SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-KSB
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended August 31, 2002 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: 000-21665
Simulations Plus, Inc.
(Exact name of registrant as specified in its charter)
California
(State or other jurisdiction of Incorporation or Organization)
95-4595609
(I.R.S. Employer identification
No.)
1220 W. Avenue J
Lancaster, CA 93534
(Address of principal executive offices including zip code)
(661) 723-7723
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE.
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $0.001 PER SHARE
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes x No
------------- -------------
Check if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B is not contained herein, and will not 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. [ ]
The issuer's revenues for the fiscal year ended August 31, 2002 were
approximately $4,444,000.
AS OF NOVEMBER 11, 2002, THE AGGREGATE MARKET VALUE OF THE VOTING STOCK
HELD BY NON-AFFILIATES OF THE ISSUER WAS APPROXIMATELY $1,805,000 BASED UPON THE
AVERAGE CLOSING BID AND ASKED PRICE OF SUCH STOCK ON SUCH DATE.
SIMULATIONS PLUS, INC.
FORM 10-KSB
FOR THE FISCAL YEAR ENDED AUGUST 31, 2002
Table of Contents Page
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PART I
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Item 1. Description of Business 1
Item 2. Description of Property 14
Item 3. Legal Proceedings 14
Item 4. Submission of Matters to a Vote of Security Holders 14
PART II
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Item 5. Market for Common Stock and Related Stockholder Matters 15
Item 6. Management's Discussion and Analysis or Plan of Operation 16
Item 7. Financial Statements 21
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 21
PART III
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Item 9. Directors, Executive Officers, Promoters and Control Persons:
Compliance with Section 16(a) of the Exchange Act 22
Item 10. Executive Compensation 23
Item 11. Security Ownership of Certain Beneficial Owners and Management 24
Item 12. Certain Relationships and Related Transactions 26
Item 13. Exhibits and Reports on Form 8-K 26
Signatures 28
Statement Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 29
Financial Statements F-1
2
FORWARD-LOOKING STATEMENTS
--------------------------
The following discussion should be read in conjunction with the financial
statements and the notes thereto appearing elsewhere in this Annual Report
("Annual Report") on Form 10-KSB for the year ended August 31, 2002 (the "Form
10-KSB"). In addition to historical information, this Annual Report contains
forward-looking statements. The forward-looking statements contained herein are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those reflected in the forward-looking statements.
Factors that might cause such a difference include, but are not limited to,
those discussed in the section entitled "Management's Discussion and Analysis or
Plan of Operation." Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's analysis only as of the
date hereof. Simulations Plus, Inc. undertakes no obligation to publicly revise
these forward-looking statements, or to reflect events or circumstances that
arise after the date hereof. Readers should carefully review the risk factors
described in other documents the Company has filed and will continue to file
from time to time with the Securities and Exchange Commission.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
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Simulations Plus, Inc. (the "Company" or "Simulations Plus") and its wholly
owned subsidiary, Words+, Inc. ("Words+") produce two types of products: (1)
Simulations Plus, incorporated in 1996, develops and produces simulation and
mathematical modeling 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.
DESCRIPTION OF SIMULATION SOFTWARE
The development of simulation software involves (1) identifying and
understanding the underlying chemistry, physics, biology, and physiology of the
processes to be simulated, (2) breaking those processes down into the lowest
practical level of individual sub-processes at which the behaviors can be
well-represented mathematically, (3) developing appropriate mathematical
relationships/equations, and (4) converting them into computer subroutines. The
software subroutines representing these individual processes are then integrated
into an overall simulation program, with appropriate coordination between
modules and design of user-friendly interface for inputs and outputs. The
predictions of these programs are then compared to known results in order to
calibrate the simulations and to demonstrate the validity of the models as
useful tools for predicting new results.
The types of simulation software produced by the Company are based on the
equations of chemistry and physics that describe or "model" the behavior of
things in the real world.
The Company's GastroPlus(TM) pharmaceutical software simulates the movement,
dissolution/precipitation, chemical/metabolic degradation and absorption of
orally-dosed drug compounds in the gastrointestinal tract of humans and several
laboratory animal species, and with additional inputs, it also simulates the
metabolism, renal clearance, and blood plasma concentration-time history of the
drug after it reaches the central circulation.
A second type of software consists of statistically significant models that
allow prediction of various properties of a chemical compound from just its
1
molecular structure. These models are not simulations, but instead are formed
from a variety of mathematical functions and relationships, including linear,
nonlinear, and artificial neural network models.
The Company's QMPRPlus(TM) program is the second type of program, and it
provides estimates for the values of several important physicochemical
characteristics of new drug-like molecules with only the structures of the
molecules as input. Recent additions to this program include the prediction of
permeability in a special line of cells called MDCK cells. This predictive model
was developed during the previous fiscal year under a funded collaboration with
the Affymax Research Institute, at that time a division of Glaxo Wellcome. The
Company recently announced the release of a powerful "4D Data Mining" module for
QMPRPlus, which further extends the utility of the software. Both the MDCK
module and the 4D Data Mining module are additional-cost options to the program.
GastroPlus and QMPRPlus are used by almost every major and a number of smaller
pharmaceutical companies in North America, Europe, and Japan. The number of
licensees continues to grow each quarter, and growing revenues reflect the
cumulative effect of annual license renewals added to new sales.
The Company is now completing the development of two new additional-cost
modules, one for GastroPlus and one for QMPRPlus. The Training Module for
QMPRPlus will allow users to build their own artificial neural network models
using a highly sophisticated, state-of-the-art model-building engine that
automates the process of finding the most effective artificial neural network
models for a particular database, using the fast descriptor engine that is part
of QMPRPlus.
The Company's award-winning FutureLab(TM) science experiment simulations for
middle school and high school students incorporate the equations of chemistry
and physics for each experiment (optics, electrical circuits, gravity, universal
gravitation, ideal gases, etc.), 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.
PHARMACEUTICAL SIMULATION SOFTWARE
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PRODUCTS:
GastroPlus:
-----------
The Company's pharmaceutical software products provide cost-effective solutions
to a number of critical problems in pharmaceutical research, and also serve in
the education of pharmacy and medical students. The Company's pharmaceutical
software products and services to date are focused on the area of pharmaceutical
research known as ADMET (Absorption, Distribution, Metabolism, Elimination, and
Toxicity). The Company released its first pharmaceutical software product,
GastroPlus, in August 1998 and immediately received enthusiastic interest from
researchers in large pharmaceutical companies such as Astra, Glaxo Wellcome,
Pfizer, Pharmacia, The Roche Group, SmithKline Beecham and Zeneca. Since then,
the majority of the world's largest pharmaceutical companies and a steadily
growing number of smaller companies have licensed the software. Some of these
companies have merged to become single companies (e.g., AstraZeneca and
GlaxoSmithKline have merged, and Pfizer is now in the process of acquiring
Pharmacia), which give the appearance of fewer customers, but the Company's
software is licensed on an annual basis by geographic location, so the actual
loss in sales has resulted from these mergers are minor. In fact, several of
these mergers have resulted in increased licenses and new geographic locations.
2
The Optimization Module for GastroPlus was released in November 1998. Two
additional modules, IVIV Correlation and PKPlus(TM) were released in November
2000. The Metabolism and Transporter Module was released in June 2001.
In August 2002, the Company completed the development of, and is now selling
licenses for, an important new extension module for GastroPlus called
PDPlus(TM). Prior versions of GastroPlus have dealt with absorption and
pharmacokinetics (what happens to the drug when it gets into the body). PDPlus
now adds pharmacodynamics for the drug (what happens to the body when the drug
gets into the body) - i.e., what kind of therapeutic and side effects it
produces. This is an important new capability because it opens up the market to
researchers who deal in later stage clinical trials, and who routinely perform
PK/PD (pharmacokinetic/pharmacodynamic) analyses. Until now, these analyses were
performed using models that treated absorption and its related processes with
simplified models - often so simplified that calculations were in error. With
PDPlus in GastroPlus, researchers will be able to perform highly sophisticated
simulations and analyses to determine the complex interactive effects of factors
that change the amount of drug that is absorbed, and how fast it is metabolized
after it is absorbed. These can result in significant variations in
pharmacodynamic effect. Without the ability to predict these effects, clinical
trial costs can soar when trials must be repeated to determine proper dosing
levels. PDPlus will enable researchers to better understand the complex
interplay among absorption, pharmacokinetics/metabolism, and pharmacodynamics,
and to better estimate dosing levels to use in clinical trials prior to the
start of those trials.
The majority of new sales now include additional extra-cost modules,
contributing significantly to revenue growth. GastroPlus has now become the
"gold standard" for simulation of oral drug absorption and pharmacokinetics, and
is in use throughout the industry in North America, Japan, and Europe. Recent
sales have included a number of drug delivery companies (companies that design
the actual 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 realize significant savings in cost and time
through accurate simulation of their drug delivery technologies. The Company
believes this part of the industry, which includes hundreds of companies,
represents major growth potential for GastroPlus.
In 1998, the Company executed a License Agreement with Therapeutic Systems
Research Laboratories, Inc. ("TSRL"), Ann Arbor, Michigan, to obtain exclusive
rights to TSRL's technology and database, including measurements of drug
permeability from nearly 60 laboratory experiments to measure the intestinal
permeability of drug compounds in human and/or rat small intestines. As a part
of this License Agreement, the Company is also entitled to ongoing consulting
assistance in the development and further enhancement of the GastroPlus
absorption simulation model from TSRL staff, including Dr. Gordon Amidon. The
Company believes that the strategic advantage of exclusive access to TSRL's
technology and expertise, combined with the Company's now well-developed
expertise in absorption and pharmacokinetics simulation, have resulted in
GastroPlus becoming the de facto standard for oral drug absorption simulation
and analysis within the pharmaceutical industry. The Company is aware that other
companies have developed oral absorption software; however, based on customer
feedback, management believes there is no significant competition for GastroPlus
at this time. The Company believes that the addition of the Metabolism and
Transporter Module last year, the new PDPlus module, and ongoing upgrades of the
core simulation, are advances in the state-of-the-art of oral drug absorption,
pharmacokinetics, and pharmacodynamics analysis. The Company's recognized
expertise in oral absorption and pharmacokinetics is evidenced by the fact that
Company staff members have been invited speak at many scientific meetings
worldwide in the past three years, and they continue to be invited to present at
a variety of meetings worldwide. Numerous technical papers and presentations by
customers and university researchers have provided independent testimony to the
effectiveness of the Company's software products and underlying science. Also,
the Company conducts contracted studies for a number of companies who prefer to
have the studies run by the Company's scientists than to acquire the software
and train someone to use it, as well as for larger companies who have the
software, but need additional expertise for particularly challenging problems.
3
QMPRPlus (Quantitative Molecular Permeability Relationships):
-------------------------------------------------------------
QMPRPlus, which can be used as a companion program to GastroPlus or by itself,
takes as inputs the structures of molecules, and provides estimates for human
intestinal permeability, octanol-water partition coefficient (logP), solubility,
diffusivity, blood-brain barrier penetration, plasma protein binding, and volume
of distribution. The ability to predict these properties prior to running wet
lab experiments allows screening of undesirable compounds much faster and at
much lower cost than using traditional experimental methods.
Most of the estimated parameters from QMPRPlus are inputs to GastroPlus.
QMPRPlus thereby extends the utility of GastroPlus into early drug discovery,
during which pharmaceutical companies may not have even made many of the
molecules that have been identified as potential drug candidates. During the
fiscal year 2001, the Company completed the development of a new intestinal
permeability model for a special line of cell culture experiments using
Manin-Darby Canine Kidney (MDCK) cells under contract to the Affymax Research
Institute, at that time a division of Glaxo Wellcome. This unique model, based
on high quality data for approximately 400 compounds, was presented at the
American Chemical Society meeting in San Diego during the first week of April
2001. The Company also completed the development of a powerful "4D Date Mining"
module in April 2002. This module provides important data visualization and
statistical analysis tools to enable researchers to better understand the
complex relationships that can exist among hundreds of different dimensions of
"chemical space" that describe a large group of molecules during screening. As
an additional enhancement to QMPRPlus, the Company completed the development of
a blood-brain barrier permeation model during the last fiscal year as well as
models for plasma protein binding and volume of distribution, and it updated all
earlier models with new artificial neural network ensembles (groups of
artificial neural networks whose outputs are averaged to obtain better
prediction than any single network can provide). By providing estimates of
physicochemical properties from structure alone, QMPRPlus, by itself or coupled
with GastroPlus, allows researchers to rank order large numbers of candidate
compounds in terms of their potential for human intestinal absorption. Because
pharmaceutical companies are dealing with many millions of compounds per year,
and because the area of ADMET has become a bottleneck, high throughput screening
on the computer ("IN SILICO") is becoming not just a convenience, but a
necessity. It is one of the fastest growing new technologies in pharmaceutical
research, and the Company believes it has positioned itself well to take
advantage of the growing expenditures in this area.
Contract Research Services:
---------------------------
The Company offers contract research services to the pharmaceutical industry in
the area of gastrointestinal absorption, pharmacokinetics, and related
technologies. The Company continues to perform study contracts for a variety of
pharmaceutical and biotechnology companies of all sizes. These studies provide
an additional source of revenue for the Company, as well as a means to introduce
the Company's software products to new customers. These studies are also
beneficial to the Company to validate and enhance its products by studying
actual data in the pharmaceutical industry. During the past fiscal year, the
Company completed several study contracts for customers and provided assistance
to several government agencies. Additional study contracts are now underway.
PRODUCT DEVELOPMENT:
In the area of simulation software for pharmaceutical research, the Company is
pursuing the development of additional modules for GastroPlus and QMPRPlus.
Although all of our development work cannot be disclosed for competitive
reasons, some of our development efforts include:
4
(1) Multiple Particle Size Dissolution Model
--------------------------------------------
The current dissolution model in GastroPlus uses a single "effective" particle
size. While this model has well represented most tablets, capsules, and
suspensions we have dealt with 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 over some range from smaller than the
average size to larger than the average size. 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.
(2) Biopharmaceutical Properties Module
---------------------------------------
This module allows researchers to estimate drug properties from structures
within GastroPlus software.
(3) QMPRPlus upgrades
---------------------
The number of molecular descriptors has been increased in beta versions of
QMPRPlus by about 25%. These new descriptors include over 60 electrotopological
indices that the Company believes will be valuable in building new models for
pharmacokinetic and metabolism properties, as well as certain other descriptors
that will be described at a later date. The prediction of ionization constants
(pKa's) is being added to QMPRPlus at this time, and is expected to be released
in early calendar year 2003.
(4) QMPRchitect(TM) module
--------------------------
A new Training Module called QMPRchitect is well along in development for
QMPRPlus. This module will allow researchers to build their own artificial
neural network models from their own data using a highly sophisticated,
state-of-the-art process for identifying critical descriptors and training
artificial neural network ensemble models in the most efficient way. Users can
have such new models included in the output of QMPRPlus along with the existing
predicted ADME properties. In addition, researchers will be able to add their
own data to existing models to provide a larger database of information for
known compounds, and then to retrain the models to include this new data.
Through the automation provided in the proprietary software for this module,
alpha versions of the software have demonstrated a reduction in the time to
build powerful ensemble artificial neural network models from 2-3 months to one
or two days, with no sacrifice in model quality. The company has received strong
indications of interest from customers for this new, additional capability,
which has been presented in North America, Europe, and Japan. The Company
expects to release this new module in the second quarter of fiscal 2003.
MARKETING AND DISTRIBUTION:
The Company markets its pharmaceutical simulation software products, and
research services based on its simulations, to pharmaceutical and biotech
companies, and to various companies that serve them, through attendance and
presentations at scientific meetings, exhibits at trade shows, seminars at
pharmaceutical companies and government agencies, through its web pages on the
Internet, and to its compiled database of prospect and customer names. The
Company's scientific team is also its sales and marketing team. The Company
believes that this is 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. The Company also uses its 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. The
Company has cultivated significant market share in North America, Europe, and in
Japan.
5
In August 1998, the Company signed a distribution agreement with Teijin Systems
Technology Ltd. (TST), a division of Teijin Limited of Tokyo, Japan. On April 1,
2001 TST merged with the Infocom Corporation of Japan. Although a new agreement
has not yet been signed, for the interim, the companies have continued to
operate more or less as before. One exception is that now Infocom pays the
travel costs for Simulations Plus personnel to assist in Infocom's marketing and
sales activities in Japan. Under the terms of the TST agreement, TST received
exclusive distribution rights to Simulations Plus' GastroPlus and QMPRPlus
software for pharmaceutical research and education in Japan. Sales in Japan have
been strong, generating approximately 20% of pharmaceutical software revenues.
PRODUCTION:
The Company's major pharmaceutical software products are designed and developed
entirely by its development team at its 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 the Company to run this production in the most
cost-efficient way.
COMPETITION:
In providing software-based research services to the pharmaceutical industry,
and in marketing simulation software for these purposes, the Company competes
against a number of established companies that provide screening, testing and
research services and products to these industries that are not based on
simulation software. There are also software companies whose products do not
compete directly, but are sometimes closely related. The Company's competitors
in this field include companies with financial, personnel, research and
marketing resources that are greater than those of the Company. While management
believes there is currently no significant competitive threat to GastroPlus or
QMPRPlus, competition should be expected at some time in the future. The Company
is aware of a few other companies that are presently developing simulation
software or simulation-software-based services to the pharmaceutical industries
for the purposes of screening compounds.
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.
The Company is not aware of any significant competition in the area of
gastrointestinal absorption simulation. The Company is aware of one other
company, Lion Biosciences AG in Germany, which recently acquired Trega
Biosciences of San Diego, that offers an absorption simulation called iDEA(TM).
Information obtained by the Company indicates that this simulation requires
specific experimental data that must be obtained through experiments with actual
compound material for accurate results. The Company believes it has identified
all former and current pharmaceutical companies who have licensed the iDEA
software, including the original consortium members that participated in its
development when it was part of Navicyte and Trega. At this time, every such
company has licensed GastroPlus in at least one, if not all, of its divisions.
The Company believes the key factors in competing in this field are its ability
to develop simulation software and related products and services to effectively
predict the ADME-related behaviors of new drug-like compounds, its 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, and its
ability to develop and maintain relationships with research and development
departments of pharmaceutical companies and government agencies. There can be no
assurances that the Company will be successful in providing these key factors.
6
EDUCATIONAL SIMULATION SOFTWARE
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PRODUCTS:
The Company's educational software products, which have won awards from
educational software testers, include simulations of laboratory experiments for
Physical Science and Chemistry courses under the umbrella name FutureLab(TM).
The Company released its first three FutureLab(TM) titles in May 1997 (OPTICS
FOR PHYSICAL SCIENCE, GRAVITY FOR PHYSICAL SCIENCE, and CIRCUITS FOR PHYSICAL
SCIENCE), and a new title, IDEAL GAS FOR CHEMISTRY in November 1997, all for
Windows-based computers. In August 1998, after a conversion effort that took
over one year for some labs, the Company released new versions of all of these
titles as well as UNIVERSAL GRAVITATION FOR PHYSICAL SCIENCE for both Windows
and Macintosh computers. Macintosh computers were said in 1997 to account for
40% or more of the educational market.
FutureLab(TM) educational software programs simulate science experiments for
high school and college level science and engineering classes. These simulations
enable students to conduct experiments on a personal computer instead of in a
traditional laboratory, thereby increasing safety, decreasing costs, and
providing expanded learning opportunities by allowing simulations of situations
not possible in a traditional laboratory environment. FutureLab(TM) software has
received recognition from Computers in Physics magazine, which declared it a
winner in its Eighth Annual Software Contest, as well as from two educational
institutions who perform rigorous educational software evaluation.
PRODUCT DEVELOPMENT:
In the area of educational simulations, the Company decided to freeze R&D
activities after finishing the latest title, TITRATION FOR CHEMISTRY. Current
sales from FutureLab continue through a network of over 30 distributors;
however, revenues are not sufficient to provide support for continued
development of educational software.
MARKETING AND DISTRIBUTION:
The Company markets its science experiment simulation software products through
software resellers and its Internet web page. As of August 1999, the Company
reduced its marketing efforts in this area in order to concentrate its resources
on the pharmaceutical software market. The Company is relying on its resellers
to provide the majority of the marketing and sales efforts for its educational
software products. FutureLab sales have continued through these distributors.
PRODUCTION:
The Company's educational software products were designed and developed entirely
by its development team at its Lancaster, California facility. The chief
materials and components used in simulation software products include CD-ROMs
and instruction books which are produced in-house.
COMPETITION:
The educational software industry in which the Company operates is competitive.
The Company competes against publishers and suppliers of textbook educational
materials that have been, and will continue to be, the primary educational
resource used in these markets. The Company also competes against educational
software publishers who provide software products that are interactive, but most
are not true simulation software. Most educational software publishers compete
in the grades below 9th grade, addressing primarily reading and math skills. The
Company competes primarily in the middle school, high school, and college
markets addressing primarily science and math subjects. A smaller number of
software publishers are addressing these markets, although existing competitors
may broaden their product lines to these markets, and additional competitors may
enter these markets.
7
DISABILITY PRODUCTS
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PRODUCTS:
The Company's wholly owned subsidiary, Words+, Inc. has been in business since
1981. Words+ is a technology leader in designing and developing augmentative and
alternative communication (AAC) computer software and hardware devices for
persons who cannot speak due to physical disabilities. Words+ also produces
computer access products that enable physically disabled persons to operate
personal computers, as well as to communicate through synthesized voice, print,
and e-mail, through movements as slight as the blink of an eye. Words+ developed
and produces the software for the computerized communication system used by
world-famous theoretical astrophysicist Professor Stephen Hawking, Lucasian
Professor of Mathematics at the University of Cambridge in England, and the
author of the best-selling book A BRIEF HISTORY OF TIME. Words+ markets its
products throughout the United States and to other countries worldwide through a
direct sales staff and through independent dealers and resellers. Words+
introduced a fully integrated, portable, lightweight personal-computer-based
communication system called TuffTalker(TM) that achieved favorable market
acceptance. In fiscal 2001, Words+ developed a dedicated device version of its
Freedom 2000 communication system that satisfies Medicare's requirements for a
communication system that does not have normal computer functions. This system,
designated Freedom 2001E, and based on Panasonic notebook computers, provides
only communication functionality, and cannot be used as a standard computer.
This is a requirement of Medicare, which has a policy of not funding computers.
The Company believes this is an unfortunate policy, because disabling the
standard computer functions of the system actually results in a higher cost and
less functionality for the user. Management believes that Medicare will someday
realize that having computer functions such as e-mail and Internet access are
also forms of communication and if they can be provided at no additional cost,
they should not be disabled in the best interests of the disabled user.
E Z Keys for Windows(TM) XP
---------------------------
One of the Company's primary software products is E Z KEYS FOR WINDOWS ("E Z
KEYS(TM)"), which is a program thAt operates on a Windows-based personal
computer. When coupled with specially designed input devices, E Z KEYS enables
even severely physically disabled persons to operate a personal computer, to
generate voice messages through a voice synthesizer, and to operate most
Windows-based software application programs, including e-mail and general
Internet usage. Input motion by the user can be through a standard keyboard,
joystick, or mouse, or it can be as slight as the blink of an eye -- or even
simple eye movement by persons who cannot blink. E Z KEYS is one of the two
Words+ programs used by Professor Stephen Hawking for computer access and
communication. During the past fiscal year, the Company completed a
19-month-long development program with significant assistance from Microsoft and
released E Z Keys for Windows XP, designed for the new Microsoft Windows XP
operating system.
Talking Screen for Windows(TM)
------------------------------
TALKING SCREEN FOR WINDOWS ("TALKING SCREEN(TM)") is a software program that
operates on a Windows-based personal computer and is designed for persons,
usually children, who cannot read and write at the level necessary to adequately
operate E Z KEYS. TALKING SCREEN provides a system of pages of pictographic and
photographic symbols by which the user can produce speech output messages
through a voice synthesizer, play recorded sounds and video files, and operate
controllers for lights, electrical appliances and other equipment. Like E Z
KEYS, TALKING SCREEN can be operated through a wide range of alternative input
devices. A Windows XP version of Talking Screen is nearly completed, with final
release expected during the first quarter of fiscal 2003.
Freedom 2000(TM)
----------------
Freedom 2000 allows persons with disabilities who read at a second-grade level
and above to speak and write through alternative input methods (rather than
traditional keyboard and mouse). Freedom 2000 with E Z KEYS gives the users the
8
ability not only to speak and write, but also to play games and control various
items in their environment, such as TV's and telephones. High-level users are
also able to deliver lectures to large groups, use the Internet, and send
e-mail. A lighter weight version of the Freedom 2000, called Freedom 2000
LITE(TM), was introduced in October 1999. Although it has a smaller display, the
4.9 lb. Freedom 2000 LITE is more attractive to ambulatory users than the 8.0
lb. Freedom 2000, especially attractive with a near eight-hour battery life.
Freedom 2001E(TM) - Dedicated Device
------------------------------------
As of January 1, 2001, the U.S. Medicare program initiated coverage of
augmentative and alternative communication (AAC) devices. In addition, effective
July 1, 2001, the agency eliminated the 24-month waiting period previously
required for patients with amyotrophic lateral sclerosis (ALS - or "Lou Gehrig's
disease") to receive Medicare benefits. These important developments were
expected to result in a significant increase in the overall AAC market in the
U.S., as potentially tens of thousands of patients will be eligible to receive
funding for communication devices. Unfortunately, the increase has not
materialized. Although new sales are being generated, the Company has observed
that now that Medicare provides funding, most state Medicaid agencies are
reducing their funding by pushing clients to Medicare as much as possible,
adding to the bureaucratic delays in processing requests. Words+ developed a
unique version of its Freedom 2000 communication system, called the Freedom
2001, to meet the requirements of the Medicare policy for dedicated
communication systems.
TuffTalker(TM)
--------------
TuffTalker is the ideal communication system for users who want computer access
virtually anywhere. It is fully encased in magnesium alloy and has a
shock-mounted hard disk drive that can withstand the rigors of the typical AAC
environment while delivering superior computer performance in a compact,
completely mobile package with touch screen access. The Company announced the
TuffTalker in July 2000 and it currently generates approximately 10% of AAC
revenues.
TuffTalker Plus(TM)
-------------------
TuffTalker Plus is a fully integrated, highly rugged ("militarized")
communication system that offers users extreme durability, power, and
convenience. It features a large active matrix color liquid crystal display
(LCD) with a convenient, easy-to-use touch screen. The LCD is also
anti-reflective, making it easy to view in bright sunlight. It also features
switch inputs for use with Morse Code, Joystick, Headmouse, Tracker 2000, single
or multiple switches, or IST Switch.
MessageMate
-----------
Since 1992, the Company has produced a highly successful series of products
called MessageMates, which are hand-held, dedicated communication devices that
store recorded speech or sound on integrated circuit chips. The user plays these
recorded sounds by touching one of the keys on the membrane keyboard, or by
using a switch (such as the IST Switch described below) and scanning to select a
position on the keyboard. MessageMates are small, lightweight (1 to 1.75 lbs.),
easy-to-use communication devices with up to ten minutes of recorded messages.
They are known for their extremely rugged design and long battery life. The
MessageMate 20 holds twenty messages, the MessageMate 40 holds forty messages,
the Multi-Level MessageMate holds up to 144 messages, and the Mini-MessageMate
holds eight messages. Since MessageMates use recorded messages and sounds, they
can be used in any language. The Company has significant sales of MessageMates
in foreign markets, including Japan.
In December 1999, the Company completed the development of and released a new
Message Builder feature for the MessageMate, which is an enhancement of the
existing MessageMate product. It enables users to select prerecorded words or
phrases one at a time, and then plays the entire message formed by them.
9
Infrared/Sound/Touch (IST) Switch
---------------------------------
Many Words+ customers cannot operate a keyboard or mouse. For some of these
persons, the Company has designed and produces a special device called the
Infrared/Sound/Touch Switch ("IST Switch"), that enables the person to operate a
personal computer or a dedicated communication device with the slightest
movement or pressure, including, for example, eye blink, or just eye movement.
The IST is activated by infrared reflection, touch, or sound, and transmits a
momentary "on" signal to the computer upon detecting these signals. This switch
has been in production in ever-improving forms since 1983, and thousands of
physically disabled persons around the world have used it.
Miscellaneous
-------------
Words+ also sells a number of other miscellaneous and peripheral devices, some
of which it designs and produces and others it buys and resells. These include:
o Micro CommPac - Company-designed and produced communication
hardware package designed for use with a notebook computer that
provides switch interface and audio amplification.
o Simplicity Wheelchair Mount - Company-designed and produced
wheelchair mount for portable computers and other devices.
o Mayer-Johnson symbols - produced by the Mayer-Johnson company of
San Diego, these pictographic symbols are used in electronic form
with the Company's Talking Screen for Windows software.
o Imaginart symbols - produced by the Imaginart company of Bisbee,
Arizona, these symbols are printed as adhesive-backed paper
symbols and are often used with MessageMates.
PRODUCT DEVELOPMENT:
The Company's wholly owned subsidiary, Words+, Inc. has been an industry
technology leader for over 20 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. The Company will continue to enhance its major
software products, E Z Keys and Talking Screen, as well as its growing line of
hardware products. The Company is finalizing the development of its Talking
Screen software for the Windows XP operating system. The Company may also
consider acquisitions of other products, businesses and companies that are
complementary to its existing augmentative and alternative communication and
computer access business lines.
MARKETING AND DISTRIBUTION:
The Company markets augmentative and alternative communication products through
a network of employee representatives and independent dealers and resellers.
At the present time the Company has 36 sales representatives worldwide: 1
salary/commission salesperson in California, 10 independent distributors and 11
independent resellers in the U.S., and 14 sales representatives overseas - 4 in
Australia, and 1 each in Canada, England, Ireland, Norway, The Netherlands, New
Zealand, Japan, Korea, Finland and Malaysia. The Company also has four inside
sales/support persons who answer telephone inquiries on the Company's 800 line
and who provide technical support. Additional outside sales persons and
independent dealers and resellers are being actively recruited at this time.
The Company directs its marketing efforts to speech pathologists, occupational
therapists, rehabilitation engineers, special education teachers, disabled
persons and relatives of disabled persons. The Company maintains a mailing list
of over 10,000 persons made up of these professionals, consumers and relatives,
and mails various marketing materials to this list. These materials include the
Company's catalog of products and announcements regarding new and enhanced
products.
10
The Company participates in industry conferences held worldwide that are
attended by speech pathologists, occupational and physical therapists, special
education teachers, parents and consumers. The Company and others in the
industry demonstrate their products at these conferences and present technical
papers that describe the application of their technologies and research studies
on the effectiveness of their products. The Communication Aids Manufacturers
Association (CAMA), co-founded by the Company's CEO over ten years ago,
organizes cooperative tours of company representatives in this field that travel
throughout the world providing seminars and workshops for professionals,
consumers and parents in the field. The Company advertises in selected
publications of interest to persons in this market.
The Company estimates that for approximately 50% of its sales of augmentative
and alternative communication 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 began providing coverage of augmentative communication
devices on January 1, 2001. An estimated 50,000 people in need of AAC technology
are thought to be eligible for Medicare coverage.
The Company's personnel provide advice and assistance to customers and
prospective customers on obtaining third-party financial assistance for
purchasing the Company's products. Third party funding has grown slowly but
continuously for 20 years. The addition of Medicare coverage for AAC devices in
2001 was the largest single increase in third party funding in the Company's
history.
PRODUCTION:
Disability software products are either loaded onto computer hard disk drives by
the Company or copied to diskettes or CD-ROM, which is performed in-house.
Microprocessors that are part of dedicated devices are purchased by the Company
and incorporated into its products, such as MessageMates, by the Company. Most
software customers also buy their notebook personal computers from the Company,
which the Company purchases at wholesale prices and resells at a markup. Cases,
printed circuit boards, labels and other components of products such as
MessageMates and CommPacs are designed by the Company. The Company outsources
the extrusion, machining and manufacturing of certain components. All final
assembly and testing operations are done by the Company at its facility.
The Company's products are shipped from its 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 the Company operates is highly competitive and some of
the Company's competitors have greater financial and personnel resources than
the Company. The industry is made up of six major competitors including the
Company, and a number of smaller ones. The Company believes that the five other
major competitors each have revenues ranging from $3 Million to under $20
Million, so that there are no large companies in this industry.
The Company believes 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 the Company
believes 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. The
Company believes that it is a leader in the industry in developing and producing
the most technologically advanced products and in providing quality customer
training and technical support. The prices of the Company's products are among
the highest in the industry and the Company has one of the smallest sales forces
11
and dealer networks in the industry. The Company believes that potential exists
for significant increases in the sales of its disability products. However,
there are few barriers to entry in the form of proprietary or patented
technology or trade secrets in this industry. While the Company believes that
cost of product development and the need for specialized knowledge and
experience in this industry would present some deterrence for new competition,
other companies may enter this industry, including companies with substantially
greater financial resources than the Company. Furthermore, companies already in
this industry may increase their market share through increased technology
development and marketing efforts.
PERSONAL PRODUCTIVITY SOFTWARE
--------------------------------------------------------------------------------
PRODUCT - ABBREVIATE!:
At the COMDEX show in November 1997, Words+ released a low cost productivity
software program called "Abbreviate!". The Company extracted the "abbreviation
expansion" technology incorporated into the E Z KEYS software used by Professor
Stephen Hawking and thousands of others around the world, and turned it into a
program that can be used by anyone with the ability to use a standard keyboard.
"Abbreviate!" was named PC Week magazine's "Tool of the Week" in their December
1, 1997 issue, and won Win95 magazine's Editor's Choice Award in March 1998.
While many word processors provide a similar "Quick Correct" feature, the
advantage "Abbreviate!" has over such features is that it runs in the background
and works with virtually all Windows applications, and in all versions of
Windows, including Windows XP. Thus, "Abbreviate!" allows the user to create a
personal library of frequently used abbreviations, each with its own special
keystroke combination, for use in virtually any program, e.g., e-mail, word
processing, database, spreadsheet, and Internet chat rooms, search engines, and
message boards. "Abbreviate!" enjoys steady ongoing sales to medical
transcriptionists through several distributors. This document was prepared using
"Abbreviate!". As an example, typing the following:
"The avg scit in teh phl ind has a graduate deg in chemy, bioy, or
physics."
could result (with "Abbreviate!") in producing:
"The average scientist in the pharmaceutical industry has a graduate
degree in chemistry, biology, or physics."
Or typing "pff" could produce
"Please feel free to contact us again if we can be of help in any way."
MARKETING AND DISTRIBUTION:
The Company is currently selling "Abbreviate!" through a variety of Internet
channels, including its own web site (www.abbreviate.cc), and through
distributors. The Company has also contacted large software manufacturers and
distributors in an effort to secure distribution agreements for "Abbreviate!".
PRODUCTION AND DISTRIBUTION:
The "Abbreviate!" personal productivity software program is currently
manufactured at the Company's Lancaster, California facility. If sales volume
warrants and higher volume capacity is required, the Company will investigate
outside sources for fulfillment.
12
COMPETITION:
A few products compete with "Abbreviate!" in the retail market; however, the
Company is not aware of any other product that works with virtually any software
in Windows 95/98/NT/XP without the need to create special links to the software.
The Company has priced "Abbreviate!" significantly less than competitors
SmarType and InstantText. The Company enlisted the help of several medical
transcriptionists as beta testers for the product, and the feedback received
from those testers and additional medical transcriptionists, who are familiar
with competitive products, has been favorable. Medical transcriptionists have
been one of the largest market segments for Abbreviate! sales over the years.
TRAINING AND TECHNICAL SUPPORT
--------------------------------------------------------------------------------
The Company believes customer training and technical support are important
factors in customer satisfaction for both its pharmaceutical and disability
products, and the Company believes it is an industry leader in providing
customer training and technical support. For pharmaceutical software, the
Company provides in-house seminars at the customer's site to demonstrate
GastroPlus and QMPRPlus. During FY 2002 and 2001, the company delivered such
seminars in numerous locations around the world. The Company has conducted
on-site seminars to thousands of scientists at many pharmaceutical and related
research companies in North America, Europe and Japan. These seminars serve as
initial training in the event the potential customer decides to license or
evaluate our software. Strong 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 an ongoing process of software upgrades to
ensure the product remains at the cutting edge of technology. Software licenses
are on an annual basis, and include all upgrades to the modules licensed by the
customer during the license year.
For Disability Products, the Company's 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. The Company and
its dealers charge a fee for additional training and service calls.
Technical support for both Simulation Software and Disability Products is
provided by the Company's inside sales and support staff based at its
headquarters facilities in Lancaster, California. The Company provides free
telephone support offering unlimited toll-free numbers in the U.S. and Canada,
and E-mail support for all of its simulation software and disability products
worldwide.
EMPLOYEES
--------------------------------------------------------------------------------
As of August 31, 2002, the Company employed 29 full-time and 3 part-time
employees, including 7 in research and development, 5 in marketing and sales, 11
in administration and accounting, 8 in production and 1 in repair. Three 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. With only one exception, the entire senior management team and
Board of Directors hold graduate degrees. The Company believes that its future
success will depend, in part, on its 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 the Company's
employees is represented by a labor union, and the Company has never experienced
a work stoppage. The Company believes that its relations with its employees are
good.
13
ITEM 2. DESCRIPTION OF PROPERTIES
The Company moved its office location from Palmdale, California to Lancaster,
California in July 1998, expanding its office space from approximately 11,800
square feet to approximately 15,600 square feet. The lease on the office space
currently occupied by the Company expired on August 31, 2001. The Company
renewed for an additional two-year term with 4% increase each year from the
previous year.
ITEM 3. LEGAL PROCEEDINGS
While the Company may from time to time be involved in various claims, lawsuits
or disputes with third parties, the Company is not a party to any significant
litigation and is not aware of any significant pending or threatened litigation
against the Company.
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 2002.
14
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is currently traded on the OTC Bulletin Board under
the symbol "SIMU". According to records of the Company's transfer agent, the
Company had about 71 stockholders of record and approximately 600 beneficial
owners as of August 31, 2002. The following table sets forth the low and high
sale prices for the Common Stock on the OTCBB for 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. The Company has not paid cash dividends on
its common stock. The Company currently intends to retain its earnings for
future growth, therefore does not anticipate paying cash dividends in the
foreseeable future. Any further determination as to the payment of dividends
will be at the discretion of the Company's Board of Directors and will depend
among other things, on the Company's financial condition, results of operations,
capital requirements and such other factors as the Board of Directors deem
relevant.
LOW SALES PRICE HIGH SALES PRICE
--------------- ----------------
Fiscal 2002:
Quarter ended August 31, 2002 . . . . . . . . 1.100 1.700
Quarter ended May 31, 2002 . . . . . . . . . 1.150 1.650
Quarter ended February 28, 2002 . . . . . . . 0.850 2.000
Quarter ended November 30, 2001 . . . . . . . 0.950 1.200
Fiscal 2001:
Quarter ended August 31, 2001 . . . . . . . . 1.180 1.550
Quarter ended May 31, 2001 . . . . . . . . . 1.350 2.250
Quarter ended February 28, 2001 . . . . . . . 1.250 2.437
Quarter ended November 30, 1999 . . . . . . . 1.500 3.812
15
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following sets forth selected items from the Company's statements of
operations (in thousands) and the percentages that such items bear to net sales
for the fiscal years ended August 31, 2002 ("FY02"), August 31, 2001 ("FY01")
and August 31, 2000 ("FY00").
Year Ended August 31,
------------------------------------------------------------------------
2002 2001 2000
---------------------- ------------------------- -----------------------
Net sales $4,444 100.0% $3,915 100.0% $3,629 100.0%
Cost of sales 1,456 32.8 1,563 39.9 1,423 39.2
------------------------------------------------------------------------
Gross profit 2,988 67.2 2,352 60.1 2,206 60.8
------------------------------------------------------------------------
Selling, general, and administrative 2,105 47.4 2,200 56.2 2,143 59.0
Research and development 382 8.6 354 9.0 300 8.3
------------------------------------------------------------------------
Total operating expenses 2,487 56.0 2,554 65.2 2,443 67.3
------------------------------------------------------------------------
Income (loss) from operations 501 11.3 (202) (5.2) (237) (6.5)
------------------------------------------------------------------------
Interest expense (14) (0.3) (22) (0.6) (22) (0.6)
Gain on disposal of furniture & equip. - - - - 3 0.1
------------------------------------------------------------------------
Net income (loss) before taxes 487 11.0 (224) (5.7) (256) (7.2)
------------------------------------------------------------------------
Provision for income taxes 2 0.1 2 0.1 2 0.1
------------------------------------------------------------------------
Net income (loss) 485 10.9% (226) (5.8)% (258) (7.1)%
------------------------------------------------------------------------
FY2002 COMPARED WITH FY2001
--------------------------------------------------------------------------------
NET SALES
---------
Net sales for FY02 increased by $529,000 or 13.5%, to $4,444,000 compared to
$3,915,000 for FY01. Simulations Plus, Inc.'s sales from pharmaceutical and
educational software increased approximately $863,000, or 73.1%, and Words+,
Inc.'s sales decreased approximately $334,000, or 12.2% for the year. Management
attributes the increase in consolidated net sales to the significant sales
increase in pharmaceutical software in FY02 compared with FY01, which outweighed
the decrease in Words+ sales. The increase in pharmaceutical software sales is
attributable to a combination of annual license renewals, new customers, new
modules, two major upgrades and larger average orders per customer. The decrease
in Words+ sales is attributed primarily to the tragic incidents on September 11,
personnel changes in three key sales representatives, a decline in MessageMate
sales, and overall sluggish economy during this time period.
COST OF SALES
-------------
The consolidated cost of sales for FY02 decreased by $107,000 or 6.8%, to
$1,456,000 from $1,563,000 in FY2001. As a percentage of sales, cost of sales
was 32.8% for FY02, compared to 39.9% for FY01, indicating a 7.1% decrease. For
Simulations Plus, cost of sales decreased $49,000, or 14.5%, of which the
significant portion of cost of sales is the systematic amortization of
capitalized software development costs, which resulted in a 43.9% decrease in
amortization cost. Although there is a significant increase in royalty expense
16
due to the increase in sales, the decrease in amortization outweighed the
increase in royalty expense. For Words+, cost of sales decreased $58,000, or
4.7%. As a percentage of sales, cost of sales was 48.6% in FY02, compared to
44.8% in FY01. Management attributes the increase in cost of sales between FY02
and FY01 to an increase in TuffTalker sales, which has a lower profit margin,
and a decrease in higher margin products such as MessageMate.
GROSS PROFIT
------------
Consolidated gross profit increased $636,000, or 27.0%, to $2,988,000 in FY02
from $2,352,000 in FY01. The gross profit margin also increased 7.1%, to 67.2%
in FY02, compared to 60.1% in FY01, primarily due to the decrease in
amortization cost of pharmaceutical software. Although the material costs for
Words+ products increased proportionally to net sales, the increase in gross
profit generated by pharmaceutical software outweighed the decrease in Words+
products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
--------------------------------------------
Selling, general and administrative ("SG&A") expenses for FY02 decreased by
$95,000, or 4.3%, to $2,105,000, compared to $2,200,000 for FY01. As a
percentage of total sales, SG&A decreased for the third straight year from 59.0%
in FY00, 56.2% in FY01, to 47.4% in FY02. For Simulations Plus, SG&A expenses
decreased $137,000, or 15.9%, primarily due to the $126,000 write-off of
capitalized software development cost for HelixGen in FY01 while there is no
such a write off in FY02. For Words+, expenses increased $42,000, or 3.2%, due
to increases in selling expenses, such as catalogs and commissions to
independent sales representatives, contract labor, depreciation expense,
building repairs and maintenance. These increases outweighed decreases in other
expenses such as travel expense, salaries and wages, and payroll related
expenses.
RESEARCH AND DEVELOPMENT
------------------------
The Company incurred approximately $477,000 of research and development costs
for both companies during FY02. Of this amount, $95,000 was capitalized and
$382,000 was expensed. For FY01, the Company incurred approximately $493,000 of
research and development costs, of which approximately $139,000 was capitalized
and approximately $354,000 was expensed. The 3.2% decrease in research and
development expenditure from FY01 to FY02 was due to the fact that, although
researchers' salaries have been increased, one of part time researcher has left
the company and has not yet been replaced, resulting in a salary expense
reduction in the aggregate amount.
INCOME (LOSS) FROM OPERATIONS
-----------------------------
During FY02, the Company generated an income from operations of $501,000, as
compared to a loss of $202,000 for FY01. Management attributes the increase in
net income from operations to an increase in sales in pharmaceutical software
and services and decreases in cost of sales, selling, general and administrative
expenses outweighed the increase in research and development expense.
INTEREST EXPENSE
----------------
Interest expense for FY02 decreased by $8,000, or 36.4%, to $14,000, compared to
$22,000 for FY01 due primarily to the decrease in the Company's revolving line
of credit which was paid off by the end of FY02.
INCOME TAXES
------------
Income taxes were $1,600 for FY02 as well as FY01. This represents the minimum
corporation tax in the state of California for the two companies.
17
NET INCOME (LOSS)
-----------------
Net income for FY02 increased $711,000, to a net income of $485,000, compared to
the net loss of $226,000 for FY01. Management attributes this increase primarily
to the increase in sales, along with decreases in cost of sales, selling,
general and administrative expenses, and interest expense.
FY01 COMPARED WITH FY00
--------------------------------------------------------------------------------
NET SALES
---------
Net sales for FY01 increased by $286,000 or 7.9%, to $3,915,000 compared to
$3,629,000 for FY00. Simulations Plus, Inc.'s sales from pharmaceutical and
educational software increased approximately $246,000, or 26.3%, and Words+,
Inc.'s sales increased approximately $40,000, or 1.5% for the year. Management
attributes the increase in consolidated net sales to the sales increase in
pharmaceutical software in FY01 compared with FY00 and a slight increase in
Words+ sales.
The increase in pharmaceutical software sales is attributable to a combination
of annual license renewals, new customers, two new products, four major upgrades
and larger average orders per customers. The increase in Words+ sales is due
primarily to the revenue from TuffTalker(TM) which its initial sales began in
September 2000. Approximately $240,000 was generated from TuffTalker sales
during FY01; however, this increase was offset by reductions in other product
sales, which management believes was caused by customers delaying purchase
decisions until Medicare/Medicaid funding could be secured under new policies
for those programs this year.
COST OF SALES
-------------
The consolidated cost of sales for FY01 increased by $140,000 or 9.8% to
$1,563,000 from $1,423,000 in FY00. As a percentage of sales, cost of sales was
39.9% for FY01, compared to 39.2% for FY00, indicating a 0.7% increase. For
Simulations Plus, cost of sales increased $48,000, or 16.5%, of which the
significant portion of cost of sales is the systematic amortization of
capitalized software development costs, which resulted in a 28.1% increase in
amortization cost. Two new modules for GastroPlus, IVIV Correlation and PKPlus,
were released on November 7, 2000 and their development costs have been
amortized systematically since then. For Words+, cost of sales increased
$92,000, or 8.1%. As a percentage of sales, cost of sales was 44.8% in FY01,
compared to 42.0% in FY00. Management attributes the increase in cost of sales
between FY01 and FY00 to an increase in TuffTalker sales, which has a lower
profit margin, and a decrease in higher margin products.
GROSS PROFIT
------------
The consolidated gross profit increased $146,000, or 6.6%, to $2,352,000 in FY01
from $2,206,000 in FY00. Although gross profit increased, gross profit margin
decreased 0.7%, to 60.1% in FY01, compared to 60.8% in FY00, primarily due to
the increase in amortization cost of pharmaceutical software and increased
material costs for Words+ products, proportionally outweighing the increase in
net sales.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
--------------------------------------------
Selling, general and administrative ("SG&A") expenses for FY01 increased by
$57,000, or 2.7% to $2,200,000, compared to $2,143,000 for FY00. As a percentage
of total sales, SG&A decreased for the third straight year from 62.3% in FY99,
59.0% in FY00 to 56.2% in FY01. For Simulations Plus, SG&A expenses increased
$109,000, or 14.5%, primarily due to the $126,000 write-off of capitalized
software development cost for HelixGen in FY01. Although HelixGen development is
still considered an on-going project, management postponed its development to
focus on development of other pharmaceutical software products. Without this
write-off expense, the selling, general and administrative expenses for FY01
would have decreased by $17,000, or 2.1%. For Words+, expenses decreased
$52,000, or 3.7%, due to reductions in depreciation expense, telephone expense,
insurance, and some selling expenses, such as promotion, commissions to
independent sales representatives. These reductions outweighed increases in
18
other expenses such as travel expense, trade shows, salaries and wages, and
payroll related expenses.
RESEARCH AND DEVELOPMENT
------------------------
The Company incurred approximately $493,000 of research and development costs
for both companies during FY01. Of this amount, $139,000 was capitalized and
$354,000 was expensed. For FY00, the Company incurred approximately $432,000 of
research and development costs, of which approximately $132,000 was capitalized
and approximately $300,000 was expensed. The 14.1% increase in research and
development expenditure from FY00 to FY01 was due to additions to staff,
resulting in increased salary expenses.
LOSS FROM OPERATIONS
--------------------
During FY01, the Company incurred a loss from operations of approximately
$202,000, as compared to a loss of $237,000 for FY00. Management attributes the
reduction in net loss from operations to an increase in sales, which outweighed
increases in cost of sales, selling, general and administrative expenses, and
research and development expense. Without the required HelixGen write-off, the
loss from operations would have been $76,000.
INTEREST EXPENSE
----------------
Interest expense between FY01 and FY00 was constant. Interest expense is
incurred due to the Company's revolving line of credit and interest on
capitalized lease obligations.
GAIN ON DISPOSAL OF FURNITURE & EQUIPMENT
-----------------------------------------
There was no gain on disposal of furniture & equipment for FY01 while there was
such a gain in FY00. During FY00, the Company claimed a loss of stolen computers
to our insurance company, and the proceeds less depreciated book value resulted
in this gain of $3,000.
INCOME TAXES
------------
Income taxes were $1,600 for FY01 as well as FY00. This represents the minimum
corporation tax in the state of California for the two companies.
NET LOSS
--------
Net loss for FY01 decreased $32,000, or 12.4%, to a net loss of $226,000,
compared to the net loss of $258,000 for FY00. Management attributes this
decline primarily to the increase in sales outweighed the increases in cost of
sales, selling, general and administrative expenses, research and development
expenses, and decrease in gain on a disposal asset. Without the required
HelixGen write-off, the net loss would have been $100,000.
SEASONALITY
--------------------------------------------------------------------------------
Sales of the Company's pharmaceutical and disability products exhibit very
little discernable seasonal fluctuation. The following table sets forth net
sales information for each of the Company's last 12 calendar quarters. In each
of the last three years, the highest quarters and the lowest quarters have been
in three different 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.
19
----------------------------------------------------------------------------------------
Net Sales
FY
First Second Third Fourth Total
Quarter Quarter Quarter Quarter
(in thousands)
-------------------- ----------- ----------- -------------- ----------- -----------
2002 . . . . . . . . 1,007 1,107 1,120 1,210 4,444
2001 . . . . . . . . 1,058 1,062 974 821 3,915
2000 . . . . . . . . 814 1,092 743 980 3,629
----------------------------------------------------------------------------------------
In general, management believes sales of its Words+ products to schools are
seasonal, with greater sales to schools during the Company's third and fourth
fiscal quarter (March-May and June-August). 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 2002, but was the lowest in the previous year.
LIQUIDITY AND CAPITAL RESOURCES
--------------------------------------------------------------------------------
The Company's principal sources of capital have been cash flows from its
operations, a bank line of credit, a government grant, cash loans from the
officers on an as-needed basis, and accruing and not paying portions of salaries
to certain executive officers and managers.
The Company has available a $100,000 revolving line of credit from a bank.
Interest is payable on a monthly basis at the bank's prime rate, which has a
floor of 7.5%, plus 3.5%. The interest rate was 11.0% at August 31, 2002 and
10.5% at August 31, 2001. At August 31, 2002, the outstanding balance under the
revolving line of credit was zero, and it was $99,000 at August 31, 2001. The
revolving line of credit is not secured by any of the assets of the Company but
is personally guaranteed by Mr. Walter S. Woltosz, the Company's Chief Executive
Officer, President and Chairman of the Board of Directors.
Beginning in August 1998, certain executive officers and managers accepted
reduced salaries on a temporary basis in order to protect the cash assets of the
Company. The unpaid portions of salaries have been accrued over 3 years and
recently some of them have been paid back as management deems the Company's cash
flow and cash reserves were sufficient to make such payment without adverse
effects to the Company's financial position. All executive officers and managers
are now receiving their regular salaries. At August 31, 2002, the remaining
unpaid salaries due to the Company's executive officers were $281,849 plus
accrued bonus of $54,057 (see Item 10 - EMPLOYMENT AND OTHER COMPENSATION
AGREEMENTS section)
The Company believes that existing capital and anticipated funds from operations
and revolving line of credit will be sufficient to meet its anticipated cash
needs for working capital and capital expenditures for the foreseeable future.
If cash generated from operations becomes insufficient to satisfy the Company's
capital requirements, the Company 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 are insufficient
to continue operations at the current level, and if no additional financing is
obtained, then management will restructure the Company in a way to preserve its
pharmaceutical and disability businesses while maintaining expenses within
operating cash flows.
20
Since July 2, 1999, trading in the shares of the Company's Common Stock has been
conducted on the Nasdaq's "Electronic Bulletin Board." Consequently, the
liquidity of the Company's securities may be impaired, not only in the number of
securities which can be bought and sold, but also through delays in the timing
of the transactions, reductions in security analysts' and the new media's
coverage of the Company, and lower prices for the Company's securities than
otherwise may be attained.
Because the company's securities are listed on the bulletin board, they are
subject to Rule 15g-9 under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), which imposes additional sales practice requirements on
broker-dealers which sell such securities to persons other than established
customers and "accredited investors" (generally, individuals with net worths in
excess of $1,000,000 or annual incomes exceeding $200,000, or $300,000 together
with their spouses). For transactions covered by this rule, a broker-dealer must
make a special suitability determination for the purchaser and have received the
purchaser's written consent to the transaction prior to the sale. Consequently,
the rule may adversely affect the ability of broker-dealers to sell the
Company's securities acquired hereby in the secondary market.
Securities and Exchange Commission ("Commission") regulations define a "penny
stock" to be any non-Nasdaq equity security that has a market price (as therein
defined) of less than $5.00 per share or with an exercise price of less than
$5.00 per share, subject to certain exceptions. For any transaction involving a
penny stock, unless exempt, the rules require delivery, prior to any transaction
in a penny stock, of a disclosure schedule prepared by the Commission relating
to the penny stock market. Disclosure is also required to be made about
commissions payable to both the broker-dealer and the registered representative
and current quotations for the securities. Finally, monthly statements are
required to be sent disclosing recent price information for the penny stock held
in the account and information on the limited market in penny stocks.
The foregoing required penny stock restrictions will not apply to the Company's
securities if such securities are listed on Nasdaq and have certain price and
volume information provided on a current and continuing basis or meet certain
minimum tangible assets or average revenue criteria. There can be no assurance
that the Company's securities will qualify for exemption from these
restrictions. In any event, even if the Company's securities were exempt from
such restrictions, it would remain subject to Section 15(b)(6) of the Exchange
Act, which gives the Commission the authority to prohibit any person that is
engaged in unlawful conduct while participating in a distribution of penny stock
from associating with a broker-dealer or participating in the distribution of a
penny stock, if the Commission finds that such a restriction would be in the
public interest. If the Company's securities were subject to the rules on penny
stocks, the market liquidity for the Company's securities would be severely
adversely affected.
ITEM 7. FINANCIAL STATEMENTS
The response to this item is submitted as a separate section of this Form 10KSB
(see pages F1 - F23.)
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
21
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
--------------------------------------------------------------------------------
NAME AGE POSITION WITH THE COMPANY SINCE
---- --- ------------------------- -----
Walter S. Woltosz 56 Chairman of the Board, Chief Executive Officer 1996
and President of the Company and Words+
Virginia E. Woltosz 51 Senior Vice President, Secretary and Director 1996
of the Company and Words+
Dr. David Z. D'Argenio 53 Director and Consultant to the Company 1997
Dr. Richard R. Weiss 69 Director 1997
Ronald F. Creeley 51 Vice President, Marketing and Sales of the 1997
Company and Words+
Momoko A. Beran 50 Chief Financial Officer of the Company and
Words+ 1996
--------------------------------------------------------------------------------
Walter S. Woltosz is a co-founder of the Company and has served as its Chief
Executive Officer and President 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 and President since its incorporation
in 1981.
Virginia E. Woltosz is a co-founder of the Company and has served as its Senior
Vice President and Secretary since its incorporation in July 1996. Mrs. Woltosz
is also a co-founder of Words+ and has served as its Vice President, Secretary
and Treasurer since its incorporation in 1981. Virginia E. Woltosz is the wife
of Walter S. Woltosz.
Dr. David Z. D'Argenio started to serve as a Director of the Company in June
1997. He is currently Professor and Chairman of Biomedical Engineering 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.
Dr. Richard R. Weiss started to serve as a Director of the Company in June 1997.
From October 1994 to the present, Dr. Weiss has 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.
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.
22
Momoko A. Beran joined Words+ in June 1993 as Director of Accounting and was
named the Company's Chief Financial Officer in July 1996. In November 1999, the
Board of Directors assigned Mrs. Beran the additional duties of Vice President,
Operations, for Words+, Inc.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth certain information concerning compensation paid
or accrued for the fiscal year ended August 2002, 2001 and 2000 by the Company
to or for the benefit of the Company's President and Vice President, Sales and
Marketing. No other executive officers of the Company received total annual
compensation for the fiscal year ended August 31, 2002, 2001 and 2000 that
exceeded $100,000. As permitted under the rules of the Securities and Exchange
Commission, no amounts are shown in the table below with respect to any
perquisites paid to named officer because the aggregate amount of such
perquisites (e.g., auto allowance) did not exceed the lesser of (i) $50,000 or
(ii) 10% of the total annual salary and bonus of a named officer.
---------------------------------------------------------------------------------------------
Name and Principal Accrued Bonus 401(k) Match Fiscal
Position Paid Salary Salary Company Paid Year
-------------------------- --------------- ---------- -------------- ------------ ------
Walter S. Woltosz $153,500.04 (1) -0- $27,028.50 (2) -0- 2002
President and Chief $126,500.08 $23,499.92 -0- $4,060.06 2001
Executive Officer $101,666.74 $48,333.26 -0- $2,866.76 2000
Ronald F. Creeley $117,980.41 (1) -0- -0- $2,359.59 2002
Vice President, Sales *** *** *** *** 2001
and Marketing $101,000.00 (1) -0- $1,364.78 $1,380.00 2000
---------------------------------------------------------------------------------------------
(1) Includes deferred salary paid.
(2) Accrued bonus due and payable within 10 days after the filing of this
annual report.
*** Total compensation less than $100,000.
EMPLOYMENT AND OTHER COMPENSATION AGREEMENTS
The Company had an employment agreement with Walter Woltosz commencing September
1, 1999 that extended until August 31, 2002. The agreement provided for an
annual salary of $150,000. Pursuant to such agreement, Mr. Woltosz was entitled
to such health insurance and other benefits that are not inconsistent with that
which the Company customarily provides to its 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 the Company may terminate the agreement upon 30 days written
notice if termination is without cause and that the Company's 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 the Company
may terminate the agreement for cause (as defined) and that the Company's only
23
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.
The Board of Directors renewed this employment agreement with an increase of 10%
in salary effective as of September 1, 2002 for three years. All other terms
remain the same.
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
the Company's 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 the Company's net annual
income before taxes. For FY02, the net income before tax was $540,570,
therefore, the Company accrued bonuses, the total amount of $54,057, for Walter
Woltosz and Virginia Woltosz. These bonuses are due and payable within 10 days
after the filing of this annual report.
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 the Company's Common Stock as of August 31, 2002 by (i) each person
who is known to own beneficially more than 5% of the outstanding shares of the
Company's Common Stock, (ii) each of the Company's 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) 2,081,000 57.31%
Momoko Beran (4) 105,100 2.89%
Ronald F. Creeley (5) 104,400 2.88%
Dr. David Z. D'Argenio (6) 3,153 *
Dr. Richard R. Weiss (7) 3,153 *
-------------------- --------
2,296,806 63.26%
----------------------------------------------------------------------------
* 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 2,071,000 plus 10,000 shares of common stock underlying
an option exercisable within the next 60 days of the date of this Annual
Report. Does not include stock option for 40,000 shares, which are not
exercisable within the next 60 days of the date of this Annual Report.
24
(4) Owns 300 shares of common stock exercised from options granted under the
1996 Stock Option plan, plus 104,800 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 95,400 shares, which are not
exercisable within the next 60 days of the date of this Annual Report.
(5) Owns 1,000 shares of common stock, plus 103,400 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 96,600 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 2,153 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 2,153 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.
STOCK OPTIONS
The following table discloses certain information regarding the options held at
August 31, 2002 by the Chief Executive Officer and each other named executive
officer.
--------------------------------------------------------------------------------
Number of Options at Value of Options at
August 31, 2002 August 31, 2002 (1)
--------------------------- ---------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------
Walter S. Woltosz 5,000 20,000 -0-* -0-*
Virginia E. Woltosz 5,000 20,000 -0-* -0-*
Momoko Beran 82,900 117,300 $7,149 $7,671
Ronald F. Creeley 81,600 118,400 $7,212 $7,608
Dr. David Z. D'Argenio 2,153 1,000 $76 $96
Dr. Richard R. Weiss 2,153 1,000 $76 $96
--------------------------------------------------------------------------------
(1) Based on a per share price of $1.52 at August 31, 2002 less applicable
option exercise prices.
* Granted at $1.54, 110% of market price of the issue date
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
As of August 31, 2002, the accrued compensation due to the Company's President
was $190,583, and bonus payable, 5% of net income before the tax based on the
underwriting agreement, was $27,029. Neither amount accrues interest.
25
As of August 31, 2002, the accrued compensation due to the Company's Vice
President of Human Resources was $8,333, and bonus payable, 5% of net income
before the tax based on the underwriting agreement, was $27,029. Neither amount
accrues interest.
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) +
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)
26
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)
99.1 S.906 - Certification of Chief Executive Officer. (10)
99.2 S.906 - Certification of Chief Financial Officer. (10)
--------------------------------------------------------------------------------
(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) Filed herewith.
(b) Reports on Form 8-K
None.
27
SIGNATURES
In accordance with Section 13or15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Lancaster, State of
California, on November 14, 2002.
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 Registrant and in the capacities
indicated on November 14, 2002.
SIGNATURE TITLE
/s/ WALTER S. WOLTOSZ
---------------------------------- Chairman of the Board of Directors
Walter S. Woltosz and Chief Executive Officer
/s/ VIRGINIA E. WOLTOSZ
---------------------------------- Senior Vice President, Secretary and
Virginia Woltosz Director of the Company and Words+
/s/ DR. DAVID Z. D'ARGENIO
----------------------------------
Dr. David Z. D'Argenio Director and Consultant to the Company
----------------------------------
Dr. Richard Weiss Director
/s/ MOMOKO A. BERAN
----------------------------------
Momoko A. Beran Chief Financial Officer of the Company
28
STATEMENT PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
BY
PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER
REGARDING FACTS AND CIRCUMSTANCES RELATING TO EXCHANGE ACT FILINGS
I, Walter Woltosz, certify that:
--------------
1. I have reviewed this annual report on Form 10-KSB of November 5, 2002;
-----------------
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 5, 2002
----------------
/s/ WALTER WOLTOSZ
-----------------------
Walter S. Woltosz
Chief Executive Officer
29
STATEMENT PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
BY
PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER
REGARDING FACTS AND CIRCUMSTANCES RELATING TO EXCHANGE ACT FILINGS
I, Momoko Beran, certify that:
------------
1. I have reviewed this annual report on Form 10-KSB of November 5, 2002;
-----------------
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 5, 2002
----------------
/s/ MOMOKO BERAN
-----------------------
Momoko A. Beran
Chief Financial Officer
30
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
AUGUST 31, 2002 AND 2001
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONTENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
Page
INDEPENDENT AUDITOR'S REPORT 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
F-1
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Shareholders of
Simulations Plus, Inc.
We have audited the accompanying consolidated balance sheet of Simulations Plus,
Inc. (a California corporation) and subsidiary as of August 31, 2002, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the two years in the period ended August 31, 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the 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 financial position of Simulations Plus,
Inc. and subsidiary as of August 31, 2002, and the results of their operations
and their cash flows for each of the two years in the period ended August 31,
2002 in conformity with accounting principles generally accepted in the United
States of America.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
October 18, 2002
F-2
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
August 31, 2002
--------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 36,072
Accounts receivable, net of allowance for doubtful
accounts of $11,212 928,237
Inventory 208,605
Prepaid expenses and other current assets 36,606
-----------
Total current assets 1,209,520
CAPITALIZED COMPUTER SOFTWARE DEVELOPMENT COSTS,
net of accumulated amortization of $1,632,394 300,775
PROPERTY AND EQUIPMENT, net 62,439
OTHER ASSETS 13,257
-----------
TOTAL ASSETS $1,585,991
===========
The accompanying notes are an integral part of these financial statements.
F-3
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
August 31, 2002
--------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 145,697
Accrued payroll and other expenses 309,764
Accrued bonuses to officers 54,058
Accrued compensation due to officers 198,916
Accrued warranty and service costs 30,996
Current portion of capitalized lease obligations 11,236
------------
Total current liabilities 750,667
CAPITALIZED LEASE OBLIGATIONS, net of current portion 9,964
DEFERRED REVENUE 57,476
------------
Total liabilities 818,107
------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
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
3,408,331 shares issued and outstanding 3,409
Additional paid-in capital 4,654,756
Accumulated deficit (3,890,281)
------------
Total shareholders' equity 767,884
------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,585,991
============
The accompanying notes are an integral part of these financial statements.
F-4
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended August 31,
--------------------------------------------------------------------------------
2002 2001
------------ ------------
NET SALES $ 4,443,842 $ 3,914,583
COST OF SALES 1,456,332 1,562,830
------------ ------------
GROSS PROFIT 2,987,510 2,351,753
------------ ------------
OPERATING EXPENSES
Selling, general, and administrative 2,105,253 2,199,611
Research and development 382,143 354,090
------------ ------------
Total operating expenses 2,487,396 2,553,701
------------ ------------
INCOME (LOSS) FROM OPERATIONS 500,114 (201,948)
------------ ------------
OTHER INCOME (EXPENSE)
Interest income 165 109
Interest expense (13,764) (22,161)
------------ ------------
Total other income (expense) (13,599) (22,052)
------------ ------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES 486,515 (224,000)
PROVISION FOR INCOME TAXES 1,600 1,600
------------ ------------
NET INCOME (LOSS) $ 484,915 $ (225,600)
============ ============
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE $ 0.14 $ (0.07)
============ ============
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING
BASIC 3,408,331 3,394,299
============ ============
DILUTED 3,525,038 3,394,299
============ ============
The accompanying notes are an integral part of these financial statements.
F-5
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, 2000 3,385,831 $ 3,386 $ 4,632,278 $(4,149,596) $ 486,068
EXERCISE OF STOCK
OPTIONS 22,500 23 22,478 22,501
NET LOSS (225,600) (225,600)
------------ ---------- ------------ ------------ ------------
BALANCE, AUGUST
31, 2001 3,408,331 3,409 4,654,756 (4,375,196) 282,969
NET INCOME 484,915 484,915
------------ ---------- ------------ ------------ ------------
BALANCE, AUGUST
31, 2002 3,408,331 $ 3,409 $ 4,654,756 $(3,890,281) $ 767,884
============ ========== ============ ============ ============
The accompanying notes are an integral part of these financial statements.
F-6
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended August 31,
------------------------------------------------------------------------------------------
2002 2001
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 484,915 $(225,600)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation and amortization of property and
equipment 64,158 65,300
Amortization of capitalized software development
costs 127,672 228,551
Impairment of capitalized software development
costs -- 126,296
(Increase) decrease in
Accounts receivable (483,837) 98,169
Inventory (26,247) (24,041)
Other assets (11,583) 13,498
Increase (decrease) in
Accounts payable (118,607) 25,247
Accrued payroll and other expenses (16,640) 16,274
Accrued bonuses to officers 54,057 --
Accrued warranty and service costs (14,460) 1,436
Deferred revenue 51,640 (33,032)
---------- ----------
Net cash provided by operating activities 111,068 292,098
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (35,329) (30,700)
Capitalized computer software development costs (94,146) (139,375)
---------- ----------
Net cash used in investing activities (129,475) (170,075)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net decrease in line of credit (98,959) (122)
Payments on capitalized lease obligations (13,214) (15,285)
Proceeds from the exercise of stock options -- 22,501
---------- ----------
Net cash provided by (used in) financing activities (112,173) 7,094
---------- ----------
The accompanying notes are an integral part of these financial statements.
F-7
SIMULATIONS PLUS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended August 31,
------------------------------------------------------------------------------------------
2002 2001
---------- ----------
Net increase (decrease) in cash and cash
equivalents $(130,580) $ 129,117
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 166,652 37,535
---------- ----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 36,072 $ 166,652
========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
INTEREST PAID $ 13,764 $ 22,161
========== ==========
INCOME TAXES PAID $ 1,600 $ 1,600
========== ==========
The accompanying notes are an integral part of these financial statements.
F-8
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
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"). The effect of the
stock-for-stock exchange is presented retroactively in the accompanying
consolidated financial statements.
Lines of Business
-----------------
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. In addition, 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.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 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. 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.
F-9
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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 three years). 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.
F-10
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Capitalized Computer Software Development Costs (Continued)
-----------------------------------------------
During the years ended August 31, 2002 and 2001, the Company recognized
$0 and $126,296, respectively, as an impairment loss related to
capitalized software costs in excess of the amount to be recovered
through revenues. The impairment loss is included in selling, general,
and administrative expenses.
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, accrued
compensation due to officers, and accrued warranty and service costs,
the carrying amounts approximate fair value due to their short
maturities. The amounts shown for capitalized lease obligations also
approximate fair value because current interest rates offered to the
Company for leases of similar maturities are substantially the same.
Advertising
-----------
The Company expenses advertising costs as incurred. Advertising costs
for the years ended August 31, 2002 and 2001 were $35,906 and $3,281,
respectively.
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.
F-11
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Income Taxes (Continued)
------------
Under this method, deferred income taxes are recognized for the tax
consequences in future years of differences between the tax bases of
assets and liabilities and their financial reporting amounts at each
year-end based on enacted tax laws and statutory tax rates applicable
to the periods in which the differences are expected to affect taxable
income. Valuation allowances are established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. The
provision for income taxes represents the tax payable for the period
and the change during the period in deferred tax assets and
liabilities.
Net Earnings (Loss) per Share
-----------------------------
The Company reports earnings (loss) per share in accordance with SFAS
No. 128, "Loss 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. The components of basic and diluted earnings
(loss) per share for the years ended August 31, 2002 and 201 were as
follows:
2002 2001
----------- -----------
Numerator
Net (income) loss attributable to common
shareholders $ 484,915 $ (225,600)
=========== ===========
Denominator
Weighted-average number of common shares
outstanding during the year 3,408,331 3,394,299
Dilutive effect of stock options 116,707 --
----------- -----------
COMMON STOCK AND COMMON STOCK
EQUIVALENTS USED FOR DILUTED EARNINGS
(LOSS) PER SHARE 3,525,038 3,394,299
=========== ===========
F-12
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Stock Options and Warrants
--------------------------
The Financial Accounting Standards Board ("FASB") issued SFAS No. 123,
"Accounting for Stock-Based Compensation," which defines a fair value
based method of accounting for stock-based compensation. However, SFAS
No. 123 allows an entity to continue to measure compensation cost
related to stock and stock options issued to employees using the
intrinsic method of accounting prescribed by Accounting Principles
Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to
Employees." 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 26% and 29% of net sales for the
years ended August 31, 2002 and 2001, respectively. Amounts due from
one major customer represented 33% of the net accounts receivable
balance at August 31, 2002.
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.
The Company does not manufacture certain of its components including
the computer that is used in one of the Company's products. Such
computer is sourced by the Company from a single vendor. The Company
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
licensing agreement to use pictographic symbols could negatively impact
the Company's financial position, results of operations, and cash
flows.
F-13
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Recently Issued Accounting Pronouncements
-----------------------------------------
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." SFAS No. 145 updates, clarifies, and simplifies
existing accounting pronouncements. This statement rescinds SFAS No. 4,
which required all gains and losses from extinguishment of debt to be
aggregated and, if material, classified as an extraordinary item, net
of related income tax effect. As a result, the criteria in APB No. 30
will now be used to classify those gains and losses. SFAS No. 64
amended SFAS No. 4 and is no longer necessary as SFAS No. 4 has been
rescinded. SFAS No. 44 has been rescinded as it is no longer necessary.
SFAS No. 145 amends SFAS No. 13 to require that certain lease
modifications that have economic effects similar to sale-leaseback
transactions be accounted for in the same manner as sale-lease
transactions. This statement also makes technical corrections to
existing pronouncements. While those corrections are not substantive in
nature, in some instances, they may change accounting practice. This
statement is not applicable to the Company.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This statement addresses
financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force ("EITF")
Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring)." This statement requires that a liability
for a cost associated with an exit or disposal activity be recognized
when the liability is incurred. Under EITF Issue 94-3, a liability for
an exit cost, as defined, was recognized at the date of an entity's
commitment to an exit plan. The provisions of this statement are
effective for exit or disposal activities that are initiated after
December 31, 2002 with earlier application encouraged. The Company does
not expect adoption of SFAS No. 146 to have a material impact, if any,
on its financial position or 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. 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.
F-14
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment at August 31, 2002 consisted of the following:
Equipment $ 104,236
Computer equipment 317,742
Furniture and fixtures 45,036
Leasehold improvements 38,215
------------
505,229
Less accumulated depreciation and amortization 442,790
------------
TOTAL $ 62,439
============
Depreciation and amortization expense was $64,158 and $65,300 for the
years ended August 31, 2002 and 2001, respectively.
NOTE 5 - LINE OF CREDIT
The Company has available an unsecured $100,000 revolving line of
credit from a bank with interest payable on a monthly basis at prime
(7.5% at August 31, 2002), with a minimum floor of 7.5%, plus 3.5%. The
line is personally guaranteed by the Company's President. As of August
31, 2002, the line of credit was unused.
NOTE 6 - COMMITMENTS AND CONTINGENCIES
Leases
------
The Company leases certain facilities for its corporate and operations
offices under a non-cancelable operating lease agreement that expires
in September 2003. The Company also leases certain office and computer
equipment under non-cancelable capital lease arrangements that expire
through August 2004.
F-15
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 6 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Leases (Continued)
------
Future minimum lease payments under non-cancelable operating and
capital leases with initial or remaining terms of one year or more at
August 31, 2002 were as follows:
Year Ending Operating Capital
August 31, Leases Leases
----------- ---------- ----------
2003 $ 146,016 $ 12,919
2004 2,434 10,704
---------- ----------
$ 148,450 23,623
==========
Less amount representing interest 2,423
----------
21,200
Less current portion 11,236
----------
LONG-TERM PORTION $ 9,964
==========
Included in property and equipment is capitalized leased equipment of
$54,053 with accumulated depreciation of $45,743 at August 31, 2002.
Rent expense was $194,400 and $184,070 for the years ended August 31,
2002 and 2001, respectively.
Employee Agreement
------------------
The Company entered into an employment agreement with its President
that expired on August 31, 2002. The employment agreement provided for
an annual salary of $150,000 and an annual bonus based on the Company's
performance not to exceed $150,000. The agreement also provided 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. Subsequent to August 31, 2002, the Company
entered into a new employment agreement with its President (see Note
11).
License Agreement
-----------------
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, TSRL received a one-time
payment of $75,000, plus a royalty of 20% of net sales of the
absorption simulation. For the years ended August 31, 2002 and 2001,
the Company paid royalties of $161,993 and $110,814, respectively.
F-16
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 6 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Listing on Stock Exchange
-------------------------
In order to maintain quotation of its securities on the NASDAQ Small
Cap Market (the "NASDAQ"), the Company has to maintain certain minimum
financial requirements. As of August 31, 2002 and 2001, the Company has
ceased to meet one of the requirements for continued listing, namely
the Company's net tangible assets as of August 31, 2002 and 2001 were
$768,000 and $283,000, respectively, which is below the $2,000,000
required by the NASDAQ. Furthermore, as of November 16, 1999, the
market value of the Company's public float was below the $4,000,000
required for continued NASDAQ listing.
The Company was unable to increase its net tangible assets and the
market value of its public float to meet the NASDAQ's requirements for
continued listing. The Company's securities were delisted from NASDAQ
effective at the closing of July 2, 1999. Trading, if any, of the
shares of common stock now need to be conducted in the over-the-counter
markets in the so-called "pink sheets" or on the NASDAQ's "Electronic
Bulletin Board." Consequently, the liquidity of the Company's
securities could be impaired, not only in the number of securities
which could be bought and sold, but also through delays in the timing
of the transactions, reductions in security analysts' and the news
media's coverage of the Company, and lower prices for the Company's
securities than otherwise might be attained.
NOTE 7 - SHAREHOLDERS' EQUITY
Warrants
--------
In August and September 1996, the Company entered into two Subscription
Agreements, whereby the Company issued 100,000 and 150,000 warrants,
respectively, to purchase shares of common stock. The warrants are
exercisable at $4 per share and expire five years from the date of
grant. During August and September 2001, the warrants to purchase
100,000 and 150,000 shares, respectively, of common stock expired prior
to being exercised.
In January 1997, the Company entered into Subscription Agreements,
whereby the Company issued notes in the amount of $1,100,000 and issued
280,000 warrants to purchase common stock. The warrants were
exercisable at $2.50 per share, were subject to a 12-month-lock-up
period, and expired five years from the grant date. During the year
ended August 31, 2002, these warrants expired. The notes were repaid
upon the completion of the Company's stock offering.
F-17
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 7 - SHAREHOLDERS' EQUITY (CONTINUED)
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.
Furthermore, 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. The Option Plan terminates in 2006, subject to earlier
termination by the Board of Directors.
The following summarizes the stock option transactions:
Weighted-
Average
Exercise
Number Price
of Options Per Share
---------- ---------
Outstanding, August 31, 2000 842,173 $ 2.24
Granted 428,000 $ 1.51
Expired/canceled (53,652) $ 2.45
----------
Outstanding, August 31, 2001 1,216,521 $ 1.97
Granted 64,043 $ 1.05
Expired/canceled (126,086) $ 2.00
----------
OUTSTANDING, AUGUST 31, 2002 1,154,478 $ 1.91
==========
EXERCISABLE, AUGUST 31, 2002 413,627 $ 2.04
==========
F-18
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 7 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plan (Continued)
-----------------
The weighted-average remaining contractual life of options outstanding
issued under the Plan was 7.77 years at August 31, 2002. The exercise
prices for the options outstanding at August 31, 2002 ranged from $1.05
to $4.25, and the information relating to these options is as follows:
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 - 2.00 747,048 238,983 5 years $ 1.44 $ 1.44
$ 2.01 - 3.00 378,250 151,300 5 years $ 2.66 $ 2.66
$ 3.01 - 4.25 29,180 23,344 5 years $ 4.25 $ 4.25
---------- -----------
1,154,478 413,627
========== ===========
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 (loss) and earnings (loss) per
share would be reduced to the pro forma amounts indicated below for the
years ended August 31, 2002 and 2001:
2002 2001
---------- -----------
Net income (loss)
As reported $ 484,915 $ (225,600)
Pro forma $ 256,364 $ (511,704)
Basic earnings (loss) per common share
As reported $ 0.14 $ (0.07)
Pro forma $ 0.08 $ (0.15)
Diluted earnings (loss) per common share
As reported $ 0.14 $ (0.07)
Pro forma $ 0.07 $ (0.15)
F-19
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 7 - SHAREHOLDERS' EQUITY (CONTINUED)
Stock Option Plan (Continued)
-----------------
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 years ended August 31, 2002 and
2001: dividend yields of 0% and 0%, respectively; expected volatility
of 92% and 100%, respectively; risk-free interest rates of 4.3% and 5%,
respectively; and expected lives of five and five years, respectively.
The weighted-average fair value of options granted during the years
ended August 31, 2002 and 2001 was $0.76 and $1.18, respectively, and
the weighted-average exercise price was $1.05 and $1.51, respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no 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.
Other Stock Options
-------------------
As of August 31, 2002, the Company granted the Board of Directors a
total of 6,206 stock options at exercise prices ranging from $1.20 to
$5.25.
NOTE 8 - INCOME TAXES
The components of the income tax provision for the years ended August
31, 2002 and 2001 were as follows:
2002 2001
----------- -----------
Current
Federal $ -- $ --
State 1,600 1,600
----------- -----------
1,600 1,600
----------- -----------
Deferred
Federal -- --
State -- --
----------- -----------
-- --
----------- -----------
TOTAL $ 1,600 $ 1,600
=========== ===========
F-20
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 8 - INCOME TAXES (CONTINUED)
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, 2002 and 2001:
2002 2001
------------- -------------
Income tax computed at federal statutory tax rate 34.0% (34.0)%
State taxes, net of federal benefit 6.1 (5.0)
Expired state net operating losses 8.1 --
Change in valuation allowance (48.4) 38.1
Other 0.5 1.6
------------- -------------
TOTAL 0.3% 0.7%
============= =============
Significant components of the Company's deferred tax assets and
liabilities for income taxes for the years ended August 31, 2002 and
2001 consisted of the following:
2002 2001
------------- -------------
Deferred tax assets
Accrued payroll and other expenses $ 207,378 $ 208,221
Accrued warranty and service costs 13,278 19,473
Net operating loss carryforward 1,332,166 1,593,849
Property and equipment 15,739 11,661
------------- -------------
Total deferred tax assets 1,568,561 1,833,204
Valuation allowance 1,383,547 1,619,000
------------- -------------
185,014 214,204
------------- -------------
Deferred tax liabilities
State taxes (56,162) (70,989)
Capitalized computer software development
costs (128,852) (143,215)
------------- -------------
Total deferred tax liabilities (185,014) (214,204)
------------- -------------
NET DEFERRED TAX ASSETS $ -- $ --
============= =============
The Company's valuation allowance decreased by $235,453 during the year
ended August 31, 2002. At August 31, 2002, the Company had federal and
state net operating loss carryforwards of approximately $3,614,000 and
$1,171,000, respectively, that expire through 2022.
F-21
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 9 - RELATED PARTY TRANSACTIONS
As of August 31, 2002, included in accrued bonuses to officers was
$27,029, which represented 5% of the Company's net income before
bonuses and taxes given to the Company's President as an annual bonus.
As of August 31, 2002, included in accrued bonuses to officers was
$27,029, which represented 5% of the Company's net income before
bonuses and taxes given to the Company's Vice President of Human
Resources as an annual bonus.
As of August 31, 2002, included in accrued compensation due to officers
was $190,583, which represented accrued salary due to the Company's
President. The amount due does not accrue interest.
As of August 31, 2002, included in accrued compensation due to officers
was $8,333, which represented accrued salary due to the Company's Vice
President of Human Resources. The amount due does not accrue interest.
NOTE 10 - LINES OF BUSINESS
For internal reporting purposes, management segregates the Company into
two divisions as follows for the years ended August 31, 2002 and 2001:
August 31, 2002
---------------------------------------------------------
Simulations
Plus, Inc. Words+, Inc. Eliminations Total
------------ ------------ ------------ ------------
Net sales $ 2,043,178 $ 2,400,664 $ -- $ 4,443,842
Income (loss)
from operations $ 675,113 $ (174,999) $ -- $ 500,114
Identifiable assets $ 1,572,422 $ 712,803 $ (699,234) $ 1,585,991
Capital expenditures $ 13,677 $ 21,652 $ -- $ 35,329
Depreciation and
amortization $ 27,802 $ 36,356 $ -- $ 64,158
F-22
SIMULATIONS PLUS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 31, 2002
--------------------------------------------------------------------------------
NOTE 10 - LINES OF BUSINESS (CONTINUED)
August 31, 2001
---------------------------------------------------------
Simulations
Plus, Inc. Words+, Inc. Eliminations Total
------------ ------------ ------------ ------------
Net sales $ 1,180,559 $ 2,734,024 $ -- $ 3,914,583
Income (loss)
from operations $ (340,539) $ 138,591 $ -- $ (201,948)
Identifiable assets $ 859,371 $ 597,494 $ (199,606) $ 1,257,259
Capital expenditures $ -- $ 30,700 $ -- $ 30,700
Depreciation and
amortization $ 47,250 $ 18,050 $ -- $ 65,300
Most corporate expenses, such as legal and accounting expenses and
public relations expenses, are included in Simulations Plus, Inc.
NOTE 11 - SUBSEQUENT EVENTS
On September 1, 2002, the Company entered into an employment agreement
with its President/Chief Executive Officer that expires in August 2005.
The employment agreement provides for an annual salary of $165,000 and
an annual bonus equal to 5% of the Company's net income before taxes,
but 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.
F-23