<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ___________ to ___________
Commission File Number: 333-11017
SIMULATION SCIENCES INC.
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization)
601 Valencia Avenue, Suite 100, Brea, California 92823
(Address of principal executive offices) (Zip Code)
95-2487793 (I.R.S. Employer Identification No.)
Registrant's telephone number, including area code:
(714) 579-0412
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 ninety (90) days.
Yes X No
The registrant had 9,471,803 shares of common stock outstanding as of
November 4, 1996.
<PAGE> 2
SIMULATION SCIENCES INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PAGE NUMBER
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets -
September 30, 1996 (Unaudited) and December 31, 1995 3
Consolidated Statements of Income (Unaudited) -
Three Months and Nine Months Ended September 30, 1996 and 1995 4
Consolidated Statements of Cash Flow (Unaudited) -
Nine Months Ended September 30, 1996 and 1995 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 16
</TABLE>
2
<PAGE> 3
PART 1 - FINANCIAL INFORMATION
SIMULATION SCIENCES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,087,366 $ 5,442,283
Short-term investments 14,531 14,531
Accounts receivable, less allowance for doubtful accounts of
$651,311 at September 30, 1996 and $456,387 at December 31, 1995 7,946,048 8,869,483
Unbilled accounts receivable 2,195,304 250,514
Income tax refund receivable 412,918 968,552
Deferred income taxes 2,170,741 2,170,741
Prepaid expenses and other current assets 350,118 411,760
------------ ------------
Total current assets 14,177,026 18,127,864
LONG-TERM INSTALLMENTS RECEIVABLE, net of unamortized
discount of $127,155 at September 30, 1996 4,829,575
PROPERTY AND EQUIPMENT
Computer equipment and programs 6,081,072 4,126,674
Furniture and fixtures 3,401,956 3,171,422
------------ ------------
9,483,028 7,298,096
Less accumulated depreciation (5,649,010) (4,956,783)
------------ ------------
Property and equipment, net 3,834,018 2,341,313
OTHER ASSETS 1,941,232 552,014
DEFERRED INCOME TAXES 533,191 533,191
------------ ------------
$ 25,315,042 $ 21,554,382
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,515,633 $ 1,401,529
Accrued vacation and bonus payable 1,400,805 1,103,794
Other accrued liabilities 3,490,729 2,345,523
Income taxes payable 1,585,058 1,087,698
Billings in excess of costs and estimated earnings on uncompleted contracts 362,452 219,526
Deferred revenue 5,349,502 5,554,699
------------ ------------
Total current liabilities 13,704,179 11,712,769
COMMITMENTS
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK,
$.001 par value; 5,000,000 shares authorized, 1,666,668 shares issued
and outstanding at September 30, 1996 and December 31, 1995 4,802,120 4,802,120
STOCKHOLDERS' EQUITY
Common stock -- $.001 par value; 30,000,000 shares authorized; 5,055,135
and 5,000,000 shares outstanding at September 30, 1996
and December 31, 1995, respectively 5,055 5,000
Additional paid-in capital 1,620,224 1,470,402
Retained earnings 5,183,464 3,564,091
------------ ------------
Total stockholders' equity 6,808,743 5,039,493
------------ ------------
$ 25,315,042 $ 21,554,382
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
SIMULATION SCIENCES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
1996 1995 1996 1995
----------------------------- -----------------------------
<S> <C> <C> <C> <C>
Revenue
Software license revenue $11,644,595 $ 7,522,765 $31,281,088 $21,475,767
Services and other revenue 452,316 738,170 2,606,800 2,031,554
----------------------------- -----------------------------
Total revenue 12,096,911 8,260,935 33,887,888 23,507,321
Cost of revenue
Cost of software license revenue 1,153,690 774,108 2,932,169 2,479,329
Cost of services and other revenue 368,831 1,032,259 1,921,293 2,426,657
----------------------------- -----------------------------
Total cost of revenue 1,522,521 1,806,367 4,853,462 4,905,986
----------------------------- -----------------------------
Gross profit 10,574,390 6,454,568 29,034,426 18,601,335
Operating expenses
Sales and marketing 4,566,532 2,513,873 11,905,111 8,177,372
Research and development 2,782,061 2,122,357 9,627,005 6,452,958
General and administrative 1,942,716 1,125,550 5,009,229 2,493,920
----------------------------- -----------------------------
Total operating expenses 9,291,309 5,761,780 26,541,345 17,124,250
----------------------------- -----------------------------
Income from operations 1,283,081 692,788 2,493,081 1,477,085
Interest and other income 135,731 (134,948) 298,984 136,838
----------------------------- -----------------------------
Income before provision for income taxes 1,418,812 557,840 2,792,065 1,613,923
Provision for income taxes 609,478 230,063 1,172,692 665,888
----------------------------- -----------------------------
Net income $ 809,334 $ 327,777 $ 1,619,373 $ 948,035
============================= =============================
Pro forma net income per share $ 0.10 $ 0.05 $ 0.21 $ 0.14
============================= =============================
Pro forma weighted average common shares 7,764,970 7,017,628 7,764,970 7,017,628
============================= =============================
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
SIMULATION SCIENCES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------
1996 1995
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,619,373 $ 948,035
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 692,227 501,993
Provision for doubtful accounts 400,929 28,443
Deferred income taxes 87
Change in operating assets and liabilities:
Short-term investments 100,000
Accounts receivable 522,506 (920,527)
Unbilled accounts receivable (1,944,790) (90,400)
Income taxes refund receivable 555,634
Prepaid expenses and other current assets 61,642 132,368
Other assets (1,389,218) 129,897
Accounts payable 114,104 (327,899)
Accrued bonus and vacation payable 297,011 387,594
Other accrued liabilities 1,145,206 (239,563)
Income taxes payable 497,360 42,422
Billings in excess of costs and estimated
earnings on uncompleted contracts 142,926 272,005
Deferred revenue (205,197) 1,022,885
----------- -----------
Net cash provided by operating activities 2,509,713 1,987,340
Cash flow from investing activities:
Purchases of property and equipment (2,184,932) (598,441)
Long-term installments receivable (4,829,575)
----------- -----------
Net cash used in investing activities (7,014,507) (598,441)
Cash flow from financing activities:
Proceeds from stock option exercises 149,877
----------- -----------
Net cash provided by financing activities 149,877 --
----------- -----------
Net increase (decrease) in cash and cash equivalents (4,354,917) 1,388,899
Cash and cash equivalents at beginning of the year 5,442,283 3,905,817
----------- -----------
Cash and cash equivalents at end of period $ 1,087,366 $ 5,294,716
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes $ 274,944 $ 109,241
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
SIMULATION SCIENCES INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The consolidated balance sheet as of September 30, 1996 and the related
consolidated statements of income and cash flows for the three month and nine
month periods ended September 30, 1996 and 1995 are unaudited and in the opinion
of management contain all necessary adjustments, consisting of normal recurring
adjustments, for a fair presentation of such financial information. These
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto contained in the Company's
prospectus dated October 25, 1996 filed with the Securities and Exchange
Commission in October 1996. Interim results are not necessarily indicative of
results for a full year.
The financial statements and notes are presented as permitted by Form
10-Q, and do not contain certain information included in the Company's audited
financial statements and notes for the fiscal year ended December 31, 1995.
2. PRO FORMA NET INCOME PER SHARE
Pro forma net income per share is computed by dividing net income by
the weighted average number of shares of common and common equivalent shares
outstanding. Weighted average common and common equivalent shares include common
shares, warrants to purchase shares of common stock, stock options using the
treasury stock method, and the pro forma conversion of all outstanding shares of
preferred stock into shares of common stock.
Pursuant to Securities and Exchange Commission Staff Accounting
Bulletin Topic 4D, stock options granted during the twelve months prior to the
date of the initial filing of the Company's Form S-1 Registration Statement have
been included in the calculation of common equivalent shares using the treasury
stock method as if they were outstanding for all periods presented.
3. STOCK PLANS
1994 Stock Option Plan - The following table summarizes stock option
activity under the 1994 Stock Option Plan for the nine months ended September
30, 1996:
<TABLE>
<CAPTION>
NUMBER OF
NUMBER OF PRICE OPTIONS
SHARES PER SHARE EXERCISABLE
-----------------------------------------------
<S> <C> <C> <C>
Balance, January 1, 1996 914,000 $2.67 - $2.73 65,800
Granted 652,667 5.37 - 7.50
Exercised (55,134) 2.67 - 2.73
Cancelled (55,034) 2.67 - 2.73
---------
Balance, September 30, 1996 1,456,499 $2.67 - $7.50 207,133
=========
</TABLE>
There was no activity under any of the Company's other stock option or stock
purchase plans during the nine months ended September 30, 1996, and as of
September 30, 1996 there were no options outstanding under any of these plans.
6
<PAGE> 7
4. SUBSEQUENT EVENTS
On October 25, 1996, the Company offered 3.6 million shares of its
Common Stock at $9.00 per share in its initial public offering. The Company sold
2.75 million shares and selling stockholders sold 850,000 shares in the
offering. Net proceeds to the Company from the offering were approximately $22
million. The Company and certain selling stockholders have granted to the
underwriters a 30-day option to purchase up to 540,000 additional shares at
$9.00 per share solely to cover overallotments, if any. If the option is
exercised in full, additional net proceeds to the Company will be approximately
$4 million.
7
<PAGE> 8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Simulation Sciences Inc. was founded in 1967 to develop simulation
technology and software used in the design of refineries for the petroleum
industry. Thereafter, the Company developed other software products to address
additional needs for plant design and operation within the petroleum industry
and later expanded the application of these software products to other process
industries, including petrochemicals and chemicals. Since 1994, the Company has
been developing products and services that further enhance and optimize plant
operation and enable integrated enterprise management. The Company hired
substantially all of its current executive management team in 1995.
The Company generally licenses its software pursuant to non-cancelable,
one- to five-year contracts. The Company receives approximately 90% of its
worldwide revenue from licenses of its software products. These licenses
obligate the Company to provide customer support, maintenance and any product
updates. During the past five years, the substantial majority of all licenses
have been renewed.
Revenue from the Company's primary simulation product, PRO/II, accounted
for approximately 70% of total revenue in each of the last three years. The
remainder of the Company's revenue is derived from other products and services,
including development, integration, Rigorous On-line Modeling ("ROM") projects,
and consulting and training services.
The Company recognizes revenue from product licensing agreements in
accordance with American Institute of Certified Public Accountants Statement of
Position No. 91-1, Software Revenue Recognition ("SOP 91-1"). SOP 91-1 generally
requires recognition of license revenue upon shipment or renewal and recognition
of revenue for maintenance and support ratably over the life of the contract.
However, if license fees and maintenance and support charges are not separately
identified, then all revenue from the contract must be recognized ratably over
its life. More than 95% of the Company's license contracts entered into before
1996 did not separately identify software license fees and charges for
maintenance and support obligations. As a result, the Company recognized revenue
from these contracts ratably over the terms of such contracts in accordance with
SOP 91-1 ("Ratable Revenue"). The remaining contracts identified the cost of the
license fee and maintenance and support separately and, under SOP 91-1, the
Company recognized revenue from the license portion of the contracts upon
shipment or renewal ("License Revenue") and from the maintenance and support
portion of such contracts as Ratable Revenue. Accordingly, the revenue
recognized under a contract resulting in License Revenue recognition will be
higher in the quarter of shipment or renewal, and lower in later quarters, than
that recognized under a contract resulting only in Ratable Revenue recognition.
In order to more closely conform to industry-standard practices regarding
licenses and maintenance agreements, the Company, in 1996, began increasing the
number of contracts for new and renewing customers that separately identify
software license fees and maintenance and support charges, resulting in
recognition of License Revenue on an increased portion of contracts. The Company
intends to convert the substantial majority of its contracts to License Revenue
terms as new and renewal contracts are executed. For this reason, the Company
does not believe that revenue and results of operations for prior periods will
be directly comparable to results for 1996 and future periods. Revenue
recognition on ROM and other service offerings is based on percentage of
completion and on attainment of project milestones.
In accordance with Financial Accounting Standards Board Statement No.
86, the Company is required to capitalize software development costs incurred
after technological feasibility of the product
8
<PAGE> 9
has been established and prior to the first shipment of such product. Because
the Company believes that its process for developing software has been
essentially completed concurrently with the establishment of technological
feasibility, no costs have been capitalized to date.
A. RESULTS OF OPERATIONS
Three Months Ended September 30, 1996 and September 30, 1995
The following table sets forth certain items in the Company's
Consolidated Statements of Income in absolute dollars and as a percentage of
total revenue for the three months ended September 30, 1996 and 1995.
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------
1996 1995
--------------------- ----------------------
AMOUNT % AMOUNT %
--------------------- ----------------------
<S> <C> <C> <C> <C>
Revenue:
Software license revenue .............. $11,645 96.3% $ 7,523 91.1%
Services and other revenue ............ 452 3.7 738 8.9
--------------------- ----------------------
Total revenue ...................... 12,097 100.0 8,261 100.0
Cost of revenue:
Cost of software license revenue ...... 1,154 9.5 774 9.4
Cost of services and other revenue .... 369 3.1 1,032 12.5
--------------------- ----------------------
Total cost of revenue .............. 1,523 12.6 1,806 21.9
--------------------- ----------------------
Gross profit ............................... 10,574 87.4 6,455 78.1
Operating expenses:
Sales and marketing ................... 4,566 37.7 2,514 30.4
Research and development .............. 2,782 23.0 2,122 25.7
General and administrative ............ 1,943 16.1 1,126 13.6
--------------------- ----------------------
Total operating expenses ........... 9,291 76.8 5,762 69.7
--------------------- ----------------------
Income from operations ..................... 1,283 10.6 693 8.4
Interest and other income .................. 135 1.1 (135) (1.6)
--------------------- ----------------------
Income before provision for income taxes ... 1,418 11.7 558 6.8
Provision for income taxes ................. 609 5.0 230 2.8
--------------------- ----------------------
Net income ................................. $ 809 6.7% $ 328 4.0%
===================== ======================
</TABLE>
Total Revenue. Total revenue increased 46% to $12.1 million for the
quarter ended September 30, 1996 from $8.3 million for the quarter ended
September 30, 1995. Software license revenue, which includes revenue from
software license, maintenance and support fees, increased 55% to $11.6 million
for the three months ended September 30, 1996 from $7.5 million for the three
months ended September 30, 1995. The increase in software license revenue was
attributable to renewals of licenses for higher fees, licenses to new customers
and the effect of the change in contract terms (see "Overview"). Services and
other revenue, which includes integration, ROM, consulting and training
services, decreased 39% to $452,000 for the three months ended September 30,
1996 from $738,000 for the three months ended September 30, 1995. The decrease
in services and other revenue was attributable to a decline in the level of ROM
and services activity and, to a lesser extent, to customer-related delays on
ROM projects.
Total Cost of Revenue. Total cost of revenue decreased 16% to $1.5
million for the quarter ended September 30, 1996 from $1.8 million for the
quarter ended September 30, 1995. Cost of
9
<PAGE> 10
software license revenue, which includes costs of production and distribution,
customer support and maintenance, and royalties, increased 49% to $1.2 million
from $0.8 million for the three months ended September 30, 1996 and 1995,
respectively. Cost of software license revenue as a percentage of software
license revenue was 10% in each of the quarters ended September 30, 1996 and
1995. Cost of services and other revenue, which includes costs of personnel
involved in training and project execution, as well as travel, third-party
professional fees and related administrative costs, decreased 64% to $369,000
from $1,032,000 for the quarters ended September 30, 1996 and 1995,
respectively. The decrease in cost of services and other revenue relates to the
decrease in services revenue. Cost of services and other revenue as a percentage
of services and other revenue decreased to 82% from 140% for the three months
ended September 30, 1996 and 1995, respectively as the Company improved employee
productivity on ROM projects.
Sales and Marketing . Sales and marketing expenses increased 82% to
$4.6 million for the quarter ended September 30, 1996 from $2.5 million for the
quarter ended September 30, 1995. Sales and marketing expenses as a percentage
of total revenue was 37.7% and 30.4% for the three months ended September 30,
1996 and 1995, respectively. The increase in sales and marketing expenses in
dollars and as a percentage of total revenue was due primarily to an increase in
the number of sales and marketing professionals and related hiring expenses. The
Company anticipates that sales and marketing expenses will increase in dollars
and will fluctuate as a percentage of total revenue in the future.
Research and Development. Research and development expenses increased
31% to $2.8 million for the three months ended September 30, 1996 from $2.1
million for the three months ended September 30, 1995. These increases were due
to an increase in the number of engineers and related hiring expenses and
third-party contractors involved in the development of a number of planned
upgrades and new products. Research and development expenses as a percentage of
total revenue were 23.0% and 25.7% for the three months ended September 30, 1996
and 1995, respectively. The Company expects to continue to devote substantial
resources to its research and development efforts to continue to develop and
support the Company's highly complex software products. Accordingly, the Company
anticipates that research and development expenses will increase in dollars and
may fluctuate as a percentage of total revenue in the future.
General and Administrative. General and administrative expenses
increased 73% to $1.9 million for the quarter ended September 30, 1996 from $1.1
million for the quarter ended September 30, 1995. General and Administrative
expenses as a percentage of total revenue were 16.1% and 13.6% in the three
months ended September 30, 1996 and 1995, respectively. The increase in general
and administrative expenses in dollars and as a percentage of total revenue was
primarily due to the addition of senior management personnel. The Company
believes that its general and administrative expenses will increase in dollars
in the future, and may fluctuate as a percentage of total revenue, due in part
to the Company's planned expansion in staffing and costs associated with being a
publicly held company.
Interest and Other Income. Interest and other income increased $270,000
to $135,000 for the quarter ended September 30, 1996 from an expense of $135,000
for the quarter ended September 30, 1995. The increase was primarily
attributable to an increase in interest income from the effect of the change in
contract terms in the quarter ended September 30, 1996, as well as foreign
currency fluctuations during the same period a year ago.
Provision for Income Taxes. The Company's effective tax rate was 43%
and 41% for the three months ended September 30, 1996 and 1995, respectively.
10
<PAGE> 11
Nine Months Ended September 30, 1996 and September 30, 1995
The following table sets forth certain items in the Company's
Consolidated Statements of Income in absolute dollars and as a percentage of
total revenue for the nine months ended September 30, 1996 and 1995.
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------
1996 1995
---------------------- ----------------------
AMOUNT % AMOUNT %
---------------------- ----------------------
<S> <C> <C> <C> <C>
Revenue:
Software license revenue .............. $ 31,281 92.3% $ 21,476 91.4%
Services and other revenue ............ 2,607 7.7 2,031 8.6
---------------------- ----------------------
Total revenue ...................... 33,888 100.0 23,507 100.0
Cost of revenue:
Cost of software license revenue ...... 2,932 8.6 2,479 10.6
Cost of services and other revenue .... 1,922 5.7 2,427 10.3
---------------------- ----------------------
Total cost of revenue .............. 4,854 14.3 4,906 20.9
---------------------- ----------------------
Gross profit ............................... 29,034 85.7 18,601 79.1
Operating expenses:
Sales and marketing ................... 11,905 35.1 8,177 34.8
Research and development .............. 9,627 28.4 6,453 27.4
General and administrative ............ 5,009 14.8 2,494 10.6
---------------------- ----------------------
Total operating expenses ........... 26,541 78.3 17,124 72.8
---------------------- ----------------------
Income from operations ..................... 2,493 7.4 1,477 6.3
Interest and other income .................. 299 0.9 137 0.6
---------------------- ----------------------
Income before provision for income taxes ... 2,792 8.3 1,614 6.9
Provision for income taxes ................. 1,173 3.5 666 2.9
---------------------- ----------------------
Net income ................................. $ 1,619 4.8% $ 948 4.0%
====================== ======================
</TABLE>
Total Revenue. Total revenue increased 44% to $33.9 million for the
nine months ended September 30, 1996 from $23.5 million for the nine months
ended September 30, 1995. Software license revenue, which includes revenue from
software license, maintenance and support fees, increased 46% to $31.3 million
from $21.5 million for the nine months ended September 30, 1996 and 1995,
respectively. The increase in software license revenue was attributable to
renewals of licenses for higher fees, licenses to new customers and the effect
of the change in contract terms (see "Overview"). Services and other revenue,
which includes integration, ROM, consulting and training services, increased 28%
to $2.6 million from $2.0 million for the nine months ended September 30, 1996
and 1995, respectively. The increase in services and other revenue was
attributable to an increase in the level of ROM and services activity.
Total Cost of Revenue. Total cost of revenue was $4.9 million for each
of the nine month periods ended September 30, 1996 and 1995. Cost of software
license revenue, which includes costs of production and distribution, customer
support and maintenance, and royalties, increased 18% to $2.9 million from $2.5
million for the nine months ended September 30, 1996 and 1995, respectively.
Cost of software license revenue as a percentage of software license revenue was
9% and 12% for the nine months ended September 30, 1996 and 1995, respectively.
Cost of services and other revenue, which includes costs of personnel involved
in training and project execution, as well as travel, third-party professional
fees and related administrative costs, decreased 21% to $1.9 million from $2.4
million for the nine months ended September 30, 1996 and 1995, respectively. The
decrease in cost of services and other
11
<PAGE> 12
revenue relates to improved employee productivity on ROM projects. Cost of
services and other revenue as a percentage of services and other revenue
decreased to 74% from 119% for the nine months ended September 30, 1996 and
1995, respectively as the Company improved employee productivity on ROM
projects.
Sales and Marketing. Sales and marketing expenses increased 46% to
$11.9 million for the nine months ended September 30, 1996 from $8.2 million for
the nine months ended September 30, 1995. Sales and marketing expenses as a
percentage of total revenue was 35.1% and 34.8% for the nine months ended
September 30, 1996 and 1995, respectively. The increase in sales and marketing
expense in dollars and as a percentage of total revenue was due primarily to an
increase in the number of sales and marketing professionals and related hiring
expenses. The Company anticipates that sales and marketing expenses will
increase in dollars and fluctuate as a percentage of total revenue in the
future.
Research and Development. Research and development expenses increased
49% to $9.6 million for the nine months ended September 30, 1996 from $6.5
million for the nine months ended September 30, 1995. The increase in research
and development expenses was due to an increase in the number of engineers and
related hiring expenses and third-party contractors involved in the development
of a number of planned upgrades and new products, and severance expenses
associated with the termination of one executive's employment. Research and
development expenses as a percentage of total revenue were 28.4% and 27.4% for
the nine months ended September 30, 1996 and 1995, respectively. The Company
expects to continue to devote substantial resources to its research and
development efforts to continue to develop and support the Company's highly
complex software products. Accordingly, the Company anticipates that research
and development expenses will increase in dollars and may fluctuate as a
percentage of total revenue in the future.
General and Administrative. General and administrative expenses
increased 101% to $5.0 million for the nine months ended September 30, 1996 from
$2.5 million for the nine months ended September 30, 1995. General and
administrative expenses as a percentage of total revenue were 14.8% and 10.6% in
the three months ended September 30, 1996 and 1995, respectively. The increase
in general and administrative expenses was primarily due to the addition of
senior management personnel. The Company believes that its general and
administrative expenses will increase in dollars in the future, and may
fluctuate as a percentage of total revenue, due in part to the Company's planned
expansion in staffing and costs associated with being a publicly held company.
Interest and Other Income. Interest and other income increased $162,000
to $299,000 for the nine months ended September 30, 1996 from $137,000 for the
nine months ended September 30, 1995. The increase was primarily attributable to
an increase in interest income from the effect of the change in contract terms.
Provision for Income Taxes. The Company's effective tax rate was 42%
and 41% for the nine months ended September 30, 1996 and 1995, respectively.
12
<PAGE> 13
B. LIQUIDITY AND CAPITAL RESOURCES
During the past three years, the Company has satisfied its cash needs
principally through cash generated from operations and existing cash resources.
Cash generated from operating activities for the nine months ended September 30,
1996 was $2.5 million, which was primarily attributable to net income and
increases in other accrued liabilities, partially offset by an increase in
accounts receivable and the increase in other assets as a result of the
acquisition of certain technology.
Cash used in investing activities during the nine months ended
September 30, 1996 totaled $7.0 million. The $7.0 million was attributable to
$2.2 million in purchases of property and equipment, related to the opening of
new offices and computer equipment, and a $4.8 million increase in long-term
installments receivable as a result of the change in the Company's software
license contracts.
Cash provided from financing activities of $150,000 was from proceeds
received from stock options exercises.
Available sources of funds at September 30, 1996 consisted of $1.1
million in cash and cash equivalents, and $3 million in unused lines of credit
with its bank. At September 30, 1996, the Company had a revolving line of credit
with a commercial bank under which it may borrow up to $3.0 million at the
bank's prime rate. The agreement, with amendments, expires January 31, 1997, is
collateralized by substantially all of the Company's assets and contains certain
financial and other covenants. At September 30, 1996, there were no borrowings
outstanding under the agreement. Subsequent to September 30, 1996, the Company
received approximately $22 million in net proceeds from its initial public
offering.
The Company believes that existing cash resources, cash flow from
operations, if any, and the line of credit, together with the net proceeds from
the initial public offering, will be sufficient to fund the Company's operations
during the next twelve months.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS.
Various paragraphs of this Item 2 (Management's Discussion and Analysis
of Financial Condition and Results of Operations) contain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
including, but not limited to, statements regarding expansion of the Company's
sales and marketing efforts and increases in the Company's research and
development expenditures and general administrative expense levels. Actual
results could differ materially from those projected in the forward-looking
statements as a result of the factors set forth below and elsewhere in this
document.
The Company's operating results have fluctuated in the past and may
fluctuate significantly from quarter to quarter or on an annual basis in the
future as a result of a number of factors, including, but not limited to: the
size and timing of customer orders; changes in license renewal rates, delays in
renewals or failure of existing customers to renew their licenses with the
Company when their current licenses expire; the length of the Company's sales
cycle; changes in contract terms (including terms affecting the timing of
recognition of license revenue) and the rate at which such changes are made;
level of services and other activity and market success of the Company's service
offerings; timing of new product announcements and introductions by the Company
and its competitors; the Company's ability to develop, introduce and market new
products and product enhancements; market acceptance of the Company's products;
deferrals of customer orders in anticipation
13
<PAGE> 14
of new products or product enhancements; the Company's ability to control costs,
including the need for, and degree of use of, third-party contractors and the
hiring of new employees; the availability of components; political instability
in, or trade embargoes with respect to, foreign markets; changes in the
Company's management team; and fluctuating economic conditions.
The Company's services revenues are typically dependent on a small
number of relatively large projects, and therefore, the number, size and timing
of services projects may have a significant effect on services revenue in any
quarter. In 1994, the Company experienced delays in the completion of ROM
projects that resulted in a material adverse effect on the Company's operating
results, and no assurance can be given that the Company will not experience
significant fluctuations in the level of services and other activity or delays
with respect to ROM or any of its products or services in the future, or that
any such fluctuation or delay would not have a material adverse effect on the
Company's business, operating results and financial condition.
The Company derives a substantial portion of its total revenue from
sales of its PRO/II simulation product. The Company currently expects PRO/ II,
individually or integrated with other products, to account for a significant
portion of the Company's total revenue in the future. Accordingly, factors
adversely affecting the pricing of or demand for PRO/II, including products and
pricing terms offered by competitors or the demand for simulation software in
general, could have a material adverse effect on the Company's business,
operating results and financial condition.
The Company derives a substantial majority of its total revenue from
software licenses and services to companies in the petroleum industry, which is
highly cyclical. Accordingly, the Company's future success is dependent upon the
continued demand for process engineering software by companies in the petroleum
industry.
The Company derives a significant portion of its total revenue from the
renewal of license agreements with existing customers. The Company expects
contract renewals to account for an increasing portion of the Company's total
revenue in the future as the Company increases the number of contracts for
renewing customers that result in the recognition of license revenue upon
shipment. There can be no assurance that the Company will be able to maintain
its historical renewal rates, and any significant or ongoing decline in renewal
rates would have a material adverse effect on the Company's business, operating
results and financial condition.
The market for commercial simulation software used in the petroleum,
chemical and other process industries is intensely competitive and is
characterized by rapidly changing technology, evolving industry standards,
frequent new product introductions and rapidly changing customer requirements.
There can be no assurance that the Company will be successful in developing and
marketing enhancements that respond to technological change, evolving industry
standards or customer requirements, that the Company will not experience
difficulties that could delay or prevent the successful development,
introduction and sale of such enhancements or that such enhancements will
adequately meet the requirements of the marketplace and achieve market
acceptance.
The Company experiences its primary competition from potential
customers' decisions to develop their own software internally rather than
purchasing commercial software products such as those offered by the Company. As
a result, the Company must continuously educate existing and prospective
customers about the advantages of purchasing the Company's products and
services. There can be no assurance that these customers or other potential
customers will perceive sufficient value in the Company's products and services
to justify purchasing them. The Company has experienced and expects to continue
to experience competition from current and future competitors, some of which
have significantly greater financial, technical, marketing and other resources
than the Company. The Company's current direct competitors include, among
others, Aspen Technology, Inc., Hyprotech Ltd.
14
<PAGE> 15
and Chemstations, Inc., and, with respect to the Company's technology and
consulting services, the Hi-Spec division of Honeywell, Inc., the Setpoint and
DMCC divisions of Aspen Technology, Inc. and ABB Simcon Inc. There can be no
assurance that the Company will be able to compete successfully against current
and future competitors, and the failure to do so would have a material adverse
effect upon the Company's business, operating results and financial condition.
A significant portion of the Company's total revenue is derived from
customers outside the United States, and the Company anticipates that
international revenue will continue to be significant in the future. The
Company's international operations are subject to risks inherent in the conduct
of international business, including unexpected changes in regulatory
requirements, exchange rates, export license requirements, tariffs and other
barriers, political and economic instability, limited intellectual property
protection, difficulties in collecting payments due from sales agents or
customers, difficulties in managing distributors or representatives,
difficulties in staffing and managing foreign subsidiary operations, and
potentially adverse tax consequences.
The Company is dependent in part on a number of strategic alliances for
the joint development and marketing of its products. For example, the Company
has entered into a joint development agreement with Shell Oil Company with
respect to the Company's ROMEO project, is jointly developing its NETOPT product
with Mobil Corporation, has jointly developed PROTISS with Strategic Analysis
and Simulation Technology, Ltd. and has recently entered into a memorandum of
understanding with the petroleum industry business unit of IBM regarding joint
development, marketing and sales activities. Failure of one or more of the
Company's strategic alliances to achieve commercial success, or the termination
of one or more of such alliances, could result in delay or termination of
product development projects, reduction in market penetration, decreased ability
to win new customers or loss of confidence by current or potential customers,
any of which could have a material adverse effect on the Company's business,
results of operations or financial condition.
Complex software products such as those offered by the Company may
contain undetected errors or failures commonly referred to as "bugs." There can
be no assurance that, despite significant testing by the Company and by current
and potential customers, errors will not be found in new products or
enhancements to existing products after commencement of commercial shipments.
Substantially all of the Company's current executive management team
has joined the Company in the last two years, including its Chief Executive
Officer and Chief Financial Officer, who joined the Company in July 1995 and
June 1996, respectively. The Company's business is currently experiencing a
period of growth that has placed and is expected to continue to place a
significant strain on the Company's personnel and resources. The Company's
ability to manage future growth, if any, will depend on its ability to continue
to implement and improve operational, financial and management information and
controls systems on a timely basis, together with maintaining effective cost
controls, and any failure to do so could have a material adverse effect on the
Company's business, operating results and financial condition.
The Company's future business results depend in significant part on the
Company's Chief Executive Officer and other senior management and key employees,
including certain technical, managerial and marketing personnel. The loss of the
services of any of these individuals or groups of individuals could have a
material adverse effect on the Company's business, operating results and
financial condition.
15
<PAGE> 16
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) No reports on Form 8-K were filed during the quarter ended
September 30, 1996
16
<PAGE> 17
SIGNATURES
Pursuant to the requirements 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.
Simulation Sciences Inc.
(Registrant)
Date: November 18, 1996 /s/ CHARLES R. HARRIS
-----------------------------------------------------
Charles R. Harris
President and Chief Executive Officer
Date: November 18, 1996 /s/ L. RONALD TREPP
-----------------------------------------------------
L. Ronald Trepp
Vice President of Finance and Chief Financial Officer
(Principal Financial and Accounting Officer)
17
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