue 132,416
-----------
Total current liabilities 690,133
Deferred revenue 8,569
-----------
Total liabilities 698,702
-----------
COMMITMENTS AND CONTINGENCIES (note 7)
SHAREHOLDERS' EQUITY (note 8)
Preferred stock, $0.001 par value
10,000,000 shares authorized
no shares issued and outstanding --
Common stock, $0.001 par value
20,000,000 shares authorized
3,648,848 shares issued and outstanding 3,650
Additional paid-in capital 5,143,926
Accumulated deficit (285,418)
-----------
Total shareholders' equity 4,862,158
-----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 5,560,860
===========
The accompanying notes are an integral part of these financial statements.
F4
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended August 31,
------------------------------------------------------------------------------------
2005 2004
----------- -----------
NET SALES $ 4,752,641 $ 5,206,674
COST OF SALES 1,508,185 1,557,122
----------- -----------
GROSS PROFIT 3,244,456 3,649,552
----------- -----------
OPERATING EXPENSES
Selling, general, and administrative 2,423,467 2,508,305
Research and development 524,561 515,016
----------- -----------
Total operating expenses 2,948,028 3,023,321
----------- -----------
INCOME FROM OPERATIONS 296,428 626,231
OTHER INCOME (EXPENSE)
Interest income 43,462 73,323
Interest expense (712) (925)
Gain on sale of assets 15,491 --
Loss on currency exchange (6,551) --
----------- -----------
Total other income 51,690 72,398
----------- -----------
INCOME BEFORE INCOME TAXES 348,118 698,629
BENEFIT FROM (PROVISION FOR) INCOME TAXES
Benefit from (provision for) income tax (85,800) 137,856
Release of valuation allowance -- --
----------- -----------
Total benefit from (provision for) income taxes (85,800) 137,856
----------- -----------
NET INCOME $ 262,318 $ 836,485
=========== ===========
BASIC EARNINGS PER SHARE $ 0.07 $ 0.24
=========== ===========
Diluted earnings per share $ 0.07 $ 0.21
=========== ===========
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING
BASIC 3,610,534 3,495,148
=========== ===========
DILUTED 3,980,518 3,895,114
=========== ===========
The accompanying notes are an integral part of these financial statements.
F5
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Years Ended August 31,
---------------------------------------------------------------------------------------------------
Common Stock Additional
------------------------- Paid-In Accumulated
Shares Amount Capital Deficit Total
----------- ----------- ----------- ----------- -----------
BALANCE, AUGUST
31, 2003 3,412,247 $ 3,413 $ 4,659,905 $(1,384,221) $ 3,279,097
SHARES ISSUED UPON
PURCHASING
SAY-IT! SAM PRODUCT 35,000 35 162,715 -- 162,750
SHARES ISSUED UPON
EXERCISE OF STOCK
OPTIONS 117,196 117 167,502 -- 167,619
NET INCOME -- -- -- 836,485 836,485
----------- ----------- ----------- ----------- -----------
BALANCE, AUGUST
31, 2004 3,564,443 3,565 4,990,122 (547,736) 4,445,951
SHARES ISSUED UPON
PURCHASING
SAGE INFORMATICS PRODUCT 14,705 15 49,982 -- 49,997
SHARES ISSUED UPON
EXERCISE OF STOCK
OPTIONS 69,700 70 103,822 -- 103,892
NET INCOME -- -- -- 262,318 262,318
----------- ----------- ----------- ----------- -----------
BALANCE, AUGUST
31, 2005 3,648,848 $ 3,650 $ 5,143,926 $ (285,418) $ 4,862,158
=========== =========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
F6
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended August 31,
--------------------------------------------------------------------------------------
2005 2004
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 262,318 $ 836,485
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization of property and
equipment 42,505 42,607
Amortization of capitalized software development
costs 164,385 181,371
(Gain) on sale of assets (15,491) --
(Increase) decrease in
Accounts receivable 607,502 (11,690)
Inventory 77,190 (151,951)
Deferred tax 84,200 (104,890)
Other assets 35,040 (50,291)
Increase (decrease) in
Accounts payable (61,845) (22,122)
Accrued payroll and other expenses 176,688 (20,345)
Accrued bonuses to officers (38,946) (55,912)
Accrued income taxes -- (40,966)
Accrued warranty and service costs (4,757) (12,234)
Deferred revenue 109,584 (15,016)
----------- -----------
Net cash provided by operating activities 1,438,373 575,046
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (70,607) (44,062)
Proceeds from sale of assets 22,641 --
Capitalized computer software development costs (474,523) (221,177)
----------- -----------
Net cash used in investing activities (522,489) (265,239)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on capitalized lease obligations -- (3,893)
Proceeds from the exercise of stock options 103,892 167,619
----------- -----------
Net cash provided by financing activities 103,892 163,726
----------- -----------
The accompanying notes are an integral part of these financial statements.
F7
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended August 31,
--------------------------------------------------------------------------------------
2005 2004
----------- -----------
Net increase in cash and cash
equivalents $ 1,019,776 $ 473,533
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 734,266 260,733
----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,754,042 $ 734,266
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
INTEREST PAID $ 712 $ 925
=========== ===========
INCOME TAXES PAID $ 1,600 $ 1,600
=========== ===========
SUPPLEMENTAL SCHEDULE OF NON-CASH TRANSACTIONS
1 During the first fiscal quarter of 2004, Minolta copier with a zero book
value was traded-in for a new Ricoh copier/printer. The remaining
obligation of $8,177 was assumed by the lessor of Ricoh copier/printer in
the exchange for a higher per print cost.
2 During the second fiscal quarter of 2004, the Company purchased all of
the rights, title, and interest in the Say-it! SAM Augmentative
communication device developed by SAM Communications, LLC, for 35,000
shares of Simulations Plus restricted common stock at $4.65 per share,
total of $162,750, equal to the closing price on the date when the
agreement was signed.
3 On August 31, 2005, the Company purchased the assets of Sage Informatics
LLC., including the Chem TK (TM) product line, a chemistry software.
The partial payment was made by issuing 14,705 shares of Simulations
Plus restricted common stock at $3.40 per share, total of $49,997,
equal to the closing price on the date when the agreement was signed.
The accompanying notes are an integral part of these financial statements.
F8
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 1 - ORGANIZATION AND LINES OF BUSINESS
Organization
------------
Simulations Plus, Inc. was incorporated on July 17, 1996. On August
29, 1996, the shareholders of Words+, Inc. exchanged their 2,000
shares of Words+, Inc. common stock for 2,200,000 shares of
Simulations Plus, Inc. common stock, and Words+, Inc. became a wholly
owned subsidiary of Simulations Plus, Inc. (collectively, the
"Company").
Lines of Business
-----------------
The Company designs and develops pharmaceutical simulation software to
promote cost-effective solutions to a number of problems in
pharmaceutical research and in the education of pharmacy and medical
students. The Company also developed and sells interactive, educational
software programs that simulate science experiments conducted in high
school science classes. In addition, the Company designs and develops
computer software and manufactures augmentative communication devices
and computer access products that provide a voice for those who cannot
speak and allow physically disabled persons to operate a standard
computer.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Our consolidated 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. Critical
accounting policies for us include revenue recognition, accounting for
capitalized software development costs, and accounting for income
taxes.
Principles of Consolidation
---------------------------
The consolidated financial statements include the accounts of
Simulations Plus, Inc. and its wholly owned subsidiary, Words+, Inc.
All significant intercompany accounts and transactions are eliminated
in consolidation.
Revenue Recognition
-------------------
The Company recognizes revenues related to software licenses and
software maintenance in accordance with the American Institute of
Certified Public Accountants ("AICPA") Statements of Position (SOP) No.
97-2, "Software Revenue Recognition." Product revenue is recorded at
the time of shipment, net of estimated allowances and returns.
Post-contract customer support ("PCS") obligations are insignificant;
therefore, revenue for PCS is recognized at the time of shipment, and
the costs of providing such support services are accrued and amortized
over the obligation period.
F9
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue Recognition (Continued)
-------------------------------
As a by-product of ongoing improvements and upgrades for the new
programs and new modules of software, some modifications are provided
to the customers, who have already purchased software, at no additional
charge. We consider these modifications to be minimal, as they are not
changing the basic functionality or utility of the software, but rather
adding convenience, such as being able to plot some additional variable
on a graph in addition to the numerous variables that had been
available before. Such software modifications for any single product
have been typically once or twice per year, sometimes more, sometimes
less. Thus, they are infrequent. The Company provides, for a fee,
additional training and service calls to its customers and recognizes
revenue at the time the training or service call is provided.
Generally, the Company enters into one-year license agreements with its
customers for the use of its software products. The Company recognizes
revenue on these contracts when all the criteria under SOP 97-2 are
met.
From time to time, the Company enters into multi-year license
agreement. The Company believes its history of collection with these
customers is sufficient to overcome the presumption that revenue should
be recognized in time with the expected cash collections, and has
therefore recognized the entire license fees, net of an applicable
discount, at the time of the software's release and acceptance by the
customer.
Comprehensive Income
--------------------
The Company utilizes Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income." This statement
establishes standards for reporting comprehensive income and its
components in a financial statement. Comprehensive income as defined
includes all changes in equity (net assets) during a period from
non-owner sources. Examples of items to be included in comprehensive
income, which are excluded from net income, include foreign currency
translation adjustments and unrealized gains and losses on
available-for-sale securities. Comprehensive income is not presented in
the Company's financial statements since the Company did not have any
of the items of comprehensive income in any period presented.
Cash and Cash Equivalents
-------------------------
For purposes of the statements of cash flows, the Company considers all
highly liquid investments purchased with original maturities of three
months or less to be cash equivalents.
F10
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Inventory
---------
Inventory is stated at the lower of cost (first-in, first-out basis) or
market and consists primarily of computers and peripheral computer
equipment.
Capitalized Computer Software Development Costs
-----------------------------------------------
Software development costs are capitalized in accordance with SFAS No.
86, "Accounting for the Cost of Computer Software to be Sold, Leased,
or otherwise 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 the Company's software products.
Amortization of capitalized software development costs is provided 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 $164,385 and $181,371 for the
years ended August 31, 2005 and 2004, respectively. We have reassessed
economic life of our pharmaceutical software based on our actual
experience, and we have determined that the remaining estimated
economic life of the products is five years starting at September 1,
2004. Accordingly, we began amortizing the net book value of
capitalized software development costs over a sixty-month period using
the straight-line method. Capitalized software development costs were
previously amortized over a thirty-six month period. As a result, we
amortized our pharmaceutical software development costs for $65,926 in
fiscal year 2005. If we had not changed our expected economic life, we
would have amortized $132,317.
Management periodically compares estimated net realizable value by
product with the amount of software development costs capitalized for
that product to ensure the amount capitalized is not in excess of the
amount to be recovered through revenues. Any such excess of capitalized
software development costs to expected net realizable value is expensed
at that time.
F11
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Property and Equipment
----------------------
Property and equipment, including equipment under capital leases, are
recorded at cost, less accumulated depreciation and amortization.
Depreciation and amortization are provided using the straight-line
method over the estimated useful lives as follows:
Equipment 5 years
Computer equipment 3 to 7 years
Furniture and fixtures 5 to 7 years
Leasehold improvements 5 years
Maintenance and minor replacements are charged to expense as incurred.
Gains and losses on disposals are included in the results of
operations.
Fair Value of Financial Instruments
-----------------------------------
For certain of the Company's financial instruments, including cash and
cash equivalents, accounts receivable, accounts payable, accrued
payroll and other expenses, accrued bonuses to officers, and accrued
warranty and service costs, the carrying amounts approximate fair value
due to their short maturities.
Advertising
-----------
The Company expenses advertising costs as incurred. Advertising costs
for the years ended August 31, 2005 and 2004 were $11,000 and $24,000,
respectively.
Shipping and Handling
---------------------
Shipping and handling costs are recorded as cost of sales, amounted to
$83,000 for the both years ended August 31, 2005 and 2004.
Research and Development Costs
------------------------------
Research and development costs are charged to expense as incurred until
technological feasibility has been established. These costs consist
primarily of salaries and direct payroll related costs.
Income Taxes
------------
The Company utilizes SFAS No. 109, "Accounting for 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
F12
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Income Taxes (Continued)
------------------------
provision for income taxes represents the tax payable for the period
and the change during the period in deferred tax assets and
liabilities.
At the end of fiscal year 2004, we recorded $1,396,000 in deferred tax
assets. For fiscal year 2005, we recorded a provision for deferred
taxes in the amount of $84,200, resulting in the deferred tax asset of
$1,311,800 at August 31, 2005. The evaluation of the deferred tax
assets is based on our history of generating taxable profits and our
projections of future profits as well as expected future tax rates to
determine if the realization of the deferred tax asset is
more-likely-than-not. Significant judgment is required in these
evaluations, and differences in future results from our estimates,
could result in material differences in the realization of these
assets.
Earnings per Share
------------------
The Company reports earnings per share in accordance with SFAS No. 128,
"Loss per Share." 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 years ended August 31,
2005 and 2004 were as follows:
2005 2004
---------- ----------
Numerator
Net income attributable to common
shareholders $ 262,318 $ 836,485
========== ==========
Denominator
Weighted-average number of common shares
outstanding during the year 3,610,534 3,495,148
Dilutive effect of stock options 369,984 399,966
---------- ----------
COMMON STOCK AND COMMON STOCK
EQUIVALENTS USED FOR DILUTED EARNINGS
PER SHARE 3,980,518 3,895,114
========== ==========
F13
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Stock Options and Warrants
--------------------------
In December 2004, the FASB issued Statement of Accounting Standard No.
123R, "Share-Based Payment", a revision of SFAS No. 123, "Accounting
for Stock-Based Compensation." SFAS 123R supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and requires all companies
to measure compensation expense for all share-based payments, including
employee stock options, based upon the fair value of the stock-based
awards at the date of grant. SFAS 123R will be effective for the
Company for the year beginning September 1, 2006. For fiscal year 2005,
we currently account for share-based payments to employees using
APB25's intrinsic value method as permitted; therefore it does not
recognize any compensation cost for employee stock options. Entities
electing to remain with the accounting method of APB 25 must make pro
forma disclosures of net income and earnings per share, as if the fair
value method of accounting defined in SFAS No. 123 had been applied.
The Company has elected to account for its stock-based compensation to
employees under APB 25.
Estimates
---------
The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenue and expenses during the reporting period. Actual results could
differ from those estimates.
Concentrations and Uncertainties
--------------------------------
International sales accounted for 25% and 31% of net sales for the
years ended August 31, 2005 and 2004, respectively. For Simulations
Plus, Inc., one customer accounted for 24% of net sales for the year
ended August 31, 2005, and for Words+, Inc., one government agency
accounted for 20% of net sales during the fiscal year 2005.
The Company operates in the computer software industry, which is highly
competitive and changes rapidly. The Company's operating results could
be significantly affected by its ability to develop new products and
find new distribution channels for new and existing products.
For Simulations Plus, four customers comprised 31%, 13%, 11% and 10% of
accounts receivable at August 31, 2005. Three customers comprised 23%,
19% and 12% of accounts receivable at August 31, 2004. For Words+, one
customer comprised 25% of accounts receivable at August 31, 2005. One
customer comprised 27% of accounts receivable at August 31, 2004.
The Company's subsidiary, Words+, Inc., purchases components for the
main computer products from a single Manufacture. Words+, Inc. also
uses a number of pictographic symbols that are used in its software
products which are licensed from a third party. The inability of the
Company to obtain computers used in its products or to renew its
F14
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Concentrations and Uncertainties (Continued)
--------------------------------------------
licensing agreement to use pictographic symbols could negatively impact
the Company's financial position, results of operations, and cash
flows.
Recently Issued Accounting Pronouncements
-----------------------------------------
In December 2004, the FASB issued Statement of Accounting Standard No.
123R, "Share-Based Payment", a revision of SFAS No. 123, "Accounting
for Stock-Based Compensation." SFAS 123R supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees." SFAS 123R requires all
companies to measure compensation expense for all share-based payments
(including employee stock options and options issued pursuant to
employee stock purchase plans) based upon the fair value of the
stock-based awards at the date of grant, and is effective for the
Company for fiscal year beginning after December 15, 2005. The impact
of adoption of Statement 123R cannot be predicted at this time because
it will depend on levels of share-based payments granted in the future.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections." This statement applies to all voluntary changes in
accounting principle and requires retrospective application to prior
periods' financial statements of changes in accounting principle,
unless this would be impracticable. This statement also makes a
distinction between "retrospective application" of an accounting
principle and the "restatement" of financial statements to reflect the
correction of an error. This statement is effective for accounting
changes and corrections of errors made in fiscal years beginning after
December 15, 2005. The Company is evaluating the effect the adoption of
this interpretation will have on its financial position, cash flows and
results of operations.
NOTE 3 - CASH AND CASH EQUIVALENTS
The Company maintains cash deposits at banks located in California.
Deposits at each bank are insured by the Federal Deposit Insurance
Corporation up to $100,000. At August 31, 2005, the uninsured portions
aggregated to $1,522,000. The Company has not experienced any losses in
such accounts and believes it is not exposed to any significant credit
risk on cash and cash equivalents.
NOTE 4 - ACCOUNTS RECEIVABLE
The Company maintains an allowance for doubtful accounts for estimated
losses that may arise if any of its customers are unable to make
required payments. Management specifically analyzes the age of customer
balances, historical bad debt experience, customer credit-worthiness,
and changes in customer payments terms when making estimates of the
uncollectability of the Company's trade accounts receivable balances.
If the Company determines that the financial conditions of any of its
F15
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 4 - ACCOUNTS RECEIVABLE (CONTINUED)
customers deteriorated, whether due to customer specific or general
economic issues, increase in the allowance may be made. Accounts
receivable are written off when all collection attempts have failed.
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment at August 31, 2005 consisted of the following:
Automobile $ 21,769
Equipment 159,646
Computer equipment 301,871
Furniture and fixtures 52,704
Leasehold improvements 38,215
--------
574,205
Less accumulated depreciation and amortization 486,887
--------
TOTAL $ 87,318
========
Depreciation and amortization expense was $42,505 and $42,607 for the
years ended August 31, 2005 and 2004, respectively.
NOTE 7 - COMMITMENTS AND CONTINGENCIES
Leases
------
The current office lease expired in August 2005, and we are now renting
on a month-to-month basis. We have signed a new lease for another
building which is under construction and is currently expected to be
completed by the first week of January 2006. The new lease has a
five-year term with two (2), three (3) year options to extend. We also
lease a Ricoh copier/printer under a non-cancelable operating lease
that expires in October 2006. Future minimum lease payments under
non-cancelable operating leases with remaining terms of one year or
more at August 31, 2005 were as follows:
Years Ending Operating
August 31, Leases
---------- --------
2006 $172,260
2007 225,976
2008 239,256
--------
$637,492
========
Rent expense was $211,252 and $206,192 for the years ended August 31,
2005 and 2004, respectively.
F16
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 7 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Employee Agreement
------------------
On August 9, 2005, the Company entered into an employment agreement
with its President/Chief Executive Officer that expires in August 2007.
The employment agreement provides for an annual salary of $172,000 and
an annual bonus equal to 5% of the Company's net income before taxes,
not to exceed $150,000. The agreement also provides that the Company
may terminate the agreement upon 30 days' written notice if termination
is without cause. The Company's only obligation would be to pay its
President the greater of a) 12 months salary or b) the remainder of the
term of the employment agreement from the date of notice of
termination.
License Agreement
-----------------
In 1997, the Company entered into an agreement with Therapeutic Systems
Research Laboratory ("TSRL") to jointly develop a computer simulation
of the absorption of drug compounds in the gastrointestinal tract. Upon
execution of a definitive License Agreement on July 9, 1997, TSRL
received an initial payment of $75,000, and thereafter, the company is
obligated to pay a royalty of 20% of net sales of GastroPlus software.
For the years ended August 31, 2005 and 2004, the Company paid
royalties of $181,951 and $188,779, respectively.
The Company's subsidiary, Words+, Inc., entered into royalty agreements
with several vendors to apply their software & technologies into the
finished goods to be sold. For the years ended August 31, 2005 and
2004, Words+ incurred such royalties of $114,507 and $74,575,
respectively.
NOTE 8 - SHAREHOLDERS' EQUITY
Stock Option Plan
-----------------
In September 1996, the Board of Directors adopted and the shareholders
approved the 1996 Stock Option Plan (the "Option Plan") under which a
total of 250,000 shares of common stock had been reserved for issuance.
In March 1999, the shareholders approved an increase in the number of
shares that may be granted under the Option Plan to 500,000. In
February 2000, the shareholders approved an increase in the number of
shares that may be granted under the Option Plan to 1,000,000. In
December 2000, the shareholders approved an increase in the number of
shares that may be granted under the Option Plan to 1,250,000.
Furthermore, in February 2005, the shareholders approved additional
250,000 shares, resulting to the total number of shares that may be
granted under the Option Plan to 1,500,000. The Option Plan terminates
in 2006, subject to earlier termination by the Board of Directors.
F17
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 8 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plan (Continued)
-----------------------------
The following summarizes the stock option transactions:
Weighted-
Average
Exercise
Number Price
of Options Per Share
---------- ---------
Outstanding, August 31, 2003 1,120,562 $ 1.93
Granted 75,000 $ 4.60
Exercised (117,196) $ 1.44
Expired/canceled (25,650) $ 1.97
----------
Outstanding, August 31, 2004 1,052,716 $ 2.17
Granted 72,000 $ 4.42
Exercised (69,700) $ 2.06
Expired/canceled (19,735) $ 2.55
----------
OUTSTANDING, AUGUST 31, 2005 1,035,281 $ 2.37
==========
EXERCISABLE, AUGUST 31, 2005 827,464 $ 2.13
==========
The fair value of the options granted during the year ended August 31,
2005 is estimated at $131,000. The fair value of these options was
estimated at the date of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions for the year
ended August 31, 2005: dividend yield of 0%, expected volatility of
30%, risk-free interest rate of 4.18%, and expected life of ten years.
The weighted-average fair value of options granted during the year
ended August 31, 2005 was $1.83, and the weighted-average exercise
price was $4.42.
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. Because the Company's employee
stock options have characteristics significantly different from those
of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock
options.
The weighted-average remaining contractual life of options outstanding
issued under the Plan was 5.3 years at August 31, 2005. The exercise
prices for the options outstanding at August 31, 2005 ranged from $1.05
to $4.60, and the information relating to these options is as follows:
F18
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 8 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plan (Continued)
-----------------------------
Weighted- Weighted- Weighted-
Average Average Average
Remaining Exercise Exercise
Stock Stock Contractual Price Price
Exercise Options Options Life of Options of Options of Options
Price Outstanding Exercisable Outstanding Outstanding Exercisable
------------- ----------- ----------- ----------- ----------- -----------
$ 1.05 - 2.00 507,636 427,019 4.9 years $ 1.47 $ 1.47
$ 2.01 - 3.00 357,700 357,700 4.4 years $ 2.65 $ 2.65
$ 3.01 - 4.60 169,945 42,745 8.1 years $ 4.46 $ 4.36
---------- ---------
1,035,281 827,464
========== =========
The Company has adopted only the disclosure provisions of SFAS No. 123.
It applies APB 25 and related interpretations in accounting for its
plans and does not recognize compensation expense for its stock-based
compensation plans other than for restricted stock and options issued
to outside third parties.
If the Company had elected to recognize compensation expense based upon
the fair value at the grant date for awards under this plan consistent
with the methodology prescribed by SFAS No. 123, the Company's net
income and earnings per share would be reduced to the pro forma amounts
indicated below for the years ended August 31, 2005 and 2004:
2005 2004
---------- -----------
Net income
As reported $ 262,318 $ 836,485
Add: Stock-based employee compensation
expense included in reported net income,
net of related tax effects -- --
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects $ (201,096) $ (218,645)
Pro forma $ 61,222 $ 617,840
Basic earnings per common share
As reported $ 0.07 $ 0.24
Pro forma $ 0.02 $ 0.18
Diluted earnings per common share
As reported $ 0.07 $ 0.21
Pro forma $ 0.02 $ 0.16
F19
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 8 - SHAREHOLDERS' EQUITY (CONTINUED)
Other Stock Options
-------------------
As of August 31, 2005, the independent members of the Board of
Directors hold options to purchase 9,206 shares of common stock at
exercise prices ranging from $1.20 to $5.25, which options were granted
prior to August 31, 2005.
Number of Weighted average
Options exercise price
------- --------------
Options outstanding 9,206 $ 2.56
Options exercisable 7,306 $ 2.39
NOTE 9 - INCOME TAXES
The components of the income tax provision for the years ended August
31, 2005 and 2004 were as follows:
2005 2004
---------- ----------
Current
Federal $ -- $ --
State (1,600) 32,966
---------- ----------
(1,600) 32,966
---------- ----------
Deferred
Federal (74,500) 82,890
State (9,700) 22,000
---------- ----------
(84,200) 104,890
---------- ----------
TOTAL $ (85,800) $ 137,856
========== ==========
A reconciliation of the expected income tax (benefit) computed using
the federal statutory income tax rate to the Company's effective income
tax rate is as follows for the years ended August 31, 2005 and 2004:
2005 2004
------- -------
Income tax computed at federal statutory tax rate 34.0% 34.0%
State taxes, net of federal benefit 6.3 5.5
Meals & Entertainment 0.9 --
Extraterritorial income exclusion (7.2) (15.5)
Research and development credit (19.9) (14.9)
Change in prior year estimated taxes 7.9 (24.4)
Other 2.6 (4.5)
------- -------
TOTAL 24.6 % (19.8)%
======= =======
F20
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 9 - INCOME TAXES (CONTINUED)
Significant components of the Company's deferred tax assets and
liabilities for income taxes for the years ended August 31, 2005 and
2004 are as follows:
2005 2004
----------- -----------
Deferred tax assets
Accrued payroll and other expenses $ 137,200 $ 198,800
Accrued warranty and service costs 11,900 13,900
Net operating loss carryforward 1,084,000 1,525,700
Tax Credits 567,800 --
Contributions 4,100 --
Property and equipment 100 --
----------- -----------
Total deferred tax assets 1,805,100 1,738,400
Less: Valuation allowance -- --
----------- -----------
1,805,100 1,738,400
----------- -----------
Deferred tax liabilities
State taxes (92,100) (95,400)
Capitalized computer software development
costs (401,200) (247,000)
----------- -----------
Total deferred tax liabilities (493,300) (342,400)
----------- -----------
NET DEFERRED TAX ASSETS $ 1,311,800 $ 1,396,000
=========== ===========
At August 31, 2005, the Company had federal and state net operating
loss carryforwards of approximately $2,863,000 and $1,251,000,
respectively. Federal net operating loss carry forwards expire through
2024, while California net operation loss carry forwards begin
expiration in 2006. The Company also has tax credit, totaling
approximately $355,000 and $213,000 to offset future Federal and State
income taxes, respectively.
NOTE 10 - RELATED PARTY TRANSACTIONS
As of August 31, 2005, included in accrued bonuses to officers was
$19,340, which represented 5% of the Company's net income before
bonuses and taxes given to the Company's President, Walter Woltosz, as
an annual bonus.
As of August 31, 2005, included in accrued bonuses to officers was
$19,340, which represented 5% of the Company's net income before
bonuses and taxes given to the Corporate Secretary, Virginia Woltosz,
as an annual bonus.
F21
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 11 - LINES OF BUSINESS
For internal reporting purposes, management segregates the Company into
two divisions as follows for the years ended August 31, 2005 and 2004:
August 31, 2005
-------------------------------------------------------
Simulations
Plus, Inc. Words+, Inc. Eliminations Total
----------- ----------- ----------- -----------
Net sales $ 2,068,789 $ 2,683,852 $ -- $ 4,752,641
Income (loss) from
operations $ 68,152 $ 228,276 $ -- $ 296,428
Identifiable assets $ 5,937,272 $ 1,576,215 $(1,864,428) $ 5,560,859
Capital expenditures $ 10,093 $ 60,514 $ -- $ 70,607
Depreciation and
amortization $ 12,700 $ 29,805 $ -- $ 42,505
----------- ----------- ----------- -----------
August 31, 2004
-------------------------------------------------------
Simulations
Plus, Inc. Words+, Inc. Eliminations Total
----------- ----------- ----------- -----------
Net sales $ 2,856,004 $ 2,350,670 $ -- $ 5,206,674
Income (loss) from
operations $ 914,577 $ (288,346) $ -- $ 626,231
Identifiable assets $ 5,488,767 $ 1,192,894 $(1,717,732) $ 4,963,929
Capital expenditures $ 3,447 $ 40,615 $ -- $ 44,062
Depreciation and
amortization $ 14,617 $ 27,990 $ -- $ 42,607
----------- ----------- ----------- -----------
Most corporate expenses, such as legal and accounting expenses, public
relations expenses, and bonuses to President and Secretary are included
in Simulations Plus, Inc.
F22
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2005
--------------------------------------------------------------------------------
NOTE 12 - GEOGRAPHIC REPORTING
The Company allocates revenues to geographic areas based on the
locations of its customers. Geographical revenues were as follows for
the fiscal years ended August 31, 2005 and 2004:
August 31, 2005
---------------------------------------------------------
North South
(in `000) America Europe Asia Oceania America Total
------- ------- ------- ------- ------- -------
Simulations Plus, Inc. 1,137 456 475 -- -- 2,068
Words+, Inc. 2,415 196 54 19 -- 2,684
------- ------- ------- ------- ------- -------
Total 3,552 652 529 19 -- 4,752
======= ======= ======= ======= ======= =======
August 31, 2004
---------------------------------------------------------
North South
(in `000) America Europe Asia Oceania America Total
------- ------- ------- ------- ------- -------
Simulations Plus, Inc. 1,493 582 781 -- -- 2,856
Words+, Inc. 2,104 177 45 19 6 2,351
------- ------- ------- ------- ------- -------
Total 3,597 759 826 19 6 5,207
======= ======= ======= ======= ======= =======
NOTE 13 - EMPLOYEE BENEFIT PLAN
The Company maintains a 401(K) Plan for all eligible employees. The
Company makes matching contributions equal to the 100% of the
employee's elective deferral, not to exceed 4% of the total employee
compensation. The Company can also elect to make a profit-sharing
contribution. Contributions by the Company to this Plan amounted to
$31,000 and $25,000 for the years ended August 31, 2005 and 2004,
respectively.
NOTE 14 - SUBSEQUENT EVENTS
Since September 1, 2005, an additional 1,200 stock options to purchase
shares have been exercised by employees.
On November 4, the Company purchased certain secured assets of
Bioreason, Inc., from its former creditors. Bioreason was a chemistry
software company providing research tools to the pharmaceutical and
biotechnology industries, in an all-cash transaction for approximately
$788,000.
F23