SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended May 31, 2006 or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1937
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 of (I.R.S. Employer
Incorporation or Organization) identification No.)
42505 10TH STREET WEST
LANCASTER, CA 93534-7059
(Address of principal executive offices including zip code)
(661) 723-7723
(Issuer's telephone number, including area code)
NOT APPLICABLE
(Former Name, Former Address and Former Fiscal Year, if Changed Since
Last Report)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 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 [ ]
The number of shares outstanding of the Issuer's common stock, par value $0.001
per share, as of July 11, 2006, was 3,704,748.
SIMULATIONS PLUS, INC.
FORM 10-QSB
FOR THE QUARTERLY PERIOD ENDED MAY 31, 2006
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page
----
Consolidated Balance Sheet at May 31, 2006 (unaudited) 2
Consolidated Statements of Operations for the three months
and nine months ended May 31, 2006 and 2005 (unaudited) 4
Consolidated Statements of Cash Flows for the nine months
ended May 31, 2006 and 2005 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis or Plan of Operations
General 14
Results of Operations 19
Liquidity and Capital Resources 23
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities 25
Item 3. Defaults upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
Signature 26
Exhibit - Certifications
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
at May 31, 2006
(Unaudited)
================================================================================
ASSETS
CURRENT ASSETS
Cash and cash equivalents (Note 3) $1,099,182
Accounts receivable, net of allowance for doubtful accounts
of $20,160 (Note 4) 1,571,312
Inventory (Note 5) 231,870
Prepaid expenses and other current assets 54,759
Current portion of deferred tax 83,000
----------
Total current assets 3,040,123
CAPITALIZED COMPUTER SOFTWARE DEVELOPMENT COSTS,
net of accumulated amortization of $2,342,391 (Note 4) 1,322,203
LONG TERM CONTRACTS RECEIVABLE, net of discounts of $6,787 294,373
PROPERTY AND EQUIPMENT, net (Note 6) 102,783
CUSTOMER RELATIONSHIPS (Note 13) 109,216
DEFERRED TAX 1,145,739
OTHER ASSETS 19,470
----------
TOTAL ASSETS $6,033,907
==========
The accompanying notes are an integral part of these financial statements.
2
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
at May 31, 2006
(Unaudited)
================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 159,410
Accrued payroll and other expenses 308,589
Accrued bonuses to officers 57,681
Accrued warranty and service costs 32,463
Current portion of deferred revenue 73,298
Other current liabilities 1,157
----------
Total current liabilities 632,598
DEFERRED REVENUE --
----------
Total liabilities 632,598
----------
COMMITMENTS AND CONTINGENCIES (Notes 7 and 12) --
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
3,702,748 shares issued and outstanding 3,703
Additional paid-in capital 5,246,954
Retained Earnings 150,652
----------
Total shareholders' equity 5,401,309
----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $6,033,907
==========
The accompanying notes are an integral part of these financial statements.
3
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
for the three and nine months ended May 31,
(Unaudited)
=======================================================================================================================
Three months ended Nine months ended
--------------------------- ---------------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------
NET SALES $ 1,788,284 $ 1,424,438 $ 4,088,890 $ 3,522,688
COST OF SALES 433,496 428,266 1,152,160 1,121,190
----------- ----------- ----------- -----------
GROSS PROFIT 1,354,788 996,172 2,936,730 2,401,498
----------- ----------- ----------- -----------
OPERATING EXPENSES
Selling, general, and administrative 795,547 644,502 2,112,040 1,811,889
Research and development 118,707 134,007 335,642 378,926
----------- ----------- ----------- -----------
Total operating expenses 914,254 778,509 2,447,682 2,190,815
----------- ----------- ----------- -----------
INCOME FROM OPERATIONS 440,534 217,663 489,048 210,683
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE)
Interest income 4,447 7,114 13,549 38,410
Miscellaneous income 58 1,189 108 1,189
Interest expense (40) (259) (40) (543)
Gain on sale of assets 4,613 2,201 7,739 7,401
Gain (loss) on currency exchange 10,076 (4,658) 8,727 (2,547)
----------- ----------- ----------- -----------
Total other income (expense) 19,154 5,587 30,083 43,910
----------- ----------- ----------- -----------
INCOME BEFORE BENEFIT FROM (PROVISION FOR)
INCOME TAXES 459,688 223,250 519,131 254,593
BENEFIT FROM (PROVISION FOR) INCOME TAXES
Provision for income tax (73,550) (50,000) (83,061) (50,000)
Change in valuation allowance -- -- -- --
----------- ----------- ----------- -----------
Total benefit from (provision for) income taxes (73,550) (50,000) (83,061) (50,000)
----------- ----------- ----------- -----------
NET INCOME $ 386,131 $ 173,250 $ 436,070 $ 204,593
=========== =========== =========== ===========
BASIC EARNINGS PER SHARE $ 0.10 $ 0.05 $ 0.12 $ 0.06
=========== =========== =========== ===========
Diluted earnings per share $ 0.09 $ 0.04 $ 0.11 $ 0.05
=========== =========== =========== ===========
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING
BASIC 3,695,771 3,627,811 3,672,009 3,602,605
=========== =========== =========== ===========
DILUTED 4,113,033 3,958,063 4,052,480 3,958,063
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
4
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the nine months ended May 31,
(Unaudited)
========================================================================================
2006 2005
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 436,070 $ 204,593
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation and amortization of property and
equipment 33,829 34,538
Amortization of customer relationships 18,826 --
Amortization of capitalized software development
costs 202,022 119,077
(Gain) on sale of assets (7,739) (7,401)
(Increase) decrease in
Accounts receivable (320,658) 312,121
Inventory 49,530 58,032
Deferred tax 83,061 50,000
Other assets 17,925 49,320
Increase (decrease) in
Accounts payable 68,369 29,397
Accrued payroll and other expenses (88,911) 58,933
Accrued bonuses to officers 19,001 (77,626)
Accrued income taxes (1,600) (1,600)
Accrued warranty and service costs 4,724 (3,988)
Deferred revenue (67,687) (8,562)
----------- -----------
Net cash provided by operating activities 446,762 816,834
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (51,979) (60,144)
Purchase of Bioreason's assets (826,192) --
Proceed from sale of property and equipment 15,425 10,972
Capitalized computer software development costs (341,957) (255,648)
----------- -----------
Net cash used in investing activities (1,204,703) (304,820)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from the exercise of stock options 103,081 102,211
----------- -----------
Net cash provided by financing activities 103,081 102,211
----------- -----------
Net increase (decrease) in cash and cash
equivalents $ (654,860) $ 614,225
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,754,042 734,266
----------- -----------
CASH AND CASH EQUIVALENTS, END OF QUARTER $ 1,099,182 $ 1,348,491
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
INTEREST PAID $ 40 $ 543
=========== ===========
INCOME TAXES PAID $ 1,600 $ 1,600
=========== ===========
The accompanying notes are an integral part of these financial statements.
5
SIMULATIONS PLUS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
Note 1: GENERAL
As contemplated by the Securities and Exchange Commission under Item 310(b) of
Regulation S-B, the accompanying financial statements and footnotes have been
condensed and therefore do not contain all disclosures required by generally
accepted accounting principles. The interim financial data are unaudited;
however, in the opinion of Simulations Plus, Inc. ("we", "our", "us"), the
interim data include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair statement of the results for the interim
periods. Results for interim periods are not necessarily indicative of those to
be expected for the full year.
Note 2: 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.
Revenue Recognition
-------------------
We recognize revenues related to software licenses and software maintenance in
accordance with the American Institute of Certified Public Accountants ("AICPA")
Statement of Position (SOP) No. 97-2, "Software Revenue Recognition." Product
revenue is recorded at the time of unlocking the software on the customer's
computer(s), net of estimated allowances and returns. Post-contract customer
support ("PCS") obligations are insignificant; therefore, revenue for PCS is
recognized at the same time, and the costs of providing such support services
are accrued and amortized over the obligation period.
As a by-product of ongoing improvements and upgrades for our software, some
modifications are provided to customers who have already licensed 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. We provide,
for a fee, additional training and service calls to our customers and recognize
such revenues at the time the training or service call is provided.
Generally, we enter into one-year license agreements with our customers for the
use of our software products. We recognize revenue on these contracts when all
the criteria under SOP 97-2 are met.
From time to time, we enter into multi-year license agreements. We believe our
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 we have in the past therefore recognized the entire license
fees, net of an applicable discount, at the time of the software's release and
acceptance by the customer. Beginning with the current fiscal year, however, we
have advised investors through our press releases and conference calls that we
will unlock and invoice software one year at a time for future multi-year
licenses. This will eliminate the extreme variability in our reported revenues
and earnings that we've experienced in the past.
6
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
our 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 $202,022 and $119,077 for the nine months ended
May 31, 2006 and 2005, respectively.
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.
Income Taxes
------------
We utilize 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.
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.
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.
Comprehensive Income
--------------------
We utilize 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 our
financial statements since we did not have any of the items of comprehensive
income in any period presented.
7
Concentrations and Uncertainties
--------------------------------
International sales accounted for 37% and 27% of net sales for the third quarter
of fiscal year 2006 (FY06) and 2005 (FY05), respectively. For Simulations Plus,
Inc., three customers accounted for 25%, 25%, and 19% of net sales for the third
quarter of FY06, and for Words+, Inc., one government agency accounted for 17%
of net sales during the third quarter of FY06.
We operate in the computer software industry, which is highly competitive and
changes rapidly. Our operating results could be significantly affected by our
ability to develop new products and find new distribution channels for new and
existing products.
For consolidated accounts receivable, three customers comprised 17%, 13%, and
10% of accounts receivable at May 31, 2006, and one government agency accounted
for 9% of total receivables. For Simulations Plus, four customers comprised 29%,
22%, 16%, and 12% of accounts receivable at May 31, 2006, comparing with three
customers comprised 32%, 19% and 17% of accounts receivable at May 31, 2005. For
Words+, one government agency accounted for 23% of accounts receivable at May
31, 2006 comparing with 25% at May 31, 2005.
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 the 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
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.
Note 3: CASH AND CASH EQUIVALENTS
For purposes of the statements of cash flows, we consider all highly liquid
investments purchased with original maturities of three months or less to be
cash equivalents.
Note 4: ACCOUNTS RECEIVABLE
We maintain an allowance for doubtful accounts for estimated losses that may
arise if any of our customers are unable to make required payments. We
specifically analyze the age of customer balances, historical bad debt
experience, customer credit-worthiness, and changes in customer payment terms
when making estimates of the uncollectability of our trade accounts receivable
balances. If we determine that the financial condition of any of our customers
deteriorated, whether due to customer-specific or general economic issues, an
increase in the allowance may be made. Accounts receivable are written off when
all collection attempts have failed.
8
Our long-term receivables are discounted at the present value. The discount is
amortized over the life of the receivable and recognized as interest income. The
balance as of May 31, 2006 represents receivables which we purchased as a part
of Bioreason's assets.
Note 5: 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.
Note 6: PROPERTY AND EQUIPMENT
Furniture and equipment as of May 31, 2006 consisted of the following:
Equipment $ 154,488
Computer equipment 311,287
Furniture and fixtures 57,705
Automobile 21,769
Leasehold improvements 56,888
------------
Sub total 602,137
Less: Accumulated depreciation and amortization (499,354)
------------
Net Book Value 102,783
============
Note 7: COMMITMENTS AND CONTINGENCIES
Leases
------
We signed a new lease and moved to a new building on February 3, 2006. This
lease has a five-year term with two (2), three (3) year options to extend.
Future minimum lease payments under the non-cancelable lease are as follows:
Fiscal Year Lease Commitment
----------- ----------------
2006 $ 68,730
2007 281,335
2008 292,588
2009 304,292
2010 316,463
Employee Agreement
------------------
On August 9, 2005, the Company entered into an employment agreement with its
President/CEO 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. As of May 31, 2006, included in
accrued bonuses to officers was $57,681, which represented 10% of the Company's
net income before bonuses and taxes, payable to the Company's President, Walter
Woltosz and Corporate Secretary, Virginia Woltosz as the annual bonuses.
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.
9
Litigation
----------
On April 6, we received a notice from a liquidator for the former French
subsidiary of Bioreason, Bioreason SARL, saying that the liquidator has
initiated legal action against Simulations Plus in the French courts with
respect to ClassPharmer distribution rights to European customers, and is
claiming commissions and legal fees with respect to European customers. We have
been working through our U.S. attorneys and a law firm in Paris. We have claimed
our rights against Bioreason SARL's assets by sending a debt recovery
declaration to the liquidator on June 15, 2006. We believe the documentation
from our purchase of certain secured assets of Bioreason clearly shows our
rights to the disputed accounts. Although we are pursuing our rights
aggressively, there can be no assurance that its outcome will be a favorable
result to us.
Note 8: STOCKHOLDERS' EQUITY
Stock Option Plan
-----------------
In September 1996, the Board of Directors adopted and the shareholders approved
the 1996 Stock Option Plan (the "Option Plan") pursuant to which a total of
250,000 shares of common stock were reserved for issuance. The shareholders
approved an additional 250,000 shares that may be granted under the Option Plan
in March 1999, an additional 500,000 shares in February 2000, and an additional
250,000 shares in December 2000. Thus, a total of 1,250,000 shares can be
granted under the Option Plan. The Option Plan terminates in September 2006,
subject to earlier termination by the Board of Directors. Furthermore, on
February 18, 2005 at an annual shareholders meeting, the shareholders approved
an additional 250,000 shares to be reserved for issuance under the 1996 Stock
Option Plan.
As of May 31, 2006, options to purchase 930,242 shares have been issued and were
outstanding to various employees at an exercise price equal to the fair market
value of our stock price at the date of each grant, with five-year vesting
periods. The outstanding options reflect the cancellation of 110,345 shares, of
which 78,945 shares were due to forfeiture because they were not exercised
within their respective terms. Also, in accordance with the by-laws of the
corporation, a total of 9,206 options to purchase shares have been issued to the
Board of Directors at exercise prices ranging from $1.20 to $5.25, with a
three-year vesting period. During the third quarter of FY06, 11,800 options were
exercised by employees.
Note 9: EARNINGS PER SHARE
We report earnings per share in accordance with SFAS No. 128, "Earnings per
Share." Basic earnings (loss) per share is computed by dividing income (loss)
available to common shareholders by the weighted-average number of common shares
available. Diluted earnings (loss) per share is computed similar to basic
earnings (loss) 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. Common equivalent shares are excluded from the computation if their
effect is anti-dilutive. Our common share equivalents consist of stock options.
10
Note 10: STOCK-BASED COMPENSATION
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 us for the year beginning September 1, 2006. For fiscal year 2006,
we currently account for share-based payments to employees using APB 25's
intrinsic value method as permitted; therefore we do 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. We have elected to account for our stock-based
compensation to employees under APB 25.
The table below represents a reconciliation of our pro forma net income giving
effect to the estimated compensation expense related to stock options that would
have been reported if we had utilized the fair value method:
Nine Nine
Months Months
FY 2006 FY 2005
----------- -----------
Net income (loss)
As reported $ 436,070 $ 204,593
Stock based employee compensation cost, net of
related tax effects, that would have been
included in the determination of net income
if the fair value method had been applied (98,056) (189,707)
----------- -----------
PRO FORMA NET INCOME (LOSS) $ 338,014 $ 14,886
=========== ===========
Earnings (loss) per common share
Basic - as reported $ 0.12 $ 0.05
Basic - Pro forma $ 0.09 $ 0.04
Diluted - as reported $ 0.11 $ 0.00
Diluted - Pro forma $ 0.08 $ 0.00
11
Note 11: SEGMENT AND GEOGRAPHIC REPORTING
We account for segments and geographic revenues in accordance with SFAS No. 131,
"Disclosure about Segments of an Enterprise and Related Information." Our
reportable segments are strategic business units that offer different products
and services. Results for each segment and consolidated results are as follows
for the nine months ended May 31, 2006 and May 31, 2005:
May 31, 2006
-------------------------------------------------------------------------------------------------------------
Simulations Words +,
Plus, Inc Inc. Eliminations Total
--------------------------------------------- ---------------- ---------------- --------------- -------------
Net Sales 2,179,379 1,909,511 4,088,890
--------------------------------------------- ---------------- ---------------- --------------- -------------
Income from operations 328,600 160,448 489,048
--------------------------------------------- ---------------- ---------------- --------------- -------------
Identifiable assets 6,166,713 1,599,912 (1,732,718) 6,033,907
--------------------------------------------- ---------------- ---------------- --------------- -------------
Capital expenditures 33,090 23,890 56,980
--------------------------------------------- ---------------- ---------------- --------------- -------------
Depreciation and Amortization 10,439 23,390 33,829
--------------------------------------------- ---------------- ---------------- --------------- -------------
May 31, 2005
-------------------------------------------------------------------------------------------------------------
Simulations Words +,
Plus, Inc Inc. Eliminations Total
--------------------------------------------- ---------------- ---------------- --------------- -------------
Net Sales 1,596,018 1,926,670 3,522,688
--------------------------------------------- ---------------- ---------------- --------------- -------------
Income (loss) from operations 110,661 100,022 210,683
--------------------------------------------- ---------------- ---------------- --------------- -------------
Identifiable assets 5,712,036 1,398,712 (1,793,461) 5,317,287
--------------------------------------------- ---------------- ---------------- --------------- -------------
Capital expenditures 6,733 53,411 60,144
--------------------------------------------- ---------------- ---------------- --------------- -------------
Depreciation and Amortization 10,065 24,473 34,538
--------------------------------------------- ---------------- ---------------- --------------- -------------
In addition, the Company allocates revenues to geographic areas based on the
locations of its customers. Geographical revenues for the nine months ended May
31, 2006 and May 31, 2005 were as follows (in thousands):
May 31, 2006
-------------------------------------------------------------------------------------------------------------
North South
America Europe Asia Oceania America Total
------------------------------ --------------- ------------ ------------ ------------ ------------ ----------
Simulations Plus, Inc. 1,089 581 510 -0- -0- 2,180
------------------------------ --------------- ------------ ------------ ------------ ------------ ----------
Words+, Inc. 1,631 215 37 17 9 1,909
------------------------------ --------------- ------------ ------------ ------------ ------------ ----------
Total 2,720 796 547 17 9 4,089
------------------------------ =============== ============ ============ ============ ============ ==========
May 31, 2005
-------------------------------------------------------------------------------------------------------------
North South
America Europe Asia Oceania America Total
------------------------------ --------------- ------------ ------------ ------------ ------------ ----------
Simulations Plus, Inc. 875 357 364 -0- -0- 1,596
------------------------------ --------------- ------------ ------------ ------------ ------------ ----------
Words+, Inc. 1,698 159 53 17 -0- 1,927
------------------------------ --------------- ------------ ------------ ------------ ------------ ----------
Total 2,573 516 417 17 -0- 3,523
------------------------------ =============== ============ ============ ============ ============ ==========
Note 12: PURCHASE OF BIOREASON'S ASSETS
On November 4, 2005, we purchased certain secured assets of Bioreason, Inc., a
technology company, for $826,192. Since the appraised value was greater than the
actual purchase price, the remaining amount, after allocation to the contracts
receivable, was allocated proportionally to the other assets purchased.
The purchase price was allocated as it follows.
Assets Allocated amounts
------ -----------------
Long-Term contracts receivable $ 447,496
Property and equipment 5,001
Software 245,653
Customer relationships 128,042
-----------------
Total $ 826,192
=================
12
Note 13: SUBSEQUENT EVENT
Press Release
-------------
We announced preliminary results for our third fiscal quarter on Tuesday, June
20, followed by an 8K filing with the SEC on June 21, 2006.
Litigation
----------
On April 6, 2006, we received a notice from a liquidator for the former French
subsidiary of Bioreason, Bioreason SARL, saying that the liquidator has
initiated legal action against Simulations Plus in the French courts with
respect to ClassPharmer distribution rights to European customers, and is
claiming commissions and legal fees with respect to European customers. We have
been working through our U.S. attorneys and a law firm in Paris to aggressively
pursue our rights. We have claimed our rights against the former Bioreason
SARL's assets by sending a debt recovery declaration to the liquidator on June
15, 2006. We believe the documentation from our purchase of certain secured
assets of Bioreason clearly shows our rights to the disputed accounts. Although
we are pursuing our rights aggressively, there can be no assurance that its
outcome will be a favorable result to us.
13
Item 2. Management's Discussion and Analysis or Plan of Operations
------------------------------------------------------------------
FORWARD-LOOKING STATEMENTS
--------------------------
CERTAIN STATEMENTS IN THIS QUARTERLY REPORT ON FORM 10-QSB, 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 (REFERRED TO IN
THIS REPORT AS THE "COMPANY") 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 STOCKHOLDERS 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.
GENERAL
BUSINESS
--------
Simulations Plus, Inc. (the "Company" or "Simulations Plus", or "we" or "our" or
"us") 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: ADMET
Modeler(TM), ADMET Predictor(TM), ClassPharmer(TM), DDDPlus(TM), and
GastroPlus(TM).
ADMET MODELER
-------------
ADMET (Absorption, Distribution, Metabolism and Excretion and Toxicity) Modeler
was first 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 new toxicity models were
developed in a matter of a few hours once we completed the tedious effort of
"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 new model to obtain similar
results.
14
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
now use their own experimental data to create very high quality predictive
models.
During the third quarter, a new version of ADMET Modeler was released. This
version improves the support vector machine ensemble modeling to include
classification models (e.g., high/medium/low classes for a predicted property)
as well as regression models (i.e., models that predict a continuous numerical
value for a property). In addition, the ability for scientists to see the
sensitivity of the predictive models to the values of various molecular
descriptors used in the artificial neural network ensemble models was added. We
believe this is a unique capability. In the past, some scientists were reluctant
to use "black box" models employing powerful artificial neural network ensembles
because they did not allow them to understand how modifying molecules would
affect the predicted properties. With this new capability, scientists can now
see an intuitive graphical representation of descriptor sensitivity.
ADMET PREDICTOR
---------------
ADMET Predictor consists of a library of statistically significant numerical
models that predict various properties of chemical compounds from just their
molecular structures. This capability means a chemist can merely draw a molecule
diagram and get reasonable estimates of these properties, even though the
molecule has never existed. Drug companies search through millions of such
"virtual" molecular structures as they attempt to find new drugs. The vast
majority of these molecules are not suitable as medicines for various reasons.
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, some degrade so quickly that they are not stable enough to have a useful
shelf life, some bind to proteins (like albumin) in blood 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 make them and then run experiments to identify these weaknesses. Today, many
molecules can be eliminated on the basis of computer predictions, such as those
provided by ADMET Predictor.
During the 2nd and 3rd quarters, numerous improvements were made to the program,
including a convenient model editor and to add an algorithm whereby scientists
can now add their own data and extend any of the predictive models into their
own "chemical space" when it is significantly different from that of the data
used to train the model. A sensitivity depiction was also added to allow
scientists to see to which particular descriptors (molecular features) a
property is most sensitive. This information is helpful to chemists to enable
them to see how different molecular structural features affect various ADMET
properties. This version was released in the 3rd quarter.
Work is now underway to integrate ADMET Predictor and ADMET Modeler into a
single program for greater user convenience. The two programs were designed to
work together from the start, so this integration will simply make it easier to
use the model-building capabilities of ADMET Modeler. In addition, we believe
that integration of the two into a single package will enhance the competitive
posture of ADMET Predictor.
15
CLASSPHARMER(TM)
----------------
In November 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. ClassPharmer is a molecule
classification software program, similar in nature to ChemTK(TM), which we
acquired from Sage Informatics in August 2005, but with more sophisticated
proprietary classification algorithms and various additional 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 ChemTK from Sage was to integrate it with
ClassPharmer and make a single package. This effort was completed during this
reporting period, and we released ClassPharmer 4.0 in March 2006. Version 4.1
has been in development since that time with additional capabilities that have
been requested by our customers. We expect release of version 4.1 early in the
4th quarter.
DDDPLUS
-------
DDDPlus (Dose Disintegration and Dissolution Plus) was first released 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.
Over 60 companies evaluated Version 1.0 of DDDPlus. This is an indication of the
strong interest and business potential in this area. However to date, few
licenses have been sold. Through the evaluation process, we received valuable
feedback about what would be required for various customers to license the
software, and we have now incorporated those improvements. We have also added
significant new functionality by enabling formulation scientists to optimize
experimental conditions to achieve a desired dissolution-time profile, and to
handle polymer matrix formulations that are often used in controlled release
formulations. Version 2.0 was released in the 3rd quarter and is now being
evaluated at a number of potential customer sites.
We continue to remain confident that significant sales of DDDPlus licenses will
take place. The initial release 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. Because such scientists have never used
software like DDDPlus before, this is an educational process to show them how
such a tool can actually save time and money, similar to the process we had with
GastroPlus ten years ago.
GASTROPLUS
----------
GastroPlus simulates 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 (i.e., degraded) 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 the optional PBPKPlus(TM) Module, released during this reporting
period, concentrations in a variety of tissues and organs can now also be
predicted. With the optional PDPlus(TM) module, the program can also simulate
how a drug affects the body, such as reducing pain, reducing blood pressure,
reducing depression, and causing adverse side effects.
16
We believe GastroPlus is the "gold standard" in the industry for its class of
simulation software. It is used from early drug discovery through development
and into early clinical trials. The information provided through GastroPlus
simulations guides project decisions in various ways. Among the kinds of
knowledge gained through such simulations 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 and tissue concentration levels would be in a large population, in
different age groups or in different ethnic groups, and (5) whether a new
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 enjoys a dominant position
in the number of users worldwide. In addition to virtually every major
pharmaceutical company, licenses include a growing number of smaller phla nd
biotech companies, 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 smaller than the
pharmaceutical giants, they can also save considerable time and money through
simulation. We believe this part of the industry, which includes hundreds of
companies, represents major growth potential for GastroPlus. Our experience has
been that the number of new companies adopting GastroPlus shows steady growth,
adding to the base of annual licenses each year.
During the third quarter, we released version 5.1, which added a "particle size
distribution" model that had been requested by our customers. This allows
formulation scientists to simulate the dissolution of solid drug particles of
various sizes, rather than using an average size to represent all particles.
Smaller particles dissolve faster than larger ones, and for slow-dissolving
drugs, the differences in simulated results can be significant.
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. Version 5.0 with the new PBPKPlus(TM) module, released in December
2005, further extended the utility of GastroPlus. Version 5.1 added additional
functionality and user convenience, and we are now working on version 5.2, which
expands the program's utility further in response to customer requests for added
features. At their request, we are currently negotiating with one of our large
pharmaceutical company partners to cover one full-time equivalent (FTE) to
expand the capabilities 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.
17
CONTRACT RESEARCH SERVICES
--------------------------
In addition to our software products, we also 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. We are also adding scientific staff, with
two new Ph.D. scientists having already accepted offers and plans to hire three
or four more. This will increase our life sciences department from seven to 12
or 13.
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) 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.
(2) 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.
This development effort accelerated during fiscal year 2005 with the hiring of a
new Ph.D. scientist who 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.
This project was put on hold in September 2005 because the previous product
manager for GastroPlus took a position with another company, and the scientist
responsible for MembranePlus was assigned to take over GastroPlus. She has done
an excellent job with GastroPlus, completing the PBPKPlus Module and all of the
many associated changes that accompanied it during this reporting period. She
will continue to work on GastroPlus as needed, but will also work on
MembranePlus again as GastroPlus activities allow. We are currently interviewing
several candidates to expand our life sciences team, with at least one in this
area to provide her with assistance on these two projects.
18
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. We intend 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 Hewlett-Packard 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. SAM-based products now account for a significant share of our growing
Words+ revenues.
Since the acquisition of the Say-it! SAM technologies, we have continued to add
new functionality to the SAM software and to offer it on additional hardware
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.
RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED MAY 31, 2006 AND 2005.
The following table sets forth our consolidated statements of operations (in
thousands) and the percentages that such items bear to net sales:
------------------------------------------------------------
Three Months Ended
------------------------------------------------------------
05/31/06 05/31/05
------------------------------- ----------------------------
Net sales $ 1,788 100% $ 1,424 100%
Cost of sales 433 24.2 428 30.1
---------------- -------------- ------------- --------------
Gross profit 1,355 75.8 996 69.9
---------------- -------------- ------------- --------------
Selling, general and administrative 795 44.5 645 45.3
Research and development 119 6.7 134 9.4
---------------- -------------- ------------- --------------
Total operating expenses 914 51.1 779 54.7
---------------- -------------- ------------- --------------
Income (loss) from operations 441 24.7 217 15.2
---------------- -------------- ------------- --------------
Other income 19 1.1 6 0.4
---------------- -------------- ------------- --------------
Net income before taxes 460 25.7 223 15.6
---------------- -------------- ------------- --------------
Provision for income taxes 74 4.1 50 3.5
---------------- -------------- ------------- --------------
Net income $ 386 21.6% $ 173 12.1%
================ ============== ============= ==============
NET SALES
Consolidated net sales increased $364,000, or 25.6%, to $1,788,000 in the third
fiscal quarter of 2006 (3Q FY06) from $1,424,000 in the third fiscal quarter of
2005 (3Q FY05). Our sales from pharmaceutical and educational software increased
approximately $434,000, or 65.5%; and our Words+, Inc. subsidiary's sales
decreased approximately $70,000, or 9.2%, for the quarter. We attribute a
portion of the increase in pharmaceutical software sales to a multi-year global
renewal order from a large customer. In FY04, we recognized their 2-year license
in full because we delivered the product by unlocking the license for 2 years,
resulted in no income from this customer in FY05. In this third fiscal quarter
of FY06, we have received a renewal of another 2-year license from the same
customer with an increase over the FY2004 order. We no longer unlock such
multi-year licenses for the full term; rather we have unlocked the software only
for the first year term, thus recognizing revenue for one year only, and
deferring the second year license till FY07. Therefore, the one-year term of
license revenue in FY06 comparing with no revenue in FY05 from this customer
resulted in an increase in FY06 from FY05, in addition to new revenues generated
from ClassPharmer software which we acquired in November 2005, and an increase
in revenue from ADMET Predictor/Modeler.
19
We attribute the small decrease in Words+ sales primarily a decrease in sales of
"TuffTalker", "Freedom" products, and increases in insurance discounts which
outweighed increases in sales of "Say-it-SAM!" and "TuffTalker Plus" products.
COST OF SALES
Consolidated cost of sales increased $5,000, or 1.2%, to $433,000 in the 3Q FY06
from $428,000 in the 3Q FY05. The percentage of cost of sales in the 3Q FY06
decreased 5.9% from the 3Q FY05. For Simulations Plus, absolute cost of sales
increased $57,000, or 74.8%. As a percentage of sales, cost of sales increased
to 12.1% in FY06 from 11.5% in FY05. A significant portion of cost of sales is
the systematic amortization of capitalized software development costs, which is
an independent fixed cost rather than a variable cost related to sales. This
amortization cost increased approximately $39,000, or 208.1%, in the 3Q FY06
compared with the same period in FY05.
For Words+, cost of sales decreased $52,000, or 14.6%. As a percentage of sales,
cost of sales decreased 2.7% between the 3Q FY06 and 3Q FY05. We attribute the
percentage decrease in cost of sales for Words+ primarily to the ability to
obtain purchase discounts by volume purchases of computers and PDAs, which are
main components of the systems we sell.
GROSS PROFIT
Consolidated gross profit increased $359,000, or 36.0%, to $1,355,000 in the 3Q
FY 06 from $996,000 in the 3Q FY05. We attribute this increase to the increase
in sales of pharmaceutical software in addition to an increase in profit margin
on Words+ products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Consolidated selling, general and administrative expenses increased $150,000, or
23.3%, to $795,000 in the 3Q FY06 from $645,000 in the 3Q FY05. For Simulations
Plus, selling, general and administrative expenses increased $186,000, or 56.2%.
One of the major increases in expenses was accrued bonuses to officers for
$57,681, which represented 10% of the Company's net income before bonuses and
taxes, payable to the Company's President, Walter Woltosz and Corporate
Secretary, Virginia Woltosz as the annual bonuses. Other increases include legal
fees incurred for a litigation brought up by an attorney/liquidator in France,
who represented the former French subsidiary of Bioreason and who is contesting
our ClassPharmer distribution rights in Europe, an accounting fee which was
incurred for a value assessment of the Bioreason assets provided by an
independent firm, commissions to a dealer, travel expenses, salary and payroll
taxes, rent, dues and subscriptions, and recruiting costs, which outweighed
decreases in investor relations, repairs, and insurances.
For Words+, selling, general and administrative expenses decreased $35,000, or
11.2%, due primarily to decreases in commission, trade shows, insurances, and
technical service costs. These decreases outweighed increases in contributions,
depreciation, rent, salaries and payroll taxes.
RESEARCH AND DEVELOPMENT
We incurred approximately $215,000 of research and development costs for both
companies during the 3Q FY06. Of this amount, $96,000 was capitalized and
$119,000 was expensed. In the 3Q FY05, we incurred $191,000 of research and
development costs, of which $57,000 was capitalized and $134,000 was expensed.
The increase of $24,000, or 12.6%, in research and development expenditures from
the 3Q FY05 to the 3Q FY06 was due primarily to salaries for additional staff in
our Life Science Department.
20
OTHER INCOME
Net other income in the 3Q FY06 increased by $13,000, from net income of $6,000
to net income of $19,000. This is due primarily to the increase in currency
exchange, from loss of $5,000 in the 3Q FY05 to a $10,000 gain in 3Q FY06. The
net change of $15,000 was offset by the decreases in interest income, which was
the amortization of present value discounts on long-term receivables, and
miscellaneous income.
PROVISION FOR INCOME TAX
We estimated income taxes of $83,000 at the end of May 31, 2006. Since we have
already recorded $9,000 in income tax based on the estimation at the end of the
second fiscal quarter of FY06, we recorded an additional $74,000 as an estimated
income tax. At the end of 3Q FY05, we estimated income tax of $50,000.
NET INCOME
Consolidated net income for the three months' operations increased by $213,000,
or 123.1%, to $386,000 in the 3Q FY06 compared to $173,000 in the 3Q FY05. We
attribute this increase in profit primarily to the increases in pharmaceutical
software and other income along with the improvement in gross margin. Although
there were increases in selling, general and administrative expense, research
and development expenditures, and provision for income taxes, the increase in
revenues combined with improved profit margins outweighed increased expenses.
COMPARISON OF NINE MONTHS ENDED MAY 31, 2006 AND 2005.
The following table sets forth our consolidated statements of operations (in
thousands) and the percentages that such items bear to net sales:
------------------------------------------------------------
Nine Months Ended
------------------------------------------------------------
05/31/06 05/31/05
------------------------------- ----------------------------
Net sales $ 4,089 100% $ 3,523 100%
Cost of sales 1,152 28.2 1,121 31.8
---------------- -------------- ------------- --------------
Gross profit 2,937 71.8 2,402 68.2
---------------- -------------- ------------- --------------
Selling, general and administrative 2,112 51.7 1,812 51.4
Research and development 336 8.2 379 10.8
---------------- -------------- ------------- --------------
Total operating expenses 2,448 59.9 2,191 62.2
---------------- -------------- ------------- --------------
Income from operations 489 12.0 211 6.0
---------------- -------------- ------------- --------------
Other income 30 0.7 44 1.2
---------------- -------------- ------------- --------------
Net income before taxes 519 12.7 255 7.2
---------------- -------------- ------------- --------------
Provision for income taxes 83 2.0 50 1.4
---------------- -------------- ------------- --------------
Net income $ 436 10.7% $ 205 5.8%
================ ============== ============= ==============
21
NET SALES
Consolidated net sales increased $566,000, or 16.1%, to $4,089,000 in the first
nine months of fiscal year 2006 (FY06) from $3,523,000 in the first nine months
of fiscal year 2005 (FY05). Our sales from pharmaceutical and educational
software increased approximately $583,000, or 36.6%; while our Words+, Inc.
subsidiary's sales decreased approximately $17,000, or 0.9%, for the nine months
ended May 31, 2006. We attribute the increase in pharmaceutical software sales
primarily to the revenues from ClassPharmer sales, and a renewal from a large
pharmaceutical company discussed above in the 3-month comparison.
We attribute the decrease in Words+ sales primarily a decrease in sales of
"TuffTalker" and "Freedom" product sales which outweighed the increase in sales
of "Say-it! SAM" and "TuffTalker Plus."
COST OF SALES
Consolidated cost of sales increased $31,000, or 2.8%, to $1,152,000 in the
first nine months of FY06 from $1,121,000 in the first nine months of FY05. The
percentage of cost of sales in the first nine months of FY06 decreased 3.6% from
the first nine months of FY05. For Simulations Plus, absolute cost of sales
increased $118,000, or 66.0%. As a percentage, cost of sales increased to 13.7%
in FY06 from 11.2% in FY05. A significant portion of cost of sales is the
systematic amortization of capitalized software development costs, which is an
independent fixed cost rather than a variable cost related to sales. This
amortization cost increased approximately $83,000, or 185.1%, in the first nine
months of FY06 compared with the same period in FY05.
For Words+, cost of sales decreased $87,000, or 9.3%. As a percentage, cost of
sales decreased 4.2% between the first nine months of FY06 and FY05. We
attribute the percentage decrease in cost of sales for Words+ primarily to the
ability to obtain purchase discounts through volume purchases of computers and
PDAs, which are main parts for the systems we sell.
GROSS PROFIT
Consolidated gross profit increased $535,000, or 22.3%, to $2,937,000 in the
first nine months of FY06 from $2,402,000 in the first nine months of FY05. We
attribute this increase to the increase in sales of pharmaceutical software in
addition to an increase in profit margin on Words+ products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Consolidated selling, general and administrative expenses increased $300,000, or
16.6%, to $2,112,000 in the first nine months of FY06 from $1,812,000 in the
first nine months of FY05. For Simulations Plus, selling, general and
administrative expenses increased $316,000, or 32.4%. The major increases in
expenses were accrued bonuses to officers for $57,681, which represented 10% of
the Company's net income before bonuses and taxes, payable to the Company's
President, Walter Woltosz and Corporate Secretary, Virginia Woltosz as the
annual bonuses, commissions, trade shows and travel, legal fees which were
incurred for the acquisition of assets from Sage Informatics and Bioreason, and
legal fee incurred for ClassPharmer distribution rights in Europe, as well as
salary and payroll-related expenses such as health insurance and payroll taxes,
rent, and recruiting costs, which outweighed decreases in investor relations and
equipment repairs.
For Words+, selling, general and administrative expenses decreased $16,000, or
0.9%, due primarily to decreases in commissions, trade shows, contract labor,
and insurances. These decreases outweighed increases in contribution, rent,
technical service costs, supplies, salaries and payroll tax.
22
RESEARCH AND DEVELOPMENT
We incurred approximately $924,000 of research and development costs for both
companies during the first nine months of FY06. Of this amount, $588,000,
including allocation of the appraised value of $245,653 on the ClassPharmer
software, was capitalized and $336,000 was expensed. In the first nine months of
FY05, we incurred $635,000 of research and development costs, of which $256,000
was capitalized and $379,000 was expensed. The increase of $289,000, or 45.5%,
in research and development expenditures from the first nine months of FY05 to
the first nine months of FY06 was due primarily to our acquisition of the
ClassPharmer software and additional salaries to new hires in our Life Science
Department.
OTHER INCOME (EXPENSE)
Net other income in the first nine months of FY06 decreased by $14,000, from net
income of $44,000 to $30,000. This is due primarily to the decrease in the
amortization of present value discounts on long-term receivables which we had
fully amortized by May 2005. We incurred other long-term receivables from a part
of the Bioreason assets purchase; however, their amortized interest was $6,000
in the first nine months of FY06, while the amortized interest revenue we had in
the same period of FY05 was $32,000. There were increases in gains from currency
exchange and sales of assets in the first nine months of FY06 compared with the
same period of FY05, however the these increases did not exceed the decreases in
interest income .
PROVISION FOR INCOME TAX
We estimate an income tax of $83,000 for the first nine months of FY 06, while
we estimated $50,000 for the first nine months of FY05.
NET INCOME
Consolidated net income for the first nine months of FY06 increased by $231,000,
or 112.7%, to $436,000 compared to $205,000 in the first nine months of FY05. We
attribute this increase in profit primarily to increased sales of pharmaceutical
software licenses in addition to an increase in profit margin on Words+
products, which outweighed increases in operating expenses and income taxes, and
decreases in other income.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of capital have been cash flows from its
operations and a bank line of credit. The Company did not renew a revolving line
of credit for $500,000 from a bank in May 2005 because the Company did not use
it during the prior year and did not expect to need it in the near future. The
Company will consider re-applying for the line of credit when there is a need
for it.
The Company believes that existing capital and anticipated funds from operations
will be sufficient to meet its anticipated cash needs for working capital and
capital expenditures for the foreseeable future. Thereafter, if cash generated
from operations is insufficient to satisfy the Company's capital requirements,
the Company may apply for a loan from a bank and may have to sell additional
equity or debt securities or obtain expanded credit facilities. In the event
such financing is needed in the future, there can be no assurance that such
financing will be available to the Company, or, if available, that it will be in
amounts and on terms acceptable to the Company. 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.
23
Item 3. Quantitative and Qualitative Disclosures about Market Risk
------------------------------------------------------------------
Our risk from exposure to financial markets is limited to foreign exchange
variances and fluctuations in interest rates. We may be subject to some foreign
exchange risks. Most of our business transactions are in U.S. dollars, although
we generate significant revenues from customers overseas. The exception is that
we were compensated in Japanese yen by most Japanese customers. As a result, we
experienced a gain from currency exchange in the first nine months of FY06. In
the future, if foreign currency transactions increase significantly, then we may
mitigate this effect through foreign currency forward contracts whose
market-to-market gains or losses are recorded in "Other Income or expense" at
the time of the transaction. To date, exchange rate exposure has not resulted in
a material impact.
Item 4. Controls and Procedures
-------------------------------
(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. As of the
end of the period covered by this report, the Company carried
out an evaluation, under the supervision and with the
participation of the Company's management, including the
Company's Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to
Exchange Act Rule 13a-14. Based upon that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures are
effective in timely alerting them to material information
relating to the Company required to be included in the
Company's periodic SEC filings.
(b) CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING. There
were no changes in the Company's internal controls over
financial reporting during the Company's most recent fiscal
quarter that have materially affected, or are reasonably
likely to materially affect, the Company's internal controls
over financial reporting.
24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
On April 6, 2006, we received a notice from a liquidator for the former
French subsidiary of Bioreason, Bioreason SARL, saying that the
liquidator has initiated legal action against Simulations Plus in the
French courts with respect to ClassPharmer distribution rights to
European customers, and is claiming commissions and legal fees with
respect to European customers. We have been working through our U.S.
attorneys and a law firm in Paris to aggressively pursue our rights. We
claimed our rights against Bioreason SARL's assets by sending a debt
recovery declaration to the liquidator on June 15, 2006. We believe the
documentation from our purchase of certain secured assets of Bioreason
clearly shows our rights to the disputed accounts, and we are pursuing
our rights aggressively. Although we are pursuing our rights
aggressively, there can be no assurance that its outcome will be a
favorable result to us.
Item 2. Changes in Securities
---------------------
None.
Item 3. Defaults Upon Senior Securities
-------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None.
Item 5. Other Information
-----------------
None.
Item 6. Exhibits
--------
(a) Exhibits:
31.1-2 Certification of Chief Executive Officer and Chief Financial
Officer
32 Certification pursuant to Sec. 906 of the Sarbanes-Oxley Act
of 2002
25
SIGNATURE
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
July 11, 2006.
Simulations Plus, Inc.
Date: July 11, 2006 By: /s/ MOMOKO BERAN
--------------------------
Momoko Beran
Chief Financial Officer
26