<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 June 30, 1997
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: 000-21283
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 10,921,504 shares of common stock outstanding as of
August 7, 1997.
<PAGE> 2
SIMULATION SCIENCES INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PAGE NUMBER
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Financial Statements:
Consolidated Balance Sheets -
December 31, 1996 and June 30, 1997 (Unaudited) 3
Consolidated Statements of Operations (Unaudited) -
Three Months and Six Months Ended June 30, 1996 and 1997 4
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 1996 and 1997 (Unaudited) 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 4. Submission of Matters to a Vote of Security Holders 18
Item 6. Exhibits and Reports on Form 8-K 18
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
SIMULATION SCIENCES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1996 1997
------------ ------------
ASSETS (unaudited)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 26,320,519 $ 14,927,460
Accounts receivable, less allowance for doubtful accounts of
$722,036 and $821,127 at December 31, 1996 and June 30, 1997 8,981,299 10,860,833
Unbilled accounts receivable 3,671,677 7,941,634
Deferred income taxes 2,930,073 2,930,073
Prepaid expenses and other current assets 379,122 466,554
------------ ------------
Total current assets 42,282,690 37,126,554
LONG-TERM INSTALLMENTS RECEIVABLE, net of unamortized discount
of $1,045,184 and $2,195,103 at December 31, 1996 and June 30, 1997 5,126,866 10,458,384
PROPERTY AND EQUIPMENT
Computer equipment and programs 6,073,879 7,082,295
Furniture and fixtures 3,885,485 4,094,586
------------ ------------
9,959,364 11,176,881
Less accumulated depreciation (5,914,287) (6,771,276)
------------ ------------
Property and equipment, net 4,045,077 4,405,605
GOODWILL, net of accumulated amortization of $29,129 at June 30, 1997 1,136,076
OTHER ASSETS 1,568,488 3,194,089
DEFERRED INCOME TAXES 174,656 174,656
------------ ------------
$ 53,197,777 $ 56,495,364
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,901,847 $ 1,385,396
Accrued vacation and bonus payable 1,564,603 1,672,250
Other accrued liabilities 3,732,078 3,036,547
Income taxes payable 2,083,664 2,415,566
Deferred revenue 5,096,380 6,233,633
------------ ------------
Total current liabilities 14,378,572 14,743,392
LONG-TERM LIABILITY 1,000,000
COMMITMENTS
STOCKHOLDERS' EQUITY
Common stock -- $.001 par value; 30,000,000 shares authorized; 9,987,340 and
10,853,052 shares issued and outstanding at
December 31, 1996 and June 30, 1997 9,987 10,853
Additional paid-in capital 32,552,964 37,489,286
Retained earnings 6,256,254 3,251,833
------------ ------------
Total stockholders' equity 38,819,205 40,751,972
------------ ------------
$ 53,197,777 $ 56,495,364
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
SIMULATION SCIENCES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ---------------------------
1996 1997 1996 1997
------------ ------------ ------------ ------------
Revenue (unaudited) (unaudited)
<S> <C> <C> <C> <C>
Software license revenue $ 10,694,561 $ 14,229,051 $ 19,636,493 $ 26,926,170
Services and other revenue 1,068,487 478,987 2,154,484 1,417,162
------------ ------------ ------------ ------------
Total revenue 11,763,048 14,708,038 21,790,977 28,343,332
Cost of revenue
Cost of software license revenue 761,464 890,304 1,778,479 1,794,814
Cost of services and other revenue 679,501 459,197 1,552,462 1,305,654
------------ ------------ ------------ ------------
Total cost of revenue 1,440,965 1,349,501 3,330,941 3,100,468
------------ ------------ ------------ ------------
Gross profit 10,322,083 13,358,537 18,460,036 25,242,864
Operating expenses
Sales and marketing 3,790,872 4,543,803 7,338,579 8,746,132
Research and development 4,145,789 4,081,033 6,844,944 7,501,239
General and administrative 1,599,203 2,314,429 3,066,513 4,475,883
In-process research and development 1,070,000 6,270,000
------------ ------------ ------------ ------------
Total operating expenses 9,535,864 12,009,265 17,250,036 26,993,254
------------ ------------ ------------ ------------
Income (loss) from operations 786,219 1,349,272 1,210,000 (1,750,390)
Interest and other income 135,086 514,459 163,253 958,953
------------ ------------ ------------ ------------
Income (loss) before provision for income taxes 921,305 1,863,731 1,373,253 (791,437)
Provision for income taxes 377,806 1,144,154 563,214 2,212,984
------------ ------------ ------------ ------------
Net income (loss) $ 543,499 $ 719,577 $ 810,039 $ (3,004,421)
============ ============ ============ ============
Pro forma and net income (loss) per share $ 0.07 $ 0.06 $ 0.10 $ (0.28)
============ ============ ============ ============
Pro forma and weighted average common shares 7,764,970 11,340,960 7,764,970 10,791,201
============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
SIMULATION SCIENCES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
----------------------------
1996 1997
------------ ------------
(unaudited)
Cash flows from operating activities:
<S> <C> <C>
Net income (loss) $ 810,039 $ (3,004,421)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 355,747 886,118
Provision for doubtful accounts 295,582 100,000
In-process research and development 6,270,000
Change in operating assets and liabilities, net of the effect of
acquisitions:
Accounts receivable 576,716 (1,858,348)
Unbilled accounts receivable (1,183,763) (4,269,957)
Income taxes receivable 555,635
Prepaid expenses and other current assets (55,975) (87,432)
Other assets (1,263,082) (497,601)
Long-term installments receivable (2,685,816) (5,331,518)
Accounts payable (383,989) (516,451)
Accrued vacation and bonus payable (12,315) 107,647
Other accrued liabilities 698,923 (725,531)
Income taxes payable 54,846 331,902
Deferred revenue (196,309) 1,137,253
------------ ------------
Net cash used in operating activities (2,433,761) (7,458,339)
Cash flow from investing activities:
Purchases of property and equipment (1,385,713) (1,106,408)
Acquisition of certain assets (3,855,500)
------------ ------------
Net cash used in investing activities (1,385,713) (4,961,908)
Cash flow from financing activities:
Proceeds from the sale of stock under stock plans 70,223 1,027,188
------------ ------------
Net cash provided by financing activities 70,223 1,027,188
------------ ------------
Net decrease in cash and cash equivalents (3,749,251) (11,393,059)
Cash and cash equivalents at beginning of period 5,442,283 26,320,519
------------ ------------
Cash and cash equivalents at end of period $ 1,693,032 $ 14,927,460
============ ============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes $ 240,217 $ 1,582,167
============ ============
Supplemental disclosures related to acquisitions:
The Company acquired certain assets of other companies
as described in Note 4. These acquisitions are
summarized as follows:
In-process research and development $ 6,270,000
Fair value of assets acquired 360,295
Goodwill 1,165,205
Common stock issued 3,910,000
Cash paid 3,855,500
Liabilities assumed 30,000
</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 June 30, 1997, the related
consolidated statement of operations for the six month period ended June 30,
1997, the consolidated statements of operations for the three month periods
ended June 30, 1996 and 1997, and the consolidated statement of cash flows for
the six month period ended June 30, 1997 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
1996 Report on Form 10-K filed with the Securities and Exchange Commission.
Interim results are not necessarily indicative of results for a full year.
The consolidated financial statements and notes are presented as permitted
by Form 10-Q, and do not contain certain information included in the Company's
audited consolidated financial statements and notes for the year ended December
31, 1996.
2. PRO FORMA AND NET INCOME (LOSS) PER SHARE
Pro forma net income (loss) per share is computed by dividing net income
(loss) by the weighted average number 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. Net income (loss) per share is
computed as described above and includes the actual conversion of the preferred
shares into the same number of common shares upon the completion of the
Company's initial public offering in October 1996.
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.
The Financial Accounting Standards Board recently issued Statement of
Financial Accounting Standards No. 128, Earnings per Share (SFAS No. 128), which
is effective for financial statements for both interim and annual periods ending
after December 15, 1997. Early adoption is not permitted. It is not expected
that the adoption of SFAS No. 128 will have a material impact on earnings per
share for the periods presented.
3. STOCK PLANS
Stock Option Plans - The following table summarizes stock option activity
under the 1994 and 1996 Stock Option Plans for the six months ended June 30,
1997:
<TABLE>
<CAPTION>
NUMBER OF
NUMBER OF PRICE OPTIONS
SHARES PER SHARE EXERCISABLE
---------------------------------------------------
<S> <C> <C> <C>
Balance, January 1, 1997 1,464,812 $2.67-$10.38 193,137
Granted 143,000 9.88- 16.25
Exercised (121,240) 2.67- 6.30
Canceled (117,133) 2.67- 16.25
----------
Balance, June 30, 1997 1,369,439 2.67- 16.25 259,625
==========
</TABLE>
6
<PAGE> 7
SIMULATION SCIENCES INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
As of March 31, 1997, there was no activity under the 1996 Director Plan.
Employee Stock Purchase Plans - On June 30, 1997, 80,249 shares of common
stock were purchased under the Company's 1996 Employee Stock Purchase Plans at
$7.65 per share. At June 30, 1997, the Company had a liability of $619 recorded
in connection with the future purchase of common stock under the plan.
4. ACQUISITIONS
In March 1997, the Company purchased substantially all of the assets of
Visual Solutions, Inc. for $5.7 million, including acquisition costs, consisting
of $1.8 million in cash and $3.9 million in common stock of the Company. Visual
Solutions, Inc. is a privately held Texas corporation providing commercial
simulation software and related services to the process industries. The
acquisition was accounted for under the purchase method of accounting and the
purchase price was allocated to in-process research and development, goodwill,
purchased technology, accounts receivable and computer equipment. $5.2 million
of the purchase price was allocated to in-process research and development and
charged to the Company's operations.
In March 1997, the Company acquired substantially all of the assets of
Salumunek & Assoc., Inc., for approximately $950,000 in cash, including
acquisition costs. Salumunek & Assoc., Inc. is a privately held Texas
corporation providing plant performance monitoring software and related services
to the process industries. The acquisition was accounted for under the purchase
method of accounting and the purchase price was allocated to goodwill and
computer equipment.
In May 1997, the Company acquired certain technology from Bayer AG for
$1.0 million to be paid over a five year period. The acquisition was accounted
for under Statement of Financial Accounting Standards No. 68, Research and
Development Arrangements (SFAS No. 68). In accordance with SFAS No. 68, an asset
and liability have been recorded for an amount equal to the purchase price.
In June 1997, the Company acquired certain technology and assets from
Raytheon Engineers & Constructors, Inc. for $1.1 million, including transaction
costs, plus assumed liabilities of $30,000. The acquisition was accounted for
under the purchase method of accounting and the purchase price was allocated to
in-process research and development and computer equipment. $1.07 million of the
purchase price was allocated to in-process research and development and charged
to the Company's operations.
7
<PAGE> 8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Simulation Sciences Inc. is a leading provider of commercial simulation
software and related services to the petroleum, petrochemical and industrial
chemical process industries as well as the engineering and construction firms
that support those industries. The Company's Windows-based graphical user
interface and simulation software products are designed to increase
profitability by reducing capital investment costs, improving yields and
enhancing management decision making.
The Company generally licenses its software pursuant to non-cancelable, one
to five year term licenses. 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, a 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 the license of other products
and engineering services.
The Company recognizes revenue from product licensing agreements in
accordance with the 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. Furthermore, because the Company had only begun to recognize
License Revenue during the quarter ending March 31, 1996, the Company does not
believe that revenue and results of operations for the three month and six month
periods ended June 30, 1997 are directly comparable to the results for the year
earlier periods. Revenue recognition on certain service offerings is based on
percentage of completion and on attainment of project milestones.
*Denotes forward looking statement. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Factors That May Affect
Future Results of Operations."
8
<PAGE> 9
A. RESULTS OF OPERATIONS
Three Months Ended June 30, 1996 and June 30, 1997
The following table sets forth certain items in the Company's consolidated
statements of operations in thousands of dollars and as a percentage of total
revenue for the three months ended June 30, 1996 and 1997.
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
------------------------------------------------------
1996 1997
-------------------------- --------------------------
AMOUNT % AMOUNT %
-------------------------- --------------------------
(in thousands)
Revenue:
<S> <C> <C> <C> <C>
Software license revenue $ 10,695 90.9% $ 14,229 96.7%
Services and other revenue 1,068 9.1 479 3.3
-------------------------- --------------------------
Total revenue 11,763 100.0 14,708 100.0
Cost of revenue:
Cost of software license revenue 761 6.5 890 6.1
Cost of services and other revenue 680 5.8 459 3.1
-------------------------- --------------------------
Total cost of revenue 1,441 12.3 1,349 9.2
-------------------------- --------------------------
Gross profit 10,322 87.7 13,359 90.8
Operating expenses:
Sales and marketing 3,791 32.2 4,544 30.9
Research and development 4,146 35.2 4,081 27.7
General and administrative 1,599 13.6 2,314 15.7
In-process research and development 1,070 7.3
-------------------------- --------------------------
Total operating expenses 9,536 81.0 12,009 81.6
-------------------------- --------------------------
Income from operations 786 6.7 1,350 9.2
Interest and other income 135 1.1 514 3.5
-------------------------- --------------------------
Income before provision for income taxes 921 7.8 1,864 12.7
Provision for income taxes 378 3.2 1,144 7.8
-------------------------- --------------------------
Net income $ 543 4.6% $ 720 4.9%
========================== ==========================
</TABLE>
Total Revenue. Total revenue increased 25% to $14.7 million for the three
months ended June 30, 1997 from $11.8 million for the three months ended June
30, 1996. Software license revenue, which includes revenue from software
licenses, maintenance and support fees, increased 33% to $14.2 million for the
three months ended June 30, 1997 from $10.7 million for the three months ended
June 30, 1996. The increase in software license revenue was primarily
attributable to the effect of the change in contract terms, renewals of licenses
for higher fees, addition of new products and services to renewing contracts and
licenses to new customers. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Overview" for a discussion of
the change in contract terms. Services and other revenue, which includes
integration, ROM, consulting and training services, was $0.5 million and $1.1
million for the three months ended June 30, 1997 and 1996, respectively. The
decrease in services and other revenue primarily relates to a decrease in ROM
projects.
Total Cost of Revenue. Total cost of revenue decreased 6% to $1.3 million
for the three months ended June 30, 1997 from $1.4 million for the three months
ended June 30, 1996. Cost of software license revenue, which includes costs of
production and distribution, customer support and maintenance, and royalties,
increased 17% to $0.9 million from $0.8 million for the three months ended June
30, 1997 and 1996, respectively. Cost of software license revenue as a
percentage of software license revenue was 6% and 7% in the three months ended
June 30, 1997 and 1996, respectively. The increase in cost of software license
revenue in dollars is primarily attributable to the addition of personnel.
The decrease as a percentage of software license revenue is due primarily
to the increase in software license revenue. Cost of services and other
revenue, which includes costs of personnel involved in project
9
<PAGE> 10
execution and training, as well as travel, third-party professional fees and
related administrative costs, decreased 33% to $0.5 million from $0.7 million
for the three months ended June 30, 1997 and 1996, respectively. Cost of
services and other revenue as a percentage of services and other revenue
increased to 96% from 64% for the three months ended June 30, 1997 and 1996,
respectively, primarily due to the fixed nature of a portion of these costs.
Sales and Marketing. Sales and marketing expenses increased 20% to $4.5
million for the three months ended June 30, 1997 from $3.8 million for the three
months ended June 30, 1996. Sales and marketing expenses as a percentage of
total revenue were 31% and 32% for the three months ended June 30, 1997 and
1996, respectively. The increase in sales and marketing expenses in dollars was
due primarily to an increase in the number of sales and marketing professionals
and related 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 were $4.1
million for the three months ended June 30, 1997 and the three months ended June
30, 1996. Research and development expenses as a percentage of total revenue
were 28% and 35% for the three months ended June 30, 1997 and 1996,
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
45% to $2.3 million for the three months ended June 30, 1997 from $1.6 million
for the three months ended June 30, 1996. General and administrative expenses as
a percentage of total revenue were 16% and 14% in the three months ended June
30, 1997 and 1996, respectively. The increase in general and administrative
expenses in dollars was primarily due to the costs associated with being a
publicly held company, costs associated with the Company's tax reduction
program, and consulting and legal expenses. The Company anticipates that its
general and administrative expenses will increase in dollars and may fluctuate
as a percentage of total revenue in the future.*
In-process Research and Development. In-process research and development
expense of $1.1 million for the three months ended June 30, 1997 was due to the
allocation of the purchase price of technology acquired from Raytheon Engineers
& Constructors, Inc. (see "Notes to Unaudited Consolidated Financial Statements
- - Note 4").
Interest and Other Income. Interest and other income increased $379,000 to
$514,000 for the three months ended June 30, 1997 from $135,000 for the three
months ended June 30, 1996. The increase was primarily attributable to interest
income associated with the proceeds received in the Company's initial public
offering in the fourth quarter of 1996 and an increase in interest income from
the effect of the change in contract terms. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Overview."
Provision for Income Taxes. The Company's effective tax rate decreased to
39% from 41% for the three months ended June 30, 1997 and 1996, respectively,
due to the Company's implementation of a tax reduction program. The $1.1 million
in-process research and development charge was not tax deductible in the current
period.
Net Income. Net income increased to $720,000, or $0.06 per share, for the
three months ended June 30, 1997 from $543,000, or $0.07 per share, for the
three months ended June 30, 1996. Excluding the $1.1 million charge for
in-process research and development, net income for the three months ended June
30, 1997 would have been $1.8 million, or $0.16 per share.
* Denotes forward looking statement. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Factors That May Affect
Future Results of Operations."
10
<PAGE> 11
Six Months Ended June 30, 1996 and June 30, 1997
The following table sets forth certain items in the Company's consolidated
statements of operations in thousands of dollars and as a percentage of total
revenue for the six months ended June 30, 1996 and 1997.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
-------------------------------------------------------
1996 1997
-------------------------- ---------------------------
AMOUNT % AMOUNT %
-------------------------- ---------------------------
(in thousands)
Revenue:
<S> <C> <C> <C> <C>
Software license revenue $ 19,637 90.1% $ 26,926 95.0%
Services and other revenue 2,154 9.9 1,417 5.0
-------------------------- ---------------------------
Total revenue 21,791 100.0 28,343 100.0
Cost of revenue:
Cost of software license revenue 1,778 8.2 1,795 6.3
Cost of services and other revenue 1,553 7.1 1,305 4.6
-------------------------- ---------------------------
Total cost of revenue 3,331 15.3 3,100 10.9
-------------------------- ---------------------------
Gross profit 18,460 84.7 25,243 89.1
Operating expenses:
Sales and marketing 7,339 33.7 8,746 30.9
Research and development 6,845 31.4 7,501 26.5
General and administrative 3,066 14.1 4,476 15.8
In-process research and development 6,270 22.1
-------------------------- ---------------------------
Total operating expenses 17,250 79.2 26,993 95.3
-------------------------- ---------------------------
Income (loss) from operations 1,210 5.5 (1,750) (6.2)
Interest and other income 163 0.8 959 3.4
-------------------------- ---------------------------
Income (loss) before provision for income taxes 1,373 6.3 (791) (2.8)
Provision for income taxes 563 2.6 2,213 7.8
-------------------------- ---------------------------
Net income (loss) $ 810 3.7% $ (3,004) (10.6)%
========================== ===========================
</TABLE>
Total Revenue. Total revenue increased 30% to $28.3 million for the six
months ended June 30, 1997 from $21.8 million for the six months ended June 30,
1996. Software license revenue, which includes revenue from software licenses,
maintenance and support fees, increased 37% to $26.9 million for the six months
ended June 30, 1997 from $19.7 million for the six months ended June 30, 1996.
The increase in software license revenue was primarily attributable to the
effect of the change in contract terms, renewals of licenses for higher fees,
addition of new products and services to renewing contracts and licenses to new
customers. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Overview" for a discussion of the change in contract
terms. Services and other revenue, which includes integration, ROM, consulting
and training services, was $1.4 million and $2.2 million for the six months
ended June 30, 1997 and 1996, respectively. The decrease in services and other
revenue primarily relates to a decrease in ROM projects.
Total Cost of Revenue. Total cost of revenue decreased 7% to $3.1 million
for the six months ended June 30, 1997 from $3.3 million for the six months
ended June 30, 1996. Cost of software license revenue, which includes costs of
production and distribution, customer support and maintenance, and royalties,
was $1.8 million for the six months ended June 30, 1997 and 1996. Cost of
software license revenue as a percentage of software license revenue was 7% and
9% in the six months ended June 30, 1997 and 1996, respectively. The decrease as
a percentage of software license revenues is due primarily to the increase in
software license revenues. Cost of services and other revenue, which includes
costs of personnel involved in project execution and training, as well as
travel, third-party professional fees and related administrative costs,
decreased 16% to $1.3 million from $1.6 million for the six months ended June
30, 1997 and 1996, respectively. Cost of services and other revenue as a
percentage of services
11
<PAGE> 12
and other revenue increased to 92% from 72% for the six months ended June 30,
1997 and 1996, respectively, primarily due to the fixed nature of a portion of
these costs.
Sales and Marketing. Sales and marketing expenses increased 19% to $8.7
million for the six months ended June 30, 1997 from $7.3 million for the six
months ended June 30, 1996. Sales and marketing expenses as a percentage of
total revenue were 31% and 34% for the six months ended June 30, 1997 and 1996,
respectively. The increase in sales and marketing expenses in dollars was due
primarily to an increase in the number of sales and marketing professionals and
related 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 10%
to $7.5 million for the six months ended June 30, 1997 from $6.8 million for the
six months ended June 30, 1996. Research and development expenses as a
percentage of total revenue were 27% and 31% for the six months ended June 30,
1997 and 1996, respectively. The increase in research and development expenses
in dollars was primarily due to an increase in the number of technical
professionals, including support staff, and related hiring expenses and
third-party contractors involved in the development of a number of planned
upgrades and new products. 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
46% to $4.5 million for the six months ended June 30, 1997 from $3.1 million for
the six months ended June 30, 1996. General and administrative expenses as a
percentage of total revenue were 16% and 14% in the six months ended June 30,
1997 and 1996, respectively. The increase in general and administrative expenses
in dollars was primarily due to the costs associated with being a publicly held
company, costs associated with the Company's tax reduction program, and
consulting and legal expenses. The Company anticipates that its general and
administrative expenses will increase in dollars and may fluctuate as a
percentage of total revenue in the future.*
In-process Research and Development. In-process research and development
expense of $6.3 million for the six months ended June 30, 1997 was due to the
allocation of the purchase price of technology acquired from Visual Solutions,
Inc. and Raytheon Engineers & Constructors, Inc. (see "Notes to Unaudited
Consolidated Financial Statements - Note 4").
Interest and Other Income. Interest and other income increased $796,000 to
$959,000 for the six months ended June 30, 1997 from $163,000 for the six months
ended June 30, 1996. The increase was primarily attributable to interest income
associated with the proceeds received in the Company's initial public offering
in the fourth quarter of 1996 and an increase in interest income from the effect
of the change in contract terms. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Overview."
Provision for Income Taxes. The Company's effective tax rate decreased to
40% from 41% for the six months ended June 30, 1997 and 1996, respectively, due
to the Company's implementation of a tax reduction program. The $6.3 million
in-process research and development charges were not tax deductible in the
current period.
Net Income (loss). Net loss was $3.0 million, or $0.28 per share, for the
six months ended June 30, 1997 compared to net income of $810,000, or $0.10 per
share, for the six months ended June 30, 1996. Excluding the $6.3 million in
charges for in-process research and development, net income for the six months
ended June 30, 1997 would have been $3.3 million, or $0.29 per share.
* Denotes forward looking statement. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Factors That May Affect
Future Results of Operations."
12
<PAGE> 13
LIQUIDITY AND CAPITAL RESOURCES
During the past three years, the Company has satisfied its cash needs
principally through cash generated from operations, if any, existing cash
resources and net proceeds from the Company's initial public offering in October
1996. Cash used in operating activities for the six months ended June 30, 1997
was $7.5 million, which was primarily attributable to increases in long-term
installments receivable, unbilled accounts receivable and accounts receivable,
partially offset by income (excluding the $6.3 million in-process research and
development charge) and an increase in deferred revenue.
Cash used in investing activities during the six months ended June 30, 1997
was $5.0 million, which was primarily attributable to the acquisition of certain
assets of Visual Solutions, Inc., Raytheon Engineers and Constructors, Inc. and
Salumunek & Assoc., Inc. (see "Notes to Unaudited Consolidated Financial
Statements - Note 4") and the purchase of property and equipment.
Cash provided by financing activities of $1.0 million for the six months
ended June 30, 1997 was due to the purchase of shares of the Company's common
stock in connection with stock plans.
Available sources of funds at June 30, 1997 consisted of $14.9 million in
cash and cash equivalents and a $2.7 million revolving line of credit, net of
$0.3 million in outstanding letters of credit, with a commercial bank. The
revolving line of credit provides for an unsecured line of credit up to $3.0
million at the bank's prime rate, contains certain financial and other
covenants, and expires March 31, 1999.
The Company believes that existing cash resources, cash flow from
operations, if any, together with the line of credit, will be sufficient to fund
the Company's operations during the next 12 months.*
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
Sentences denoted by an asterisk (*) in this Report 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.
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.
Fluctuations in Future Operating Results. 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; the timing and structure of future acquisitions, if any;
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 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.*
* Denotes forward looking statement. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Factors That May Affect
Future Results of Operations."
13
<PAGE> 14
The Company's services revenue is 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.
Product Concentration. 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.*
Concentration of Revenue in the Petroleum Industry. 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. In addition,
companies in the petroleum industry are experiencing growing pressures to
consolidate in response to the increasing need to reduce costs to remain
competitive. There can be no assurance that consolidation in the petroleum
industry will not result in a loss of revenue or will not have a material
adverse effect on the Company's business, operating results or financial
condition.
Dependence on Contract Renewals. 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.
Need to Achieve Greater Market Penetration. The success of the Company's
strategy is dependent upon increased market acceptance of commercial simulation
software in general, and of the Company's software products and services in
particular, in the process industries. In recent periods, the Company has
increased sales and marketing expenditures and expects to continue to increase
such expenditures in future periods in an effort to achieve greater market
penetration in the process industries.* If the Company fails to increase market
acceptance of its products, or if the Company's sales and marketing efforts do
not result in a corresponding increase in total revenue through greater market
penetration, the Company's operating margins and opportunity for future growth
would be substantially restricted and therefore could have a material adverse
effect on the Company's business, operating results and financial condition.
Competition. 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.
* Denotes forward looking statement. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Factors That May Affect
Future Results of Operations."
14
<PAGE> 15
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. and Chemstations, Inc., and, with respect
to the Company's technology and consulting services, the Hi-Spec division of
Honeywell, Inc., the Advanced Control and Optimization Division 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.
Past and Future Acquisitions. The Company in recent periods has concluded a
number of asset purchases and/or license transactions. Although the Company does
not anticipate that the integration of the acquired or licensed assets will
adversely affect its operating results, such integration will involve the
assimilation of conflicting operations and products, which will divert the
attention of the Company's management team and may have a material adverse
effect on the Company's operating results in future quarters. The Company may
make additional acquisitions in the future, although there can be no assurance
that suitable companies, divisions or products will be available for
acquisition.* Such acquisitions entail numerous risks, including an inability to
successfully assimilate acquired operations and products, diversion of
management's attention, difficulties and uncertainties in transitioning the
business relationships from the acquired entity to the Company and loss of key
employees of acquired companies. In addition, future acquisitions by the Company
may result in dilutive issuances of equity securities, the incurrence of debt,
large one-time expenses, and the creation of goodwill or other intangible assets
that could result in significant amortization expense. Any one or more of these
factors could have a material adverse effect on the Company's business,
operating results and financial condition.
Risks Associated with International Operations. 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.
Dependence on Strategic Relationships. 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 number of strategic
alliances with respect to its core products, new products and product
enhancements, including a development arrangement with Mobil Oil Corporation
with respect to NETOPT; a joint development arrangement with Shell Oil Company
with respect to ROMeo; and a development and marketing agreement with IFP, ELF
and TOTAL with respect to PIPEPHASE-TACITE. The Company also has entered into
cooperation agreements with Fluor Daniel, IBM and SAP AG. 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.
* Denotes forward looking statement. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Factors That May Affect
Future Results of Operations."
15
<PAGE> 16
Dependence Upon Product Development; Rapid Technological Change. The
software market in which the Company competes is subject to rapid technological
change, frequent introductions of new products, changes in customer demand and
evolving industry standards which can render existing products obsolete and
unmarketable. There can be no assurance that the Company will be successful in
developing and marketing enhancements to existing products or new products 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 new products, or that such enhancements or new products will
adequately meet the requirements of the marketplace and achieve market
acceptance, and the failure to do so would have a material adverse effect on the
Company's business, operating results and financial condition.
Potential for Software Defects. 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.
Management of Growth. 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.*
Dependence on Key Personnel. 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.*
Limited Protection of Proprietary Rights. The Company relies upon a
combination of copyright, trade secret and trademark laws to protect its
proprietary technology. The Company enters into confidentiality agreements with
its employees, developers, distributors and customers and limits access to and
distribution of the source code to its software and other proprietary
information. However, policing unauthorized use of the Company's products is
difficult. There can be no assurance that the steps taken by the Company in this
regard will be adequate to prevent misappropriation of its technology.
Certain technology used in the Company's current products and products
under development, including NETOPT, PROTISS, PIPEPHASE-TACITE and ROMeo, is
licensed from third parties. These licenses generally require the Company to pay
royalties and to fulfill confidentiality obligations. The termination of any
such licenses, or the failure of the third party licensors to adequately
maintain or update their products, could result in a material adverse effect on
the Company's business, operating results and financial condition by delaying
the Company's ability to ship products.*
From time to time third parties may assert patent, trademark, copyright and
other intellectual property rights to technologies that are important to the
Company. In such an event, the Company may be required to incur significant
costs in litigating a resolution to the asserted claims.* There can be no
assurance that such a resolution would not require that the Company pay damages
or obtain a license of a third party's proprietary rights.
* Denotes forward looking statement. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Factors That May Affect
Future Results of Operations."
16
<PAGE> 17
Dependence on Contract Developers. The Company currently subcontracts
certain aspects of its research and development to outside contractors. There
can be no assurance that the Company will be able to manage its contract
developers effectively or that these developers will meet the Company's future
requirements for timely delivery of high-quality products.
Product Liability. The Company's license agreements with its customers
typically contain provisions designed to limit the Company's exposure to
potential product liability claims. It is possible, however, that the limitation
of liability provisions contained in the Company's license agreements may not be
effective as a result of existing or future federal, state or local laws or
ordinances or unfavorable judicial decisions. Although the Company has not
experienced any product liability claims to date, the sale and support of its
simulation and optimization software may entail the risk of such claims.* A
successful product liability claim brought against the Company in excess of its
insurance coverage or outside the scope of such coverage could have a material
adverse effect upon the Company's business, operating results and financial
condition.
* Denotes forward looking statement. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Factors That May Affect
Future Results of Operations."
17
<PAGE> 18
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company held an Annual Meeting of Stockholders on April 22, 1997. At the
Annual Meeting, the following votes were cast for the proposals indicated:
Proposal One: Election of Directors of the Company
<TABLE>
<CAPTION>
NAME OF NOMINEE VOTES FOR VOTES WITHHELD
--------------- --------- --------------
<S> <C> <C>
Dr. Narendra K. Gupta 8,017,140 180,208
Charles R. Harris 8,130,262 67,086
Walter G. Kortschak 8,017,140 180,208
</TABLE>
<TABLE>
<CAPTION>
VOTES FOR VOTES AGAINST ABSTAINING
-------- ------------ ----------
<S> <C> <C> <C>
Proposal Two: Ratification of
Appointment of Deloitte & Touche LLP
as the Company's Independent Public 8,025,524 92,201 79,623
Accountants
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) A report on Form 8-K was filed on April 10, 1997 in connection
with the acquisition of substantially all of the assets of
Visual Solutions, Inc.
18
<PAGE> 19
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: August 11, 1997 /s/ CHARLES R. HARRIS
---------------------------------------
Charles R. Harris
President and Chief Executive Officer
Date: August 11, 1997 /s/ L. RONALD TREPP
--------------------------------------
L. Ronald Trepp
Vice President of Finance and Chief
Financial Officer
(Principal Financial and Accounting Officer)
19
<PAGE> 20
EXHIBIT INDEX
Exhibit
No. Description
------- -----------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 14,927,460
<SECURITIES> 0
<RECEIVABLES> 19,623,594
<ALLOWANCES> 821,127
<INVENTORY> 0
<CURRENT-ASSETS> 37,126,554
<PP&E> 11,176,881
<DEPRECIATION> 6,771,276
<TOTAL-ASSETS> 56,495,364
<CURRENT-LIABILITIES> 14,743,392
<BONDS> 0
0
0
<COMMON> 10,853
<OTHER-SE> 40,741,119
<TOTAL-LIABILITY-AND-EQUITY> 56,495,364
<SALES> 0
<TOTAL-REVENUES> 28,343,332
<CGS> 0
<TOTAL-COSTS> 3,100,468
<OTHER-EXPENSES> 26,893,254
<LOSS-PROVISION> 100,000
<INTEREST-EXPENSE> (958,953)
<INCOME-PRETAX> (791,437)
<INCOME-TAX> 2,212,984
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,004,421)
<EPS-PRIMARY> (0.28)
<EPS-DILUTED> 0
</TABLE>
