ITEM 1. BUSINESS
We develop, sell and support simulation software and services that vehicle manufacturers use to enhance the performance of their products, reduce product development costs and improve the efficiency of their design and engineering processes. Our solutions enable engineers and designers to augment or replace conventional methods of evaluating design alternatives that rely on expensive and inefficient physical prototypes and test facilities, such as wind tunnels, with accurate digital simulations that are more useful and timely. Our simulation solutions enable our customers to gain crucial insights about design performance early in the design cycle, reducing the likelihood of expensive redesigns and late-stage engineering changes. As a result, our customers realize significant cost savings and fundamental improvements in their vehicle development process.
Simulation-driven design has enabled product and process improvements in many industries, and as a result, the process in which products are conceptualized and developed is undergoing a radical transformation. Digital simulation not only provides feedback earlier and in a more useful form than traditional approaches, but in many areas simulation has reached a level of accuracy and robustness that is sufficient to enable a manufacturer to rely solely on its results for design decisions, without prototype testing.
Global vehicle manufacturers face increasing pressure, from government mandates as well as from consumers, to improve the efficiency of their products and to reduce particulate and greenhouse gas emissions. This requires different powertrain choices (diesel, electric, hybrid), changes in the shape of the vehicle, and reductions in vehicle weight. Consumers also demand improved quality and durability, and equally important, innovative and emotionally expressive designs. In addition, manufacturers are offering a broader array of vehicles for different niche customer segments and geographies on a faster design refresh schedule than in the past. We believe these industry forces favor the adoption of simulation-driven design.
One of the most critical challenges for our customers in their vehicle development processes is measuring or predicting how a vehicle feature or a mechanical system will interact with air, water or other fluids. For example, developing vehicles with reduced aerodynamic drag is critical to achieving the improvements in fuel efficiency that are increasingly desired by customers and mandated by government regulations. Our core product, PowerFLOW, is an innovative software solution for simulating complex fluid flow problems, including aerodynamics, thermal management, and aeroacoustics, or wind noise. PowerFLOW relies upon proprietary technology that enables it to predict complex fluid flows with a level of reliability comparable to or better than physical testing. The combination of PowerFLOW’s accuracy and timeliness provides results that are superior to those of alternative computational fluid dynamics, or CFD, methods.
We currently focus primarily on the ground transportation market, including manufacturers in the passenger vehicle, highway truck, off-highway vehicle and train markets, as well as their suppliers. Over 125 manufacturers currently utilize our products and services, including 14 of the global top 15 passenger vehicle manufacturer groups such as BMW, Ford, Hyundai, Jaguar Land Rover, Nissan, Porsche, Renault, Toyota and Volkswagen; truck and off-highway vehicle manufacturers such as Hyundai, Kenworth, Kobelco, MAN, Peterbilt, Scania and Volvo Truck; and suppliers to these manufacturers, such as Cummins, Denso and Magna Steyr. We are also beginning to explore other markets in which we believe the capabilities of PowerFLOW have broad application, such as the aerospace, oil and gas production, chemical processing, architecture, engineering and construction, power generation, biomedical and electronics industries.
We derive our revenue primarily from the sale of our simulation software, using an annual capacity-based licensing model. Customers usually purchase PowerFLOW simulation capacity under one-year licenses. Simulation capacity may be purchased as software-only, to be run on the customer’s own computer hardware, or provided in the form of software-as-a-service, via our hosted PowerFLOW OnDemand offering. To introduce new customers to our simulation solutions, we typically perform fixed-price projects that include simulation services accessed via our OnDemand facilities, along with engineering and consulting services. Customers typically license our products for one application, such as aerodynamics, and over time expand to other applications such as thermal management or aeroacoustics.
We sell our products and project services primarily through our direct sales force, including sales executives and applications engineering teams deployed near our customers in the United States, United Kingdom, France, Germany, Italy, Japan, Korea and China. We also conduct business in Sweden, India, Brazil, Russia, Canada, Finland, Spain and Australia. In our customer engagement model, our applications management teams engage with our customers in long-term relationships focused on identifying problems that we can help them solve, demonstrating the value of our solutions and ensuring that the customer achieves maximum benefit from them. In this process we interact continuously with our customers to improve our software and services and add new solutions, and at the same time deepen our knowledge of their industry.
We were founded in 1991 and had 257 employees worldwide at January 31, 2014. Our corporate headquarters, including our principal administrative, marketing, technical support, research and product development facilities, are located in Burlington, Massachusetts. Our website is www.exa.com, and we make available through the investor relations section of this site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission, or the SEC. We also make our code of ethics and certain other governance documents and policies available through our website. We intend to make required disclosures of amendments to our code of ethics, or waivers of a provision of our code of ethics, on the “Corporate Governance” page of our website’s investor center.
Our Industry
Manufacturers’ requirements
A wide range of industries such as ground transportation, aerospace, power generation, chemical and industrial processing, architecture, electronics and biomedicine face increasing and often conflicting demands to:
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meet customer and regulatory requirements for improved efficiency in areas such as fuel economy and reduced environmental impact;
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meet customer desires for innovative product designs;
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optimize products for quality, performance and safety;
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accelerate product development cycles and time-to-market; and
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reduce product development, material and warranty costs.
All of these activities are significantly influenced by rising consumer expectations for more efficient and environmentally sensitive products, and by government regulatory activity that is pervasive in many industries. For example, the product strategies of automobile manufacturers have for years been shaped by their need to comply with an array of regulatory requirements, including mandatory corporate average fuel economy, or CAFE, standards. The United States passenger car and light truck CAFE standard continues to rise, from 27.3 miles per gallon, or MPG, in 2011 to 35.5 MPG in 2016 and to a proposed 56.2 MPG by 2025, requiring a doubling of fuel economy performance over the next 11 years. Similar mandates relating to particulate and CO2 emissions apply in other segments of the transportation industry. For manufacturers of transportation systems, achieving these goals requires major improvements in aerodynamics, weight, and propulsion systems of their products. Our customers need to attain these goals while continuing to meet customer demands for aesthetically pleasing and innovative product designs.
These goals often conflict, requiring manufacturers to make careful trade-offs of competing values. Thus, the automotive designer’s task is not to create the most attractive, or fastest, or quietest, or most fuel-efficient car, but rather a car that satisfies sufficiently the design preferences and functional and quality expectations of its target customer, offers fuel efficiency within a desired target range, and can be brought to market on time at an acceptable profit. This need to optimize the balance of industrial design, performance factors, cost and process efficiencies is a continual challenge for the ground transportation industry and many other industries, as they seek to develop new and innovative products.
The Vehicle Development Process
Vehicle development is a complex, multi-disciplinary process. The trend toward shorter model lives and increased model proliferation has led to increasing numbers of new vehicle design programs being launched simultaneously. This trend has been compounded by the global demand for more efficient and lower emission modes of transportation. These combined global trends are forcing radical changes in the vehicle development process.
The new vehicle development process consists of three primary phases: design, engineering and manufacturing. In each of these phases, the ability to predict or verify how a new design will behave under real world conditions is a critical factor in the manufacturer’s efforts to improve the design, performance and profitability of the new vehicle.
Design. In this stage, designers in the studio develop the design of a new vehicle. They begin the process of bringing an innovative new vehicle to life within a set of packaging, powertrain, fuel efficiency and other attributes that must be met. However, in the past a large part of this up front design work has been completed without knowing how the design will actually perform on target attributes such as aerodynamic drag, weight, handling, noise and ability to manage heat, as it is cost and time prohibitive to build and test physical prototypes for every new concept that is conceived. As a consequence, required performance attributes are either ignored or
are attempted to be met via conservatism (for example, ensuring airflow is sufficient for engine cooling by making the front grille larger than necessary). For decades, physical systems such as clay models and wind tunnels have been the primary predictive tool used in the design and development process. As a result, our customers spend a significant portion of their research and development budgets, which we estimate (based upon our analysis of publicly available industry data and information provided to us by our customers) to be as much as 10% to 15%, or over $6 billion per year, on physical prototypes, test facilities and related travel and staff costs. These physical experimental methods are not only expensive and inefficient, but also limited in their ability to provide accurate predictive information early in the design process, when such information is most valuable. Physical prototypes often lack features necessary to predict key attributes of vehicle performance: for example, thermal management and acoustic characteristics cannot be tested on a clay model that has no engine or interior. As changes to the design occur, time consuming construction of new prototypes may be necessary to test each variation, adding cost and slowing the process.
Engineering. This is the longest phase of the development process, where all of the details and functionality of the vehicle are developed, achieved and verified in order to ensure that the product design can be realized within the specified constraints. Each new vehicle design needs to be evaluated across numerous performance attributes involving many engineering disciplines, including aerodynamics, powertrain, thermal management, climate control and aeroacoustics. In this stage, experimental testing of full scale functional prototypes in wind tunnels, climate chambers and test tracks is used extensively to verify that the vehicle will meet required parameters for performance and quality. Physical testing of this type is expensive and cumbersome and also occurs late in the development process, when design changes are more difficult and expensive to implement. For example, track testing can only be performed near the end of the development process when working pre-production prototypes become available, and even then its accuracy can be affected by prototype quality, variable environmental conditions and the difficulty of measuring multiple performance attributes on a moving vehicle.
As a result of these intrinsic limitations of physical experimentation as a method of verification, performance deficiencies such as a component that overheats, or a side mirror that produces excessive wind noise, may not be discovered until late in the vehicle development process. At this point, a problem that could have been detected earlier may require corrective changes that add cost and weight to the vehicle, compromising program performance goals and profitability.
Manufacturing. At multiple points throughout each phase of the vehicle development process, key attributes of the new vehicle design must be certified as meeting the manufacturer’s program requirements, in a process known as signoff, before the design can be released to the next stage in the process. Achieving each of these signoffs is a key milestone in the vehicle development process. For example, one of the largest costs associated with designing and engineering a new car, truck or machine is that of the tooling for the manufacturing process. The large stamping presses used to create many of the body components and sheet metal can each cost tens to hundreds of millions of dollars and the lead times in this process are long, requiring the design of a new vehicle to be “released to tooling” more than a year before production can commence.
Design verification using physical experimentation has been the principal method of obtaining these signoffs. However, testing of a limited number of functional prototypes may not identify all potential performance problems. Manufacturing variability can cause significant performance differences. Gaps of even a few millimeters due to variations in the manufacturing process or surface changes due to oxidization of high temperature components can materially alter the vehicle’s acoustic or thermal performance. The inability to predict and account for such effects earlier in the development process, before the final design is released to tooling, can lead to quality and reliability issues and higher warranty costs.
Emergence of simulation-driven design technologies
In recent years, computer-aided technology has played an increasingly important role in the product development process. Digital modeling and simulation in particular have emerged as enabling technologies to aid in the design, analysis, and manufacture of products. Digital simulation-driven design is not only cheaper and
faster in providing feedback than experimental approaches such as the construction of prototypes or wind tunnel testing, but in many industries it is now approaching a level of accuracy and robustness that is sufficient to utilize its predictions for design decisions.
A number of technology factors are facilitating the emergence of simulation-driven design:
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increasing adoption of computer-aided design, or CAD, and product lifecycle management, or PLM, software by manufacturers and their suppliers;
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continually decreasing cost of computing power, transforming computing power from a scarce resource that is conserved to one that is inexpensive and readily available; and
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increasingly powerful tools for visualization and computer generated imaging: the ability to see eases the ability to understand and communicate-key attributes in a very complex design process with many interdependent silos.
Challenges of fluid dynamics simulation
In the ground transportation industry, as in many other industries, a critical element in optimizing product design is predicting how a vehicle feature or a mechanical subsystem will interact with air, water or other fluids. Fluid dynamics modeling is extremely challenging due to the complexity of the physics necessary to accurately predict the behavior of fluid flows, particularly when complex, non-linear phenomena such as turbulence are involved. As a result, for many years the only available means of addressing fluids engineering challenges have been addressed by physical experimentation or design conservatism, based on what was known to work in the past. Both of these approaches limit innovation in the product or process development activities, because they provide limited information and knowledge of how systems perform and, more importantly, little or no insight into how to improve them.
Software-based simulation tools using computational fluid dynamics, or CFD, methods have been commercially available for over 40 years. In this approach, numerical methods are utilized to provide approximate solutions to the Navier-Stokes equations, which statistically describe the behavior of a fluid in motion. The limitations of this approach are not with the Navier-Stokes equations but with the numerical techniques utilized to find approximate solutions to them for industrial problems. Most existing fluid dynamics solutions are limited in their ability to analyze highly complex geometries and predict the flow at a high level of accuracy within practical time frames.
Our Solution
We provide a powerful, innovative software solution for simulating complex fluid flow problems. Customers use our PowerFLOW simulation solutions to enhance the performance of their products, reduce product development costs and improve the efficiency of their product development processes. Our technology and products are catalyzing a disruptive change in how our customers design, engineer and optimize their products. Simulation-driven design enabled by PowerFLOW makes predictive information available earlier in the design process, permitting deeper exploration of the design space, with iterative simulations providing insight into how new concepts can improve the design.
Our products enable engineers and designers to replace conventional methods of verifying design behavior that rely on expensive physical prototypes and test facilities with accurate digital simulation-driven design and engineering processes that are more useful, more timely and less expensive. This enables our customers to gain crucial insights about the performance of alternative design approaches early in the product development cycle, improving the efficiency of the design and engineering process and reducing the likelihood of expensive redesigns or engineering fixes to remedy problems that might otherwise only be discovered late in the product development program.
In each phase of the vehicle development process, PowerFLOW simulations can be utilized to improve the product in its performance attributes, development costs, product costs, manufacturing costs, and warranty and other product lifecycle costs.
For example:
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Aerodynamics: Reducing aerodynamic drag is a core focus for every transportation system. Aerodynamic drag can be responsible for over half of the fuel consumption of a vehicle at high speeds. Our solutions allow our customers to rapidly explore the design space, visualizing the impact of design modifications in real time, to find opportunities to reduce drag while maintaining their styling themes.
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Heat Transfer: Braking systems have stringent heat dissipation requirements, as temperature affects braking effectiveness. Manufacturers have historically used physical mock-ups of the wheel and braking system to evaluate braking performance and cool down time. Because these test rigs do not include the full car they cannot reproduce the effect of air flow from the vehicle body and chassis that surround the braking system. Thus, actual performance is discovered only when functional prototypes become available. With PowerFLOW, full thermal braking simulations can be performed early in the design cycle, based on the proposed geometry of the entire vehicle.
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Acoustics: PowerFLOW can accurately predict the air-driven turbulent fluctuations that agitate the glass panel on a vehicle’s front passenger door and produce wind noise, an indicator of quality and comfort that vehicle manufacturers work extremely hard to reduce. Our PowerACOUSTICS module enables engineers to model the transmission of these noise sources through the door and glass structures to predict the noise in the interior of the vehicle. Historically, our customers could evaluate interior wind noise only by wind tunnel testing, which was possible only when functional prototypes became available late in the development process. PowerFLOW’s ability to predict interior noise early in the product development workflow enables acoustic engineers to analyze and address wind noise issues early in the development process, when small but critical design changes can more easily be made.
Our simulation solutions can also enhance the efficiency and reduce the cost of our customers’ design and engineering processes as reliance on physical test procedures is reduced or eliminated. Our proprietary Digital Physics approach enables accurate complex fluid dynamics modeling to be performed within dramatically shorter time frames than are available through physical experimentation, and typically at much lower cost. As a result, our applications can augment or even replace expensive and time consuming model making and wind tunnel testing.
Our integrated suite of aerodynamic, thermal management and aeroacoustics simulation capabilities provides a single solution for critical fluid dynamics problems, and our interactive visualization capabilities enable rapid iteration of design modifications and simulations. Our case preparation tools and user interface shorten set-up time, and reduce the need for personnel with extensive CAD expertise. Our product architecture and user interface facilitate sharing of data and collaboration across departments, design teams and engineers. Our OnDemand delivery model and suite of professional project services simplify deployment and reduce cost of ownership, and our capacity-based pricing model allows customers to purchase our simulation services in a cost-effective manner, to be used when they need them.
By adding functionality that addresses phenomena such as thermal radiation or acoustic transmission, we have been able to provide our customers with solutions that extend beyond our initial fluid dynamics focus. As we continue to add new applications solutions to broaden the range of simulation problems that PowerFLOW can address, adoption of our technology has spread from the automotive market that was our initial focus to other segments of the ground transportation industry. For example, the addition of thermal management capability to our product in fiscal year 2008 enabled us to offer simulation solutions to the truck and off-highway equipment markets, in which thermal management is a significant challenge. In fiscal year 2014, these market segments accounted for approximately 16% of our total revenue.
We provide solutions to some of the most difficult simulation problems that are faced by our customers. Relying upon deep knowledge of our vertical market, our applications management teams work with design and engineering groups in various disciplines within our customers’ organizations to identify their needs, to develop solutions using our technology to meet their specific requirements, and to assist the customer in validating and implementing these solutions. We leverage the key attributes of our proprietary technology and more than 20 years of industry experience to provide answers that previously have been unattainable through traditional physical testing or existing CFD methods.
As our customers have recognized the predictive accuracy of our simulation solutions, they are beginning to adopt verification of design behavior by means of PowerFLOW simulation as an alternative to physical experimentation as a basis for critical design signoffs. Similar approaches are now being utilized by regulatory agencies. For example, greenhouse gas regulations issued by the United States Environmental Protection Agency and National Highway Traffic Safety Administration for medium and heavy-duty vehicles permit aerodynamic drag (a key value used to determine compliance with CO2 emission standards) to be certified by means of fluid dynamics simulation.
The result is a significant increase in the usefulness and cost-effectiveness of simulation. The use of PowerFLOW can accelerate design cycles, enhance innovation and provide flexibility to experiment with designs that might otherwise be thought too costly, reducing research and development and manufacturing costs and improving product reliability and quality. We believe that our proprietary solution has the potential to transform the product development process not only in our current target market but in other markets that face similar problems, including the aerospace, oil and gas production, chemical processing, architecture, engineering and construction, power generation, biomedical and electronics industries.
Our Business Strengths
We believe that the following key business strengths will assist us in taking advantage of the opportunities we are pursuing:
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Customer engagement model. Delivering value to our customers and ensuring their success is at the core of our business philosophy. Our dedicated field and applications management teams engage with our customers in long-term relationships focused on identifying problems we can help them solve, demonstrating the value of our solutions and ensuring that the customer achieves maximum benefit from them. In this process we interact continuously with our customers to improve our software and services and add new solutions, and at the same time deepen our knowledge of the industry. Our customer-centric focus, significant domain expertise and integrated accurate solutions have led to the establishment of stable and growing customer relationships. In addition, our close cooperation and communication with our customers provides us with invaluable information concerning the accuracy, usefulness and cost-effectiveness of our products.
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Solutions focus and deep domain expertise. Our customers value our core intellectual property and technology, but they equally value our focus on surrounding that technology with know-how and best practices that enable them to solve their engineering and design problems. In order to deliver upon our solutions-oriented approach, we have built a strong applications management team that understands our customers’ problems and translates this understanding into product development roadmaps and deployment best practices.
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Expertise in our targeted vertical market. A natural outcome of our solutions focus is our vertical industry focus. We have concentrated initially on the ground transportation market, where management of aerodynamic drag and related fuel efficiency, heat transfer and aerodynamic noise are critical problems in product design. This focus has enabled us to deliver solutions that are based on a deep understanding of our customers’ fluid flow simulation problems and provide highly differentiated solutions that are difficult or impossible for our competitors to replicate. It has also enabled us to focus our sales and marketing efforts on a large market that we believe remains significantly underpenetrated.
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Predictable business model. Our revenue is derived primarily from the sale of access to our simulation software, under annual capacity-based licenses for which we typically invoice our customers at the beginning of the license term. The principal driver of our revenue growth is customers’ increased consumption of simulation capacity, as our solutions penetrate more deeply and widely across their organizations. The recurring nature of our revenues, as customers annually renew or increase their simulation capacity, provides high visibility into future performance. On average over the last three fiscal years, more than 61% of our annual revenue was attributable to contractual commitments that were in place at the beginning of the fiscal year.
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Proprietary and protected intellectual property. Our core and layered technologies, including our Digital Physics approach, are protected by patent coverage and non-disclosed trade secrets which provide a strong competitive advantage over alternative solutions. Our senior scientific and engineering leadership, some of whom have been with Exa since its founding, pioneered our proprietary approach to fluid dynamics simulation and have developed extensive know-how relating both to the fundamental underlying physics as well as its application to the specific problems our customers face.
Our Growth Strategy
Our goal is to become the global leader in digital simulation solutions in the target markets we serve. Our strategies to achieve this objective include:
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Deepen deployment in our existing customer base. We remain underpenetrated at our existing customers and see significant growth potential as they migrate their product development processes based on physical test and prototypes to digital-based approaches. Once our PowerFLOW technology has been adopted in one area of a customer’s organization, we seek opportunities to expand to other disciplines and departments. Our core technology and product architecture, which use the same geometric model for aerodynamic, thermal management and aeroacoustic analysis, along with our intuitive user interface and case preparation tools, ease deployment and facilitate sharing of data and collaboration across departments.
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Add new customers in the ground transportation market. We believe that the addressable market in ground transportation is significantly underpenetrated and there continue to be favorable regulatory and market dynamics pushing the industry to improve fuel efficiency and emissions and enhance the performance and quality of its products. Hundreds of passenger car, highway truck and off-highway vehicle manufacturers and their suppliers worldwide represent potential new customers for us. We intend to continue to add sales personnel to capture this opportunity.
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Enable additional applications and solutions. We will continue to expand the applications we offer so that our customers can meet an expanded set of needs through simulation-driven design. Our applications management teams will identify new applications for which our customers need solutions, and develop product requirements, validation data, best practices and deployment assistance for our customers, with the outcome of broadening the use of our simulation services and increased consumption of simulation capacity. Expanded applications will lead to increased demand as different applications require unique simulations due to evaluating the vehicle under different operating conditions or configurations.
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Penetrate new geographies. We have a strong presence in North America, Europe and Japan and Korea. Ground transportation customers in Brazil, India and China are rapidly maturing their design and engineering capabilities as they work to become global competitors. We have been working to expand our presence and business in these geographies, and will continue to do so.
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Explore new vertical markets. We believe that our solution has the potential to transform the design process not only in our current target market but in other markets that face similar problems, including the aerospace, oil and gas production, chemical processing, architecture, engineering and construction, power generation, biomedical and electronics industries. Our core technology is extendable to
applications beyond those required in the ground transportation market. For example, we have developed a prototype simulation capability for multi-phase fluid flows, such as air-water mixtures, that we believe would be of value to the oil and gas, chemical and power generation markets.
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Selectively pursue strategic acquisitions. There are many fragmented and complementary software products and technologies that would enable us to expand our product and solutions offering, increase the value delivered to our customers, and expand our customer base. We will selectively pursue opportunities to acquire complementary business, products or technologies.
Our Products and Applications
We provide our solutions through our core product, PowerFLOW and a suite of related software products. We surround that technology with more than 20 years of technical know-how and vertical industry expertise, which we employ to deliver applications tailored specifically to the requirements of the ground transportation market. In cooperation with our customers, we also generate validation data to substantiate the accuracy of the resulting PowerFLOW simulations in comparison to physical test results and identify best practices for implementation that enable customers to solve with confidence their engineering and design problems.
Our solution focus starts with our powerful and patented fluids simulation technology. Combining our inherently transient simulation engine with a single detailed geometric model allows the software to connect with other physics algorithms to address the requirements of many engineering disciplines. The same geometric model can be used for aerodynamic, aeroacoustic and thermal simulations, saving engineering time and expense and allowing for cross-disciplinary studies.
The simulation process occurs in three stages: simulation preparation, the simulation itself and analysis of the simulation results. In the simulation preparation stage, our software tools are used to prepare a digital geometric model, often based on CAD design data, for use in our PowerFLOW simulation engine. The user then selects the environmental and operating conditions, such as highway speed with a cross wind or slow towing hill climb, under which to evaluate the digital model. The simulation stage involves the use of our PowerFLOW simulation engine to model complex fluid flows and other phenomena as they relate to the digital model and test conditions prepared in the simulation preparation. Lastly, simulation analysis involves the use of visualization and other tools to gain insights into the data generated by the simulation step. These results can be used to further refine the digital model for use in later iterations of the simulation step. In the analysis phase, we offer sophisticated optimization algorithms that assist in searching within specified constraints for improved designs, something that is not possible in physical test environments.
The complete PowerFLOW software suite includes the simulation engine and grid generation engine (also called the discretizer), along with complementary pre- and post-processing software products. The software is delivered in a client/server architecture in which the computationally intensive discretization and simulation processes generally run on a centralized multi-processor simulation server, while the front-end applications for simulation preparation and back-end applications for post-processing analysis run on desktop clients that interact with the central server.
The main driver of our revenue is customers’ usage of simulation hours on the simulation server, to which we provide access under capacity-based term licenses. Customers usually purchase PowerFLOW simulation capacity under one-year licenses that provide the customer either with dedicated access to a specified number of processor cores throughout the contract year or with a block of “simulation hours” that may be used at any time but expire if not used by the end of the contract year. We separately license the client software that interfaces with our PowerFLOW simulation server for a fixed annual fee, based on the number of concurrent users.
Our products
Our product suite includes the following principal offerings:
Simulation preparation
Key Features
The desktop-based simulation preparation products described below enable users to quickly and easily import complex geometric models and incorporate them into a PowerFLOW simulation case and to manipulate and modify these digital models, and evaluate potential design improvements.
PowerDELTA with PowerCLAY
Streamlines and automates the simulation model preparation process by applying proven concepts of parametric feature modeling and history tree model management to the process of simulation model creation and update. PowerDELTA now includes PowerCLAY morphing technology that allows users to perform real-time, studio-quality morphing of models for easy design optimization. Design data in most major CAD and mesh formats are supported-even at varying levels of quality.
PowerCASE
Efficiently creates, edits, and compiles a complete PowerFLOW simulation case. The compiled case file controls the construction of the simulation grid produced by the discretizer (PowerFLOW’s grid generator), which in turn drives the actual simulation.
Simulation Server
Key Features
The server-based simulation products described below form the core of our PowerFLOW suite. These products utilize our proprietary Digital Physics technology to accurately model complex fluid flows and other phenomena.
PowerFLOW
Our core product, which incorporates all of our proprietary Digital Physics technology, efficiently and accurately simulates fluid dynamics, even on models with extreme geometric complexity.
PowerTHERM
Couples with PowerFLOW to accurately predict surface temperatures and heat fluxes generated by thermal radiation and conduction.
PowerCOOL
Couples with PowerFLOW to accurately calculate the heat transfer between a heat exchanger and the cooling airflow while seamlessly integrating into the PowerFLOW work flow.
Simulation Analysis
Key Features
The desktop-based simulation analysis products described below allow users to efficiently visualize and evaluate the simulation data generated by PowerFLOW. Using this information and our simulation preparation tools, users can quickly and easily refine their design and prepare a new simulation case for additional testing.
PowerINSIGHT
A graphical user interface that offers a library of user configurable templates and generates comparative results, allowing users to interactively browse these results to gain insight into their simulation and automatically generate reports in a variety of formats, including PowerPoint.
PowerVIZ
High-performance visualization and analysis application used for processing simulation results from PowerFLOW and spectral analysis results from PowerACOUSTICS. Provides a wide variety of tools to perform detailed analyses, a fast, intuitive, and interactive user interface, and the ability to quickly process large data sets. Different visualization techniques can be combined within the same image to explore simulation data.
PowerACOUSTICS
Enables accurate pressure fluctuation prediction, noise source identification, wind noise transmission to interior, and sound package parameter study capabilities.
Our Applications
Our goal is to promote simulation-based design techniques throughout each of the core disciplines and departments within our customers’ organizations, which include aerodynamics, thermal management, aeroacoustics, climate control and powertrain. Each of these departments is responsible for a particular aspect of the design of a vehicle and tradeoffs often must be made between the priorities of these departments. For example, a design change made to improve the aerodynamic properties of a vehicle may negatively affect the thermal management or aeroacoustic properties of the vehicle. Our customers tell us that by providing timely and accurate insights about the performance of alternative design approaches early in the product development cycle, our products allow their engineers to better understand these tradeoffs and thereby reduce the likelihood of expensive redesigns or engineering fixes to remedy problems that might otherwise only be discovered late in the product development program. Toward that end, our applications management teams dedicated to each of these disciplines seek opportunities to apply our core fluids and related physics simulation engines to address new target problems. In this process, we develop new solutions, which can then be marketed to other customers, all of which drives simulation consumption.
For example, one of the earliest applications of our technology in the automotive market was the modeling of aerodynamic drag, a key concern of engineers in our customers’ aerodynamics departments. However, the same core transient simulation engine that enables the prediction of drag can also be extended to address the problems of a different group of engineers in the same company who are responsible for the vehicle’s soiling and water management attributes. This group works to understand and mitigate the amount of soil (road dirt, brake dust or salt) that accumulates on critical components such as doors, side glass and mirrors, for safety and quality reasons. Similarly, for off highway equipment, accumulation of particles in the air intake and cooling systems can significantly affect performance. All of this can now be studied and optimized digitally using PowerFLOW early in the design process where changes are less costly to implement.
A major strength of our proprietary Digital Physics technology is its extensibility when compared to traditional CFD solutions, which require extensive and specialized tuning for each new application. By layering on top of our core fluids solver additional functionalities that address phenomena such as thermal radiation or acoustic transmission, we are able to provide broader solutions that extend beyond our initial fluid dynamics focus. These include the interior noise simulation capability that we offer to our customers’ aeroacoustics department, or the brake cooling simulation capability that we provide to engineers in their thermal management department.
Deployment of each new functional solution results in increased utilization of simulation capacity, which leads to new license purchases and revenue. We believe the customer base for most of these applications remains only partially deployed. As our customers gradually alter their development processes to take more advantage of the digital development methods we are enabling, we seek opportunities to cross-sell our products to new engineering groups within our existing customers.
Our Technology
PowerFLOW is built on our proprietary Digital Physics technology, which is based on an extended implementation of the lattice Boltzmann method that we have developed over two decades. PowerFLOW differs from competing CFD technology in fundamental ways that make our simulations more useful to our customers. PowerFLOW simulations are:
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transient: can simulate time-dependent phenomena such as turbulent flows;
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stable: reliable even when used to analyze complex geometries; and
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accurate: validation studies by us and our customers demonstrate that digital simulations utilizing PowerFLOW are comparable in accuracy to the physical tests that they replace, and in some cases, are more accurate.
PowerFLOW leverages the fact that it is a transient solver with high three-dimensional resolution and low dissipation. This allows PowerFLOW to directly simulate large unpredictable turbulent scales. PowerFLOW uses turbulence theory to model only where it is valid and directly simulates the rest.
These combined attributes of PowerFLOW’s underlying technology enable us to bring simulation solutions to new levels of accuracy and robustness that have not been possible before. Our customers tell us that this has enabled them to improve their development processes by replacing physical prototype testing at many stages of the vehicle development process with robust, detailed and accurate digital simulations. This allows the final prototype stage to be primarily one of confirmation rather than discovery.
Customers and Markets
Our initial focus has been on the ground transportation market, and primarily on makers of passenger vehicles, due to the immediate benefits and strong value proposition of our solutions for vehicle manufacturers. Over 96% of our fiscal year 2014 revenues were generated from the ground transportation market, including 61% from our ten largest customers and 12% from our largest customer.
The segments of the ground transportation market that we serve include the following:
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Passenger vehicle manufacturers;
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Highway truck manufacturers;
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Off-highway vehicle manufacturers (including agricultural, construction and military vehicles and machines);
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Train manufacturers; and
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Suppliers to the above manufacturers.
Over 125 manufacturers currently utilize our products and services, including 14 of the global top 15 passenger vehicle manufacturer groups, based on motor vehicle production volume for 2012, as reported by the Organisation Internationale des Contructeurs d’Automobiles, or the International Organization of Vehicle Manufacturers, such as BMW, Ford, Hyundai, Jaguar Land Rover, Nissan, Porsche, Renault, Toyota and Volkswagen; truck and off-highway vehicle manufacturers such as Hyundai, Kenworth, Kobelco, MAN, Peterbilt, Scania and Volvo Truck; and suppliers to these manufacturers, such as Cummins, Denso and Magna Steyr.
We have also begun to explore new markets in which we believe the capabilities of PowerFLOW have broad application, including the aerospace, oil and gas production, chemical processing, architecture and construction, power generation, biomedical and electronics industries. For example, we have a prototype for multi-phase fluids that we believe would be of value to the oil and gas, chemical and power generation markets.
Sales and Marketing
We sell our products and services primarily through our direct sales force of 137 persons in the United States, United Kingdom, France, Germany, Italy, Japan, Korea and China at January 31, 2014, including 26 sales executives, 32 technical account managers assigned to our most deployed customers and a worldwide staff of 78 field applications engineers. We also sell our products and services through a distributor in India and through a sales agent in Brazil.
Our sales executives and applications engineering teams are based near our customers to enable quick, efficient, local time zone and language support. Our sales team is responsible for building a long-term, value-driven relationship with our customers. They also have access to our global technical resources to carry out and deliver project-based engagements. They utilize these project resources strategically to enable customers over time to deploy our solutions independently.
To introduce new customers to our simulation solutions, we typically perform fixed price projects that include simulations accessed via our OnDemand facilities, along with engineering and consulting services. Initial projects typically focus on a specific real problem in an active development program and are executed over the course of a few weeks or months. We may perform one or a series of projects, in which our applications management teams work with the design and engineering groups in various disciplines within our customers’ organizations to identify their needs and to assist the customer in validating and implementing our solution. As we work with the customer in project-based mode, we work towards building a value proposition that supports a license sale.
Once our PowerFLOW technology has been adopted in one area of a customer’s organization, we seek opportunities to expand to other disciplines and departments. We believe that we are currently marginally deployed at many of our current customers and see significant growth potential from existing customers. For example, a manufacturer of luxury automobiles initially implemented our aerodynamic simulation solutions for use in styling evaluation and optimization. Over the course of our multi-year relationship with this customer, the range of our solutions deployed by the customer has expanded to include thermal management (including convective drive train cooling, brake cooling, underhood temperatures and climate control solutions) as well as aeroacoustics, resulting in an increase in simulation capacity purchased by this customer by a factor of over 50 times over a period of six years.
Customers usually purchase PowerFLOW simulation capacity under one-year licenses that provide the customer either with dedicated access to a specified number of processor cores throughout the contract year or with a block of “simulation hours” that may be used at any time but expire if not used by the end of the contract year. As an illustration, a highway truck customer, based on a new truck design program, may estimate that it will run a minimum of 200 aerodynamic simulations in its next fiscal year. A typical highway truck aerodynamics simulation requires 3,000 simulation-hours each. Thus, this customer will require a minimum of 600,000 simulation-hours.
Simulation capacity may be purchased as software-only, to be run on the customer’s own computer hardware, or provided in the form of software-as-a-service, via our hosted PowerFLOW OnDemand offering. We provide our PowerFLOW OnDemand services primarily through a data center operated by IBM in Piscataway, New Jersey. We separately license the front-end and back-end applications software that interfaces with our simulation server software for a fixed annual fee, based on the number of concurrent users at the customer. As customers continue to use our solutions and deploy them more widely within their organizations, their consumption of our simulation services typically increases. We offer volume discounts based on the annual volume of simulation capacity ordered.
Research and Development
Our product development activities are carried out by our research and development organization, which at January 31, 2014 encompassed 98 persons, including 21 scientists engaged in basic research in fluid dynamics, 37 software engineers, 32 applications management personnel and 8 product management personnel. Our senior research and development scientists include leaders in the field of fluid dynamics who have pioneered the use of the lattice Boltzmann method. Our applications management teams, which are organized around the core engineering disciplines and departments within our customers’ organizations, perform a critical role in establishing and executing our product development roadmap, by identifying customer needs, developing product requirements and working with customers to implement and improve our solutions. Examples of our current research and development activities include basic research to improve the capabilities and performance of our core fluids simulation engine, which is currently in its fifth generation, as well as the expansion of our solutions to address new simulation applications, for example, modeling of moving geometries such as rotating machinery.
Our total expenditures on research and development were $18.2 million, or 33.5% of total revenues in fiscal year 2014, $16.7 million, or 34.1% of total revenues in fiscal year 2013 and $14.4 million, or 31.5% of total revenues, in fiscal year 2012. In order to maintain and extend our technology leadership and competitive position, we intend to continue to devote significant effort to our research and development activities.
Intellectual Property
We regard our software as proprietary. Our strategy is to rely on a combination of copyright, patent, trademark and trade secret laws in the United States and other jurisdictions, and to rely on license and confidentiality agreements, and software security measures to further protect our proprietary technology and brand. The laws of some countries in which our products are licensed may not protect our intellectual property rights to the same extent as the laws of the United States.
We have obtained or applied for patent protection with respect to some of our core intellectual property, but generally do not rely on patents as a principal means of protecting intellectual property. As of January 31, 2014 we owned eleven patents issued in the United States and sixteen pending patent applications in the United States.
We conduct business under our trademarks and use trademarks on some of our products. We believe that having distinctive marks may be an important factor in marketing our products. As of January 31, 2014, we have registered thirteen of our significant trademarks in the United States and in limited subset in selected other countries. Although we have a foreign trademark registration program for selected marks, the laws of many countries protect trademarks solely on the basis of registration and we may not be able to register or use such marks in each foreign country in which we seek registration. We monitor use of our trademarks and intend to enforce our rights to our trademarks.
We rely on trade secrets to protect substantial portions of our technology. We generally seek to protect these trade secrets by entering into non-disclosure agreements with our employees and customers, and historically have restricted access to our software source code and licenses, which we regard as proprietary information. In these cases, we rely on non-disclosure and other contractual provisions to protect our proprietary rights. Trade secrets may be difficult to protect, and it is possible that parties may breach their confidentiality agreements with us.
In addition to the protections described above, our software is protected by United States and international copyright laws. We license our software products utilizing a combination of web-based and hard copy license terms and forms. We rely primarily on “click-wrap” licenses. The enforceability of these types of agreements under the laws of some jurisdictions is uncertain.
The steps we have taken to protect our proprietary rights may not be adequate to deter misappropriation of our technology or independent development by others of technologies that are substantially equivalent or superior to our technology. Any misappropriation of our technology or development of competitive technologies could harm our business. We could incur substantial costs in protecting and enforcing our intellectual property rights.
Executive Officers and Directors
The following table sets forth information with respect to our executive officers as of March 26, 2014:
Name
Age
Position
Stephen A. Remondi
Chief Executive Officer, President, Director
Edmond L. Furlong (1)
Chief Operating Officer and Chief Financial Officer
Jean-Paul Roux
Vice President of European Operations
Hudong Chen, Ph.D.
Chief Scientist, Vice President of Physics
James Hoch
Vice President of Software Development
Stephen P. Sarno (1)
Vice President, Finance and Chief Accounting Officer
(1) As previously announced, on November 1, 2013, Mr. Furlong notified us that he intends to resign his employment with us effective as of March 31, 2014. Mr. Sarno has been appointed to serve as our Acting Chief Financial Officer upon the effectiveness of Mr. Furlong’s resignation.
Stephen A. Remondi co-founded Exa Corporation in 1991 and has held the positions of Chief Executive Officer and President since 1999. Prior to 1999, Mr. Remondi held numerous positions within Exa, including Vice President of Applications Development and Business Development. In that role, Mr. Remondi was responsible for the development of the PowerFLOW product and management of Exa’s strategic customer partnerships. Prior to founding Exa, Mr. Remondi held various engineering and engineering management positions at Alliant Computer Systems Corporation and Data General Corporation. Mr. Remondi has a B.S. in Electrical & Computer Engineering from Tufts University and an M.B.A. from Bentley College. We believe that Mr. Remondi’s educational background in engineering and management, his professional experience as an engineer and executive, and his extensive knowledge of our company’s history and culture, its products, technology and personnel, and its markets and customers, qualify him to serve as a member of our board of directors.
Edmond L. Furlong served as a director of Exa Corporation from 2001 to January 2005 when he became our Chief Operating Officer and Chief Financial Officer. Immediately prior to joining Exa, Mr. Furlong held the position of Senior Vice President of Fidelity Strategic Investments, the venture capital arm of Fidelity Investments. Prior to his tenure at Fidelity Strategic Investments, Mr. Furlong held several investment and operations roles including Chief Operating Officer of UAM Investment Services, Inc., Vice President and National Sales Manager of Fidelity Investments Tax-Exempt Services Company and Chief Financial Officer of Fidelity Investments Tax-Exempt Services Company and also served as a management consultant at The Boston Consulting Group, Inc., and an associate in the investment banking group of Dillon, Read & Company, Inc. Mr. Furlong holds a B.S. in Economics from The Wharton School of The University of Pennsylvania and an M.B.A. from The Harvard Business School.
Jean-Paul Roux joined Exa in 2001 as our managing director for Southern and Western Europe. In April 2003 Mr. Roux assumed the position of Vice President of European Operations. Prior joining to Exa, Mr. Roux was Managing Director of Tecnomatix UK, a provider of product lifecycle management software, and its Scandinavian subsidiary. Mr. Roux has extensive experience selling software solutions to engineers in the manufacturing, electronics, automotive, aerospace and off-highway equipment industries. Mr. Roux holds a language degree from Catholic University and a business degree from Ecole Superieure de Commerce in Grenoble, France.
Dr. Hudong Chen joined Exa in 1993 and has been our Chief Scientist since 1997 and Vice President of Physics since 2000. Prior to his tenure at Exa, Dr. Chen was a visiting assistant physics professor at Dartmouth College and a postdoctoral fellow at Los Alamos National Laboratory. Dr. Chen has a Ph.D. in Physics from Dartmouth College, a M.S. in Physics from the College of William and Mary, and a B.S. in Physics from Fudan University in China. Dr. Chen is known for his pioneering work in lattice Boltzmann methods as well as contributions in turbulence and kinetic theory. Dr. Chen has been a Fellow of the American Physical Society since 2000.
James Hoch joined Exa in 1993 and has been our Vice President of Software Development since rejoining the company in 1999. Prior to joining Exa, Mr. Hoch was the lead architect on several research parallel computer systems and related compiler projects at Sandia National Laboratories. Mr. Hoch was also chief architect at Maker Communications, a developer of network communications processors, from October 1998 to July 1999. Mr. Hoch has extensive experience in compiler technology and parallel computing and holds both M.S. and B.S. degrees from Purdue University in Computer and Electrical Engineering.
Stephen P. Sarno joined Exa in November 2012. Prior to joining the company, Mr. Sarno served as Senior Vice President, Finance and Corporate Controller at Education Holdings 1, Inc., formerly The Princeton Review, from 2011 to 2012. Additional prior work experience highlights include a role as Vice President, Corporate Controller and Chief Accounting Officer with Sapient Corporation as well as over 10 years of experience at PricewaterhouseCoopers as a Senior Manager. He is a Certified Public Accountant in the Commonwealth of Massachusetts, holds an MBA from the University of Texas at Austin and a BBA from the University of Massachusetts at Amherst.
Item 1A.
Item 1A. Risk Factors
You should carefully consider the risks and uncertainties described below, together with the information included elsewhere in this Annual Report on Form 10-K and other documents we file with the SEC. The risks and uncertainties described below are those that we have identified as material, but are not the only risks and uncertainties facing us. Our business is also subject to general risks and uncertainties that affect many other companies, such as overall U.S. and non-U.S. economic and industry conditions including a global economic slowdown, geopolitical events, changes in laws or accounting rules, fluctuations in interest and exchange rates, terrorism, international conflicts, major health concerns, natural disasters or other disruptions of expected economic and business conditions. Additional risks and uncertainties not currently known to us or that we currently believe are immaterial also may impair our business operations and liquidity.
Risks Related to Our Business and Industry
We depend on our PowerFLOW suite of simulation solutions for substantially all of our revenue, and our business will suffer if demand for, or usage of, PowerFLOW declines.
We derive substantially all of our revenue from subscription licenses to use our PowerFLOW software suite and related services. We expect revenue from PowerFLOW to continue to account for substantially all of our revenue for the foreseeable future. If demand for, or usage of, PowerFLOW declines for any reason, our revenue would decline and our operating results would suffer.
We are dependent on a small number of significant customers for a substantial portion of our revenues.
A significant portion of our revenues is derived from renewals by our existing customers of annual licenses to use PowerFLOW, and in any fiscal period, a large portion of our revenue is typically attributable to a small number of significant customers. In fiscal years 2014, 2013 and 2012, approximately 61%, 62% and 64% of our revenue, respectively, was attributable to our ten largest customers in the aggregate. Due to the concentration of revenue in a small number of customers, a significant reduction in usage of PowerFLOW by any of these customers, or the non-renewal of their annual licenses, due to the cancellation or postponement of vehicle development programs or for any other reason, could have a materially adverse effect on our results of operations.
Our success depends on continued adoption of digital simulation in our target markets, and if potential customers are unwilling to adopt our digital simulation technologies to augment or replace their traditional physical methods of design validation and testing, our opportunities for future revenue growth may be limited.
Most of our customers and potential customers have historically tested their product designs using experimental methods such as wind tunnels and road tests. Manufacturers often have made substantial investments in physical test facilities and associated staff and infrastructure and have accumulated many years of experience in using these methods. For organizational, cultural, financial or other reasons, potential customers may be reluctant to reduce their reliance on physical experimental methods as the primary means to validate and test their designs. If we are not successful in overcoming these obstacles by demonstrating to potential customers that the results of digital simulation using PowerFLOW can be delivered in a timely and cost effective manner and are sufficiently reliable to be used as the basis of design decisions, they may not adopt, or may delay broader adoption of, our digital simulation technology, which could limit our opportunities for revenue growth and adversely affect our business.
Economic downturns that affect the ground transportation industry may adversely affect our revenues and operating results.
We derive a substantial majority of our total revenue from companies in the ground transportation industry. Accordingly, our future success depends upon the continued demand for digital simulation software and services by companies in this industry. The ground transportation industry and the other manufacturing industries that we
serve, or may expand into, periodically experience economic downturns that can adversely affect our business. For example, we were negatively impacted by the suspension or postponement of vehicle development programs by our customers in response to the 2008 financial crisis and resulting recession, which significantly affected the automotive industry. Furthermore, terrorist attacks, other increased global hostilities and natural disasters have, at times, contributed to widespread uncertainty and speculation in the world financial markets. The impact of events of this kind may be exacerbated by other economic factors, such as increased operating and manufacturing costs due to rising global energy prices or the tightening of the financial and credit markets, and by changes in commercial and consumer preferences and spending habits. In the future, such cyclical trends and economic factors may adversely affect our business by reducing customer capital expenditures, extending design cycles and reducing our revenue and, ultimately, our results of operations. In addition, manufacturers in the ground transportation market tend to adhere to a technology choice for long periods, possibly an entire product development cycle. As a result, a lost opportunity with a given customer may not again become a new opportunity for several years or projects may be delayed if development of a new product is put on hold or terminated.
Adverse changes in the economy and global economic and political uncertainty may also cause delays and reductions in information technology spending by our customers and a deterioration of the markets for our products and services. If adverse economic conditions occur, we would likely experience reductions, delays and postponements of customer purchases that will negatively impact our revenue and operating results.
In the past, worldwide economic downturns and pricing pressures have led to reorganizations of companies in the automotive industry. Such reorganizations have in the past caused delays and reductions in capital and operating expenditures including for products and services like ours. In addition, a consolidation or reorganization affecting a significant customer could result in discontinuation of use by the acquired company of our simulation solutions, if the acquiring company has not adopted our technology or prefers other methods of design verification. Domestic and foreign economic conditions or any other factors that result in reduced spending on new product development by companies in the automotive industry could harm our operating results in the future.
Our lengthy and complicated sales cycle makes it difficult for us to predict the timing of our entry into new license agreements.
The development of our business relationship with a potential customer can be a lengthy process, typically spanning three to six months or longer. Our strategy is to engage initially with new customers, or with new engineering groups within existing customers, by performing fixed-price projects. Once new customers are familiar with the capabilities of our products, they generally, but not always, transition to a license-based model for access to PowerFLOW. Because the license fees for our products can be substantial and the internal process changes necessary for a customer to implement our solution can be significant, the software license sales cycle may involve multiple divisions within a potential customer’s organization and multiple layers of management. Due to the length and complicated nature of our sales cycle, predicting the fiscal period in which a new license agreement will be entered into, if at all, is difficult. Delay in booking a new license agreement could cause our quarterly revenues to fall substantially below our expectations and those of public market analysts and investors. Delays in sales could cause significant shortfalls in our revenue and operating results for any particular period.
Competition from software offered by current competitors and new market entrants, as well from internally developed solutions by our customers, could adversely affect our ability to sell our software products and related services and could result in pressure to price our products in a manner that reduces our profitability.
The market for digital simulation software is characterized by vigorous competition. We consider the primary competition to adoption of our solutions to be our customers’ continued use of physical prototypes and test facilities. We also encounter competition from companies that provide multi-function digital simulation
software that is used for various purposes in the ground transportation industry and elsewhere, primarily CD-adapco, with its products STAR-CD and STAR-CCM+, and ANSYS, with its products Fluent and CFX. CD-adapco has a strong presence in the automotive market, and offers capabilities in certain areas where we do not currently focus, such as combustion. ANSYS offers a suite of digital simulation software that includes many applications that we do not address, such as structural mechanics and electromagnetism, which it markets to a broad spectrum of industries. We also compete against open source software such as OpenFOAM that includes computational fluid dynamics capabilities.
In most of our existing and potential new accounts, products such as these are already in use for a variety of purposes, and likely will remain so. Our ability to further penetrate the ground transportation market will therefore depend on our ability to demonstrate that our solutions deliver economic value in the form of significant process and cost improvements that competing products are unable to provide. As we expand our offerings into other markets, we may face competition from the same competitors as well as from companies that we have not typically competed against in the past. Many of our current and potential competitors have greater financial, technical, marketing, service and other resources than we have and may expand into our markets by acquiring other companies or otherwise. As a result, these companies may be able to offer lower prices, additional products or services, or other incentives that we cannot match or offer. Existing and potential customers may perceive the cost of our solution as being higher than that of our competitors’ products. This perception could become an obstacle to wider adoption of our simulation solutions, or result in pressure to reduce our prices or change our capacity-based pricing model. We may not be able to compete successfully against current or future competitors and competitive pressures may materially adversely affect our business, financial condition and operating results.
The significant cost of deep deployment of our solutions could deter their wider adoption.
Under our capacity-based license model, license fees are based on simulation capacity, purchased on an annual basis. Increased utilization, or continued usage after the expiration of the license term, requires the purchase of additional simulation capacity. As customers increase their reliance on our digital simulation solutions and deploy them more widely within their organizations, their consumption of our simulation capacity increases. For example, one customer has expanded the annual simulation capacity it purchases from us by a factor of over 50 times over a period of six years. At some point, the significant cost of implementing our solutions pervasively throughout their organizations under a capacity-based licensing model may deter our customers from more widely adopting our solutions, which could limit our prospects for growth.
Our success depends in part on our ability to develop and introduce new and enhanced products and we may not be able to timely develop new and enhanced products to satisfy changes in demand.
Our success depends in part on our ability to develop and market new and enhanced solutions on a timely basis. Successful product development and marketing depends on numerous factors, including our ability to anticipate customer requirements, changes in technology, our ability to differentiate our products and solutions from those of our competitors, and market acceptance. Enterprises are requiring their application software vendors to provide greater levels of functionality and broader product offerings. Moreover, our industry is characterized by rapidly changing technologies and evolving industry standards and operating platforms. We may not be able to develop and market new or enhanced solutions in a timely or cost-effective manner or to develop and introduce products that satisfy customer requirements. Our products also may not achieve market acceptance or correctly anticipate technological changes. In particular, a critical component of our growth strategy is to increase the penetration and expansion of PowerFLOW and our related products with our existing customers in the ground transportation market. We may not be successful in developing and marketing, on a timely basis, new products or product enhancements, or adequately addressing the changing needs of our customers and potential customers or successfully increasing the penetration of PowerFLOW and our related products in our existing, or any other, markets.
Our success in penetrating new vertical markets will depend, in part, on our ability to develop a deep understanding of the challenges facing potential customers in those markets.
We have historically concentrated our development efforts primarily on the ground transportation market. While we anticipate that the substantial majority of our revenues will continue to be derived from the ground transportation market for the foreseeable future, in order to achieve our long-term growth goals, we will need to penetrate additional vertical markets, such as the aerospace, oil and gas production, chemical processing, architecture and construction, power generation, biomedical and electronics industries. Our success in the ground transportation market depends on our deep understanding of the design processes utilized by our customers in that market. In order to penetrate new vertical markets, we will need to develop a similar understanding of the design processes, and associated technical difficulties, utilized by participants in those markets. Developing this level of understanding will be a time consuming and potentially expensive process, and we may not be successful. We will also need to demonstrate to potential customers that PowerFLOW and our other products and services can provide digital simulation solutions that compare favorably to physical testing methods as well as the offerings by our competitors with respect to cost, accuracy, set-up time and ease of use. If we fail to penetrate these new vertical markets, our revenue may grow at a slower rate than we anticipate and our financial condition could suffer.
We may not be able to obtain or maintain necessary licenses of third-party technology on commercially reasonable terms, or at all, which could delay product sales and development and adversely impact product quality.
We have incorporated third-party licensed technology into certain of our products. We anticipate that we are also likely to need to license additional technology from third parties in connection with the development of new products or product enhancements in the future. Third-party licenses may not be available to us on commercially reasonable terms, or at all. The inability to retain any third-party licenses required in our current products or to obtain any new third-party licenses to develop new products and product enhancements could require us to obtain substitute technology of lower quality or performance standards or at greater cost, and delay or prevent us from making these products or enhancements, any of which could seriously harm the competitive position of our products.
Defects or errors in our products could harm our reputation, impair our ability to sell our products and result in significant costs to us.
PowerFLOW and the other products that we offer are complex and, despite extensive testing and quality control, may contain undetected errors or failures when first introduced or as new versions are released. We have not suffered significant harm from any defects or errors to date, but we have from time to time found defects in our products and we may discover additional defects in the future. We may not find errors in new or enhanced products before the products are released and such errors may not be discovered by us or our customers until after the products have been implemented. We have in the past issued and may in the future need to issue corrective releases of our products to remedy defects and errors. Any of these problems may result in the loss of or delay in customer acceptance and sales of our products, which could have a material, adverse effect on our business, financial position, results of operations and cash flows.
We could be subject to significant expenses and damages because of liability claims related to our products and services.
Our customers’ reliance on our digital simulation solutions or project-based services in their vehicle design processes may entail the risk of product liability claims and associated damages, and our software products and services could give rise to warranty and other claims. As we expand into new market segments outside the ground transportation industry, the risk of product liability exposure may increase. Any errors, defects, performance problems or other failure of our software could result in significant liability to us for damages or for violations of environmental, safety and other laws and regulations. Our agreements with our customers generally
contain provisions designed to limit our exposure to potential product liability claims. It is possible, however, that the limitation of liability provisions in our agreements may not be effective as a result of federal, foreign, state or local laws or ordinances or unfavorable judicial decisions. A substantial product liability judgment against us could materially and adversely harm our operating results and financial condition. Even if our software is not at fault, a product liability claim brought against us could be time consuming, costly to defend and harmful to our operations. In addition, although we carry general liability insurance, our current insurance coverage may be insufficient to protect us from all liability that may be imposed under these types of claims.
If there are interruptions or delays in our PowerFLOW OnDemand services due to third-party error, our own error or the occurrence of unforeseeable events, delivery of our solutions and the use of our service could become impaired, which could harm our relationships with customers and subject us to liability.
We provide PowerFLOW OnDemand services primarily through a data center operated by IBM in Piscataway, New Jersey under an agreement with IBM. IBM provides the system infrastructure and owns or leases the computer hardware used for the PowerFLOW OnDemand services that it hosts. Design and mechanical errors, spikes in usage volume and failure to follow system protocols and procedures could cause our systems, or those in the IBM data center, to fail, resulting in interruptions in our service. Interruptions or delays in our PowerFLOW OnDemand service could result from the termination of our arrangement with IBM, third-party error, our own error, natural disasters or security breaches. Such interruptions or delays, whether accidental or willful, could harm our relationships with customers, damage our brand and reputation, divert our employees’ attention, reduce our revenue, subject us to liability, cause us to issue credits or cause customers to fail to renew their subscriptions, any of which could adversely affect our business, financial condition and results of operations.
If our security measures, or those of third-party providers for our PowerFLOW OnDemand service, are breached and unauthorized access is obtained to client data, clients may curtail or stop their use of our solutions, which could harm our business, financial condition and results of operations.
Our PowerFLOW OnDemand service involves the storage and transmission of confidential information of customers, including their design data. We may also in the course of our service engagements have access to such confidential customer information. If our, or our third-party service providers’, security measures were ever breached as a result of employee error, malfeasance or otherwise, and, as a result, an unauthorized party obtained access to this confidential data, our reputation could be damaged, our business could suffer and we could incur significant liability. Techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not discovered until launched against a target. As a result, we and our third-party providers may be unable to anticipate these techniques or to implement adequate preventative measures. If an actual or perceived breach of our or our third-party suppliers’ security occurs, the market perception of our OnDemand services could be harmed and we could lose sales and clients.
Seasonal variations in the purchasing patterns of our customers may lead to fluctuations in the timing of our cash flows.
We have experienced and expect to continue to experience seasonal variations in the timing of customers’ purchases of our software products. Many customers make purchase decisions based on their fiscal year budgets, which often coincide with the calendar year, except for our customers in Japan. These seasonal trends materially affect the timing of our cash flows, as license fees become due at the time the license term commences. As a result, customer orders for new and renewal licenses have been concentrated in the fourth quarter of our fiscal year, and our cash flows from operations have been highest in the first quarter of the succeeding fiscal year.
Declines in new software license sales or in the rate of renewal of our software may not be fully reflected in our current period operating results and could lead to future revenue shortfalls that could affect our results of operations.
Because our software products are sold pursuant to annual subscription agreements and we recognize revenue from these subscriptions over the term of the agreement, downturns or upturns in new or renewal licenses may not be fully reflected in our current period operating results. We do not intend to report or disclose our bookings or invoices on a current basis. If our new and renewal license purchases in any period decline or fail to grow at a rate consistent with our historical trends, particularly in the fourth quarter of our fiscal year, when a disproportionate percentage of our new license and renewal sales typically occur, our revenue in future periods could fall short of analysts’ expectations which, in turn, could adversely affect the price of our common stock.
Our cost structure is relatively fixed in the short term, which makes it difficult to reduce our expenses quickly in response to declines in revenue or revenue growth.
Most of our expenses, such as those associated with headcount and facilities, are relatively fixed and can be difficult to reduce in the short term. Our expense levels are based in part on our expectations regarding future revenue levels. As a result, if revenue for a particular quarter is below our expectations, our expenses for that quarter may constitute a larger percentage of our operating budget than we planned, causing a disproportionate effect on our expected results of operations and profitability for that quarter.
If we are unable to manage our expected growth, our performance may suffer.
Our business has grown rapidly, and if we are successful in executing our business strategy, this growth will continue as we expand our offerings in the ground transportation market and seek to penetrate new vertical markets. We will need to continue to expand our managerial, operational, financial and other systems and resources to manage our operations, continue our research and development activities, increase our sales force and expand project-based services by increasing our field application engineers and worldwide support staff. It is possible that our management, finance, development personnel, systems and facilities currently in place may not be adequate to support this future growth. Our need to effectively manage our operations, growth and products requires that we continue to develop more robust business processes and improve our systems and procedures in each of these areas and to attract and retain sufficient numbers of talented employees. We may be unable to successfully implement these tasks on a larger scale and, accordingly, may not achieve our research, development and growth goals.
Our business could be adversely affected if we are unable to attract, integrate and retain key personnel.
Our success in the highly competitive digital simulation market depends largely on our ability to attract, integrate and retain highly skilled technical, managerial, consulting, sales and marketing personnel. Competition for these personnel in our industry is intense. We may not be able to continue to attract and retain the appropriately qualified, highly skilled employees necessary for the development of our products and services and the growth of our business, or to replace such personnel who leave our employ in the future. The loss of services of any of our key personnel, the inability to retain and attract qualified personnel in the future, or delays in hiring required personnel, particularly scientific, product development and applications management personnel, could make it difficult to meet key objectives, such as timely and effective product introductions, penetration and expansion into existing accounts and growth in our share of the domestic and international digital simulation market.
We may expand by acquiring or investing in other companies, which may divert our management’s attention, result in additional dilution to our stockholders and consume resources that are necessary to sustain our business.
Although we have no agreements or commitments for any material acquisitions, our business strategy may in the future include acquiring complementary services, technologies or businesses. We also may enter into relationships with other businesses to expand our service offerings or our ability to provide service in foreign
jurisdictions, which could involve preferred or exclusive licenses, developing channels of distribution or investments in other companies. Negotiating these transactions can be time-consuming, difficult and expensive, and our ability to close these transactions may often be subject to approvals that are beyond our control. Consequently, these transactions, even if undertaken and announced, may not close.
An acquisition, investment or business relationship may result in unforeseen operating difficulties and expenditures. In particular, we may encounter difficulties assimilating or integrating the businesses, technologies, products, personnel or operations of the acquired companies, particularly if the key personnel of the acquired company choose not to work for us, the company’s technology is not easily adapted to work with ours or we have difficulty retaining the customers of any acquired business due to changes in management or otherwise. Acquisitions may also disrupt our business, divert our resources and require significant management attention that would otherwise be available for development of our business. Moreover, the anticipated benefits of any acquisition, investment or business relationship may not be realized or we may be exposed to unknown liabilities. Our acquisitions may not be successfully integrated or any such acquisitions may not otherwise be successful. If our acquisitions are unsuccessful for any reason, our business may be harmed and the value of your investment may decline.
We sell our products and services internationally and are subject to various risks relating to these international activities; if we fail to manage our international operations effectively, our business, financial condition and results of operations could be adversely affected.
International sales of PowerFLOW and our related products and services are important to our growth and profitability. In the fiscal year ended January 31, 2014, 77% of our revenue was attributable to sales in international markets, and at January 31, 2014, we had 15 offices in 8 countries. By doing business in international markets, we are exposed to risks separate and distinct from those we face in our domestic operations, and if we are unable to manage the various risks associated with supporting our international sales and service efforts effectively, the growth and profitability of our business may be adversely affected.
Engaging in international business inherently involves a number of other difficulties and risks, including:
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changes in foreign currency exchange rates;
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changes in a specific country’s or region’s political or economic conditions, particularly in emerging markets;
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burdens of complying with a wide variety of foreign customs, laws and regulations;
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burdens of complying with United States laws regulating international business activities, including the United States Foreign Corrupt Practices Act and economic and trade sanctions regimes;
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natural disasters or outbreaks of infectious diseases affecting the regions in which our customers operate;
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unexpected changes in tariffs or trade protection measures;
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import or export licensing requirements and other restrictions on technology imports and exports;
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potentially negative consequences from changes in foreign government regulations, tax laws and regulatory requirements;
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laws and business practices favoring local companies;
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difficulty in managing a geographically dispersed workforce in compliance with diverse local laws and customs;
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difficulties and costs of staffing and managing foreign operations;
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disproportionate management attention or company resources;
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changes in diplomatic and trade relationships;
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international terrorism and anti-American sentiment;
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possible future limitations on the ownership of foreign businesses;
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difficulties in enforcing agreements and collecting receivables through certain foreign legal systems;
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longer accounts receivable payment cycles;
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less effective protection of intellectual property; and
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the challenges of handling legal disputes in foreign jurisdictions.
Because most of our international sales are denominated in the currency of the country where the purchaser is located, as we continue to expand our direct sales presence in international regions, our accounts receivable and payment obligations denominated in foreign currencies continues to increase. As a result, increases or decreases in the value of the U.S. dollar relative to foreign currencies may affect our financial position, results of operations and cash flow. Currently, our largest exposures to foreign exchange rates exist with respect to the euro and the Japanese yen. We do not currently hedge our exposure to fluctuations in foreign exchange rates. Any hedging policies we may implement in the future may not be successful, and the cost of those hedging techniques may have a significant negative impact on our operating results.
Our exposure to each of these risks may increase our costs, impair our ability to market and sell our products and require significant management attention. Our business, financial position, results of operations and cash flows may be materially adversely affected by any of these risks.
Our effective tax rate may fluctuate, and we may incur obligations in tax jurisdictions in excess of amounts that have been accrued.
We are subject to income taxes in both the United States and various foreign jurisdictions, and we may take certain income tax positions on our tax returns that tax authorities may disagree with. When necessary, we provide reserves for potential payments of tax to various tax authorities related to uncertain tax positions. However, the calculation of our tax liabilities involves the application of complex tax regulations to our global operations in many jurisdictions. Therefore, any dispute with any tax authority may result in a payment that is materially different from our current estimate of the tax liabilities associated with our returns.
Changes in tax laws or tax rulings could materially impact our effective tax rate. In the United States, there are several proposals to reform corporate tax law that are currently under consideration. These proposals include reducing the corporate statutory tax rate, broadening the corporate tax base through the elimination or reduction of deductions, exclusions and credits, implementing a territorial regime of taxation, limiting the ability of United States corporations to deduct interest expense associated with offshore earnings, modifying the foreign tax credit rules, and reducing the ability to defer United States tax on offshore earnings. These or other changes in the United States tax laws could increase our effective tax rate which would affect our profitability.
Our ability to use our net operating loss carryforwards may be subject to limitation.
Under Section 382 of the Internal Revenue Code of 1986, as amended, substantial changes in our ownership may limit the amount of net operating loss carryforwards that could be utilized annually in the future to offset our taxable income. Specifically, this limitation may arise in the event of a cumulative change in ownership of our company of more than 50% within a three-year period. Any such annual limitation may significantly reduce the utilization of our net operating loss carryforwards before they expire. We performed an analysis as of January 31, 2014, and determined that we had not experienced an ownership change for purposes of Section 382. However, future transactions in our common stock could trigger an ownership change for purposes of Section 382, which could limit the amount of net operating loss carryforwards and other attributes that could be utilized annually in the future to offset our taxable income, if any. Any such limitation, whether as the result of sales of common stock by our existing stockholders or sales of common stock by us, could have a material adverse effect on our results of operations in future years.
We may need substantial additional funding and we may be unable to raise capital when needed, which could force us to delay, reduce or eliminate our product development programs or commercialization efforts.
We believe that our cash on hand and cash flows from operations will be sufficient to meet our anticipated cash requirements for at least the next twelve months. However, our actual capital requirements will depend on many factors, many of which are outside our control, including:
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future revenue generation;
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future operating expenses, including planned increases in our research and development, sales and marketing and general and administrative expenses;
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the cost of filing and prosecuting patent applications and defending and enforcing our patent and other intellectual property rights;
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the cost of defending, in litigation or otherwise, any claims that we infringe third party intellectual property rights;
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the effect of competing technological and market developments; and
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the extent to which we acquire or invest in businesses, products and technologies, although we currently have no commitments or agreements relating to any of these types of transactions.
Historically, we have financed our operations and internal growth primarily through private placements of our equity securities and debt and through our initial public offering. We cannot be certain that additional public or private financing will be available in amounts acceptable to us, or at all. If we raise additional funds by issuing equity securities, you may experience dilution. Furthermore, any new securities we issue may have rights, preferences and privileges superior to our common stock. Debt financing, if available, may involve restrictive covenants. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders.
Risks Related to Our Intellectual Property
We may not be able to adequately protect our intellectual property rights in internally developed software and other materials and efforts to protect them may be costly.
Our ability to compete effectively is dependent in part upon our ability to protect our intellectual property rights in our software and other materials that we have developed internally. While we hold issued patents and pending patent applications covering certain elements of our technology, these patents, and, more generally, existing patent laws, may not provide adequate protection for portions of the technology that are important to our business. In addition, our pending patent applications may not result in issued patents. We have largely relied on copyright, trade secret and, to a lesser extent, trademark laws, as well as generally relying on confidentiality procedures and agreements with our employees, consultants, customers and vendors, to control access to, and distribution of, technology, software, documentation and other confidential information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain, use or distribute our technology without authorization. If this were to occur, we could lose revenue as a result of competition from products infringing or misappropriating our technology and intellectual property and we may be required to initiate litigation to protect our proprietary rights and market position.
United States patent, copyright and trade secret laws offer us only limited protection and the laws of some foreign countries do not protect proprietary rights to the same extent. Accordingly, defense of our proprietary technology may become an increasingly important issue as we continue to expand our operations and product development into countries that provide a lower level of intellectual property protection than the United States. Policing unauthorized use of our technology is difficult and the steps we take may not prevent misappropriation of the technology we rely on. If competitors are able to use our technology without recourse, our ability to compete would be harmed and our business would be materially and adversely affected.
We may elect to initiate litigation in the future to enforce or protect our proprietary rights or to determine the validity and scope of the rights of others. That litigation may not be ultimately successful and could result in substantial costs to us, the reduction or loss in intellectual property protection for our technology, the diversion of our management attention and harm to our reputation, any of which could materially and adversely affect our business and results of operations.
Claims asserted by the Massachusetts Institute of Technology could subject us to litigation or require the payment by us of royalties.
In 1991, we entered into a license agreement with the Massachusetts Institute of Technology, or MIT, which was subsequently amended in 1993, 1994, 1995 and 1997, relating to two patents related to methods and systems for simulating fluid dynamics that had been developed by an MIT scientist, Dr. Kim Molvig. Dr. Molvig is one of our co-founders, but has not been employed by us since 1998. Under the MIT license agreement, as amended, we were required to pay royalties at rates ranging from 1% to 3%, up to a maximum aggregate amount of $2.8 million, on any sales by us of products that incorporated the licensed technology. We paid minimum annual royalties in the amount of $20,000 per year from 1996 to 2007 under this agreement. In 1998, after we developed the extended lattice Boltzmann method that forms the core of our current product offering, we discontinued the use in our products of the technology licensed from MIT. We ceased paying minimum royalties to MIT in 2007.
In 2011, we were notified by MIT that it believed that we are practicing the patents covered by the license agreement, and therefore are in arrears in the payment of royalties under the agreement. We have advised MIT that we do not believe that we have practiced the subject patents at any time since at least 1998, or that we owe any royalties under the agreement.
As of January 31, 2014, MIT has not commenced suit against us with respect to its claims, and if any such suit is commenced by MIT, we intend to defend it vigorously. Litigation instituted by MIT alleging infringement by us of its patent rights, whether meritorious or not, could be time-consuming to defend and could damage our reputation, result in substantial and unanticipated costs associated with litigation, or result in the payment by us of damages. We believe that if MIT were to prevail in any such litigation, the royalties due under the terms of the license agreement, after giving effect to the approximately $0.2 million in royalties that we have already paid, would not exceed approximately $2.6 million (excluding any interest or costs of litigation).
Assertions by any other third party that we infringe its intellectual property, whether successful or not, could subject us to costly and time-consuming litigation and expensive licenses.
The software and technology industries are characterized by frequent litigation based on allegations of infringement or other violations of patents, copyrights, trademarks, trade secrets or other intellectual property rights. We cannot be certain that our products and services do not infringe the intellectual property rights of third parties. Additionally, because our software is integrated with our customers’ business processes and other software applications, third parties may bring claims of infringement against us, as well as our customers and other software suppliers, if the cause of the alleged infringement cannot be easily determined. Although we believe that our intellectual property rights are sufficient to allow us to market our products and services without incurring liability to third parties, third parties may bring claims of infringement or misappropriation against us. Except as set forth above with regard to MIT, no claims of this type have been asserted against us to date. However, such claims of alleged infringement of intellectual property rights of third parties could be asserted against us in the future. We cannot be sure that we would prevail against any such asserted claim. In addition to possible claims with respect to our proprietary information, some of our products contain technology developed by and licensed from third parties and we may likewise be susceptible to infringement or misappropriation claims with respect to these third party technologies.
Claims of alleged infringement of third party intellectual property rights may have a material adverse effect on our business. Any intellectual property rights claim made against us or our customers, with or without merit, could be time-consuming, expensive to litigate or settle, and could divert management attention and financial
resources. An adverse determination could prevent us from offering our products or services to our customers and may require that we procure or develop substitute products or services that do not infringe. Claims of intellectual property infringement also might require us to enter into costly royalty or license agreements. We may be unable to obtain royalty or license agreements on terms acceptable to us or at all. Furthermore, many of our license agreements require us to indemnify our customers for certain third-party intellectual property infringement claims, which could increase our costs as a result of defending such claims and may require that we pay damages if there were an adverse ruling related to any such claims. Even if we are not a party to any litigation between a customer and a third party, an adverse outcome in any such litigation could make it more difficult for us to defend our intellectual property in any subsequent litigation in which we are a named party. Moreover, such infringement claims may harm our relationships with our existing customers and may deter future customers from subscribing to our services on acceptable terms, if at all.
We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of employees’ former employers.
We could in the future be subject to claims that we or our employees have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of our employees’ former employers. Litigation may be necessary to defend against these claims. If we fail in defending against such claims, a court could order us to pay substantial damages and prohibit us from using technologies or features that are essential to our products if such technologies or features are found to incorporate or be derived from the trade secrets or other proprietary information of the former employers. In addition, we may lose valuable intellectual property rights or personnel. A loss of key personnel or their work product could hamper or prevent our ability to develop, market and support potential products or product enhancements, which could severely harm our business. Even if we are successful in defending against these claims, such litigation could result in substantial costs and be a distraction to management.
Our use of open source software could impose limitations on our ability to provide our services, which could adversely affect our financial condition and operating results.
We utilize open source software in our products. The use and distribution of open source software can lead to greater risks than the use of third-party commercial software, as open source software does not come with warranties or other contractual protections regarding infringement claims or the quality of the code. From time to time parties have asserted claims against companies that distribute or use open source software in their products and services, asserting that open source software infringes their intellectual property rights. We could be subject to suits by parties claiming infringement of intellectual property rights with respect to what we believe to be open source software. In such event, we could be required to seek licenses from third parties in order to continue using such software or offering certain of our services or to discontinue the use of such software or the sale of our affected services in the event we could not obtain such licenses, any of which could adversely affect our business, operating results and financial condition. In addition, if we combine our proprietary software with open source software in a certain manner, we could, under some of the open source licenses, be required to release the source code of our proprietary software.
Risks Related Ownership of Our Common Stock
The market price for our common stock may be volatile, which could contribute to the loss of your investment.
Shares of our common stock were sold in our July 2012 initial public offering at a price of $10.00 per share, and, through January 31, 2014, our common stock has subsequently traded at prices as high as $16.42 and as low as $6.88 per share. An active, liquid and orderly market for our common stock may not continue, which could depress the trading price of our common stock and limit your opportunities to resell shares of our common stock at or above the price you paid.
Factors affecting the trading price of our common stock may include:
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actual or anticipated fluctuations in our quarterly financial results or the quarterly financial results of companies perceived to be similar to us;
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changes in the market’s expectations about our operating results;
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the effects of seasonality on our business cycle;
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success of competitive products and services;
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our operating results failing to meet the expectation of securities analysts or investors in a particular period or failure of securities analysts to publish reports about us or our business;
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changes in financial estimates and recommendations by securities analysts concerning our company, the digital simulation market, or the software industry in general;
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operating and stock price performance of other companies that investors deem comparable to us;
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news reports relating to trends in the markets we serve, such as the ground transportation market, including changes in estimates of the future size and growth rate of our markets;
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announcements by us or our competitors of acquisitions, new offerings or improvements, significant contracts, commercial relationships or capital commitments;
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our ability to market new and enhanced product and services offerings on a timely basis;
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changes in laws and regulations affecting our business;
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commencement of, or involvement in, litigation involving our company, our general industry, or both;
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changes in our capital structure, such as future issuances of securities or the incurrence of additional debt;
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the volume of shares of our common stock available for public sale;
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any major change in our board or management;
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sales of substantial amounts of common stock by our directors, executive officers or significant stockholders or the perception that such sales could occur; and
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general economic and political conditions such as recessions, interest rates, fuel prices, international currency fluctuations and acts of war or terrorism.
Broad market and industry factors may materially harm the market price of our common stock irrespective of our operating performance. The stock market in general, and the NASDAQ Global Market and the market for technology companies and software companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the particular companies affected. The trading prices and valuations of these stocks, and of ours, may not be predictable.
A loss of investor confidence in the market for technology or software stocks or the stocks of other companies which investors perceive to be similar to us, the opportunities in the digital simulation market or the stock market in general, could depress our stock price regardless of our business, prospects, financial conditions or results of operations.
In addition, in the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against the affected company. This type of litigation, even if unsuccessful, could be costly to defend and could distract our management.
Our revenue, operating results and gross margin have historically fluctuated significantly from quarter to quarter, and we expect they will continue to do so, which could cause the trading price of our stock to decline.
Our quarterly revenue and results of operations have fluctuated in the past and may do so in the future as a result of a variety of factors, many of which are outside of our control. If our quarterly revenue or results of operations fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Fluctuations in our results of operations may be due to a number of factors, including, but not limited to, those listed below and identified throughout this “Risk Factors” section in this Annual Report on Form 10-K:
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our recognition of project revenues during the quarter in which services are completed, rather than ratably over the period of performance of services;
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our ability to retain and increase sales to existing customers and attract new customers;
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changes in the volume and mix of products sold in a particular quarter;
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seasonality of our business cycle, given that our cash flows from operating activities are typically significantly higher in our first fiscal quarter;
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our policy of expensing sales commissions on license and project sales;
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the timing and success of new product introductions or upgrades by us or our competitors;
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changes in our pricing policies or those of our competitors;
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failure to achieve anticipated levels of customer acceptance of our existing or new applications or platform changes;
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failure to expand the utilization of PowerFLOW in our customer base or to penetrate new customers and market segments;
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unexpected outcomes of matters relating to litigation;
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unanticipated changes in tax rates and tax laws;
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failure to effectively protect our intellectual property, especially in developing countries;
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failure to successfully integrate acquired businesses and technologies;
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renegotiation or termination of royalty or intellectual property arrangements;
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unanticipated impact of accounting for technology acquisitions, if any;
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general economic conditions, particularly in countries where we derive a significant portion of our revenue;
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greater than anticipated expenses or a failure to maintain cost controls;
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competition, including entry into the market by new competitors and new product offerings by existing competitors;
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the amount and timing of expenditures related to expanding our operations, research and development, or introducing new products;
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fluctuations in foreign currency exchange rates;
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changes in the licensing or payment terms for our products and services; and
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the purchasing and budgeting cycles of our customers.
Customers may choose not to renew annual licenses, resulting in reduced revenue to us. In addition, customers may wish to negotiate renewals of licenses on terms and conditions that require us to change the way we recognize revenue under our existing revenue recognition practices at the time of such renewal with such customers. Any such changes could result in a material adverse effect on our results.
We expect that the factors listed above and other risks discussed in this report will continue to affect our operating results for the foreseeable future. Because of the factors listed above and other risks discussed in this report, we believe that period-to-period comparisons of our operating results are not necessarily meaningful and should not be relied upon as indications of future performance.
The JOBS Act allows us to postpone the date by which we must comply with certain laws and regulations intended to protect investors and to reduce the amount of information we provide in our reports filed with the SEC, which could undermine investor confidence in our company and adversely affect the market price of our common stock.
The JOBS Act, which was enacted in April 2012, is intended to reduce the regulatory burden on “emerging growth companies.” As defined in the JOBS Act, a public company whose initial public offering of common equity securities occurred after December 8, 2011 and whose annual gross revenues are less than $1.0 billion will, in general, qualify as an emerging growth company until the earliest of:
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the last day of its fiscal year following the fifth anniversary of the date of its initial public offering of common equity securities;
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the last day of its fiscal year in which it has annual gross revenue of $1.0 billion or more;
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the date on which it has, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; and
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the date on which it is deemed to be a “large accelerated filer,” which will occur at such time as the company (a) has an aggregate worldwide market value of common equity securities held by non-affiliates of $700 million or more as of the last business day of its most recently completed second fiscal quarter, (b) has been required to file annual and quarterly reports under the Securities Exchange Act of 1934 for a period of at least 12 months, and (c) has filed at least one annual report pursuant to the Securities Act of 1934.
Under this definition, we are currently an emerging growth company and could remain an emerging growth company until as late as January 31, 2018.
The JOBS Act provides that, so long as a company qualifies as an emerging growth company, it will, among other things:
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be exempt from the provisions of Section 404(b) of the Sarbanes-Oxley Act requiring that its independent registered public accounting firm provide an attestation report on the effectiveness of its internal control over financial reporting;
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be exempt from the “say on pay” provisions (requiring a non-binding shareholder vote to approve compensation of certain executive officers) and the “say on golden parachute” provisions (requiring a non-binding shareholder vote to approve golden parachute arrangements for certain executive officers in connection with mergers and certain other business combinations) of the Dodd-Frank Act and certain disclosure requirements of the Dodd-Frank Act relating to compensation of its chief executive officer;
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be permitted to omit the detailed compensation discussion and analysis from proxy statements and reports filed under the Securities Exchange Act of 1934 and instead provide a reduced level of disclosure concerning executive compensation; and
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be exempt from any rules that may be adopted by the Public Company Accounting Oversight Board requiring mandatory audit firm rotation or a supplement to the auditor’s report on the financial statements.
We have irrevocably elected not to take advantage of the extension of time to comply with new or revised financial accounting standards available under Section 102(b) of the JOBS Act. We currently intend to take advantage of some or all of the reduced regulatory and reporting requirements that will be available to us so long
as we qualify as an “emerging growth company”. Among other things, this means that our independent registered public accounting firm will not be required to provide an attestation report on the effectiveness of our internal control over financial reporting so long as we qualify as an emerging growth company, which may increase the risk that weaknesses or deficiencies in our internal control over financial reporting go undetected. Likewise, so long as we qualify as an emerging growth company, we may elect not to provide you with certain information, including certain financial information and certain information regarding compensation of our executive officers, that we would otherwise have been required to provide in filings we make with the SEC, which may make it more difficult for investors and securities analysts to evaluate our company. As a result, investor confidence in our company and the market price of our common stock may be adversely affected.
We are subject to financial and other reporting and corporate governance requirements that may be difficult for us to satisfy. Evolving regulation of corporate governance and public disclosure may result in additional expenses and continuing uncertainty.
Prior to our initial public offering of common stock in July 2012, we operated our business as a private company. As a result of our initial public offering, we became obligated to file with the Securities and Exchange Commission annual and quarterly information and other reports that are specified in Sections 13 and 15(d) of the Exchange Act, and we also became subject to other new financial and other reporting and corporate governance requirements, including the requirements of the Nasdaq Stock Market and certain provisions of the Sarbanes-Oxley Act of 2002 and the regulations promulgated thereunder, which impose significant compliance obligations upon us, particularly after we are no longer an emerging growth company. These obligations require a commitment of additional resources and result in the diversion of our senior management’s time and attention from our day-to-day operations. In particular, we have been required, or may in the future be required, to undertake some or all of the following:
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create or expand the roles and duties of our board of directors, our board committees and management;
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institute a more comprehensive financial reporting and disclosure compliance function;
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hire additional financial and accounting personnel and other experienced accounting and finance staff with the expertise to address the complex accounting matters applicable to public companies;
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establish an internal audit function;
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prepare and distribute periodic public reports in compliance with our obligations under the federal securities laws;
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establish an investor relations function; and
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establish new internal policies, such as those relating to disclosure controls and procedures and insider trading.
We may not be successful in complying with these obligations, and compliance with these obligations could be time-consuming and expensive.
If we are unable to maintain effective internal control over financial reporting, investors could lose confidence in our financial statements and our company, which could have a material adverse effect on our business and stock price.
We are required to maintain internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted accounting principles. In addition, once we are no longer an emerging growth company, our independent registered public accounting firm will be required to consider our internal controls over financial reporting and express an opinion as to their effectiveness. If our management or our independent registered public accounting firm identifies one or more unremediated material weaknesses in our internal control over financial reporting, we will be unable to conclude that such internal control is effective. If we are unable to conclude that our internal control over financial reporting is effective because the material
weaknesses identified above have not been remediated or for any other reason, or, when we are no longer an emerging growth company, if our independent registered public accounting firm is unable to express an opinion that our internal control over financial reporting is effective, investors could lose confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.
If securities analysts do not publish research or reports about our business or if they downgrade our stock, the price of our common stock could decline.
The trading market for our common stock relies in part on the research and reports that industry or financial analysts publish about us, our business, our markets and our competitors. We do not control these analysts. If securities analysts do not cover our common stock, the lack of research coverage may adversely affect the market price of our common stock. Furthermore, if one or more of the analysts who do cover us downgrade our stock or if those analysts issue other unfavorable commentary about us or our business, our stock price would likely decline. If one or more of these analysts cease coverage of us or fails to regularly publish reports on us, we could lose visibility in the market and interest in our stock could decrease, which in turn could cause our stock price or trading volume to decline and may also impair our ability to expand our business with existing customers and attract new customers.
We do not currently intend to pay dividends on our common stock and, consequently, your ability to achieve a return on your investment will depend on the appreciation in the price of our common stock.
We have never declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings to fund our future growth and do not expect to declare or pay any dividend on shares of our common stock in the foreseeable future. As a result, you may only receive a return on your investment in our common stock if the market price of our common stock appreciates and you sell your shares at a price above your cost. The price of our common stock may not appreciate in value or ever exceed the price that you paid for shares of our common stock.
Anti-takeover provisions in our amended and restated certificate of incorporation and amended and restated bylaws, as well as provisions in Delaware law, might discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.
Our amended and restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could have the effect of rendering more difficult or discouraging an acquisition deemed undesirable by our board of directors. Our corporate governance documents include provisions:
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providing for three classes of directors with the term of office of one class expiring each year, commonly referred to as a staggered board;
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authorizing blank check preferred stock, which could be issued with voting, liquidation, dividend and other rights superior to our common stock;
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limiting the liability of, and providing indemnification to, our directors and officers;
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limiting the ability of our stockholders to call and bring business before special meetings and to take action by written consent in lieu of a meeting;
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requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our board of directors;
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controlling the procedures for the conduct and scheduling of board and stockholder meetings;
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limiting the determination of the number of directors on our board and the filling of vacancies or newly created seats on the board to our board of directors then in office; and providing that directors may be removed by stockholders only for cause.
These provisions, alone or together, could delay hostile takeovers and changes in control or changes in our management.
As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation law, which prohibits a publicly-held Delaware corporation from engaging in a business combination with an interested stockholder, generally a person which together with its affiliates owns, or within the last three years has owned, 15% of our voting stock, for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner.
The existence of the foregoing provisions and anti-takeover measures could limit the price that investors might be willing to pay in the future for shares of our common stock. They could also deter potential acquirers of our company, thereby reducing the likelihood that you could receive a premium for your common stock in an acquisition.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
Our principal offices occupy approximately 60,000 square feet of leased office space in Burlington, Massachusetts pursuant to a lease agreement that expires in March 2016. We also maintain sales, support and applications management offices in Livonia, Michigan; Brisbane, California; Paris, France; Stuttgart, Germany; Munich, Germany; Ciriè, Italy; Yokohama, Japan; Seoul, Korea; and Shanghai, China. We believe that our current facilities are suitable and adequate to meet our current needs. We intend to add new facilities or expand existing facilities as we add employees, and we believe that suitable additional or substitute space will be available as needed to accommodate any such expansion of our operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any pending legal proceedings. However, because of the nature of our business, we may be subject at any particular time to lawsuits or other claims arising in the ordinary course of our business, and we expect that this will continue to be the case in the future
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Price Range of Common Stock
Our common stock trades on the NASDAQ Global Market tier of the NASDAQ Stock Market under the symbol: “EXA.” The following table sets forth the high and low sales prices per share of our common stock, for each quarter during fiscal years 2014 and 2013, following the consummation of our initial public offering on July 2, 2012.
On March 21, 2014, the last reported sale price on the NASDAQ Global Market for our common stock was $14.00 per share. On March 21, 2014, there were approximately 85 holders of record of our common stock. This number does not include stockholders for whom our shares were held in “nominee” or “street” name.
Dividend Policy
We have never paid or declared any cash dividends on our common stock and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. Covenants in the agreements governing our term loan and line of credit also restrict our ability to pay cash dividends. We intend to retain all available funds and any future earnings, if any, to fund the development and expansion of our business. Payment of future cash dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs, outstanding indebtedness and plans for expansion and restrictions imposed by lenders, if any.
Unregistered Sales of Equity Securities
From November 1, 2013 through January 31, 2014, we issued 240 shares of our common stock to an employee at a per share price of $6.50 pursuant to exercises of options granted under our 2007 Stock Incentive Plan, resulting in aggregate cash consideration to us of $1,560.
The sales of the above securities were exempt from registration under the Securities Act of 1933, as amended, or the Securities Act, in reliance upon Section 4(a)(2) of the Securities Act and Rule 701 promulgated under Section 3(b) of the Securities Act as a transaction by an issuer not involving any public offering and pursuant to benefit plans and contracts relating to compensation as provided under Rule 701.
For information regarding securities authorized for issuance under our equity compensation plans, see Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”
Comparative Stock Performance
The following stock performance graph compares the cumulative total return to stockholders for our common stock for the period commencing June 26, 2012 (the date on which our common stock commenced trading on the NASDAQ Global Market) and ended January 31, 2014 against the cumulative total return of the NASDAQ Composite Index and the NASDAQ Computer and Data Processing Index. The calculation of total cumulative returns assumes a $100 investment in our common stock, the NASDAQ Composite Index and the NASDAQ Computer and Data Processing Index, and assumes reinvestment of all dividends, if any. The historical information set forth below is not necessarily indicative of future performance.
Use of Proceeds
On July 3, 2012, we completed the initial public offering of our common stock pursuant to our Registration Statement on Form S-1 (File No. 333-176019), which was declared effective by the Securities and Exchange Commission on June 27, 2012. The underwriters for the offering were Stifel Nicolaus & Company, Incorporated, Robert W. Baird & Co. Incorporated, Canaccord Genuity Inc. and Needham & Company, LLC. We did not utilize any of the net proceeds of this offering in our business during the three months ended January 31, 2014.
ITEM 6:
ITEM 6: SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes in Part IV, Item 8 of this Annual Report on Form 10-K and with our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7
ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and notes included in Part IV, Item 15 of this Annual Report on Form 10-K. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report, including but not limited to those set forth in “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors”.
Overview
We develop, sell and support simulation software and services that vehicle manufacturers use to enhance the performance of their products, reduce product development costs and improve the efficiency of their design and engineering processes. Our solutions enable our customers to augment or replace inefficient and expensive methods of evaluating alternative designs, such as wind tunnel testing using physical prototypes, with accurate digital simulations that are more useful and timely. We believe, based on feedback from our customers and data published by them, that use of our software solutions enables significant cost savings and fundamental improvements in their vehicle development process by allowing their engineers and designers to gain crucial insights about design performance early in the design cycle.
Our core product, PowerFLOW®, is an innovative software solution for simulating complex fluid flow problems, including aerodynamics, thermal management, and aeroacoustics, or wind noise. PowerFLOW relies upon our proprietary technology that we refer to as Digital Physics®, which is based on algorithms known as the lattice Boltzmann method. Our proprietary technology enables PowerFLOW to predict complex fluid flows with a level of reliability comparable to or better than physical testing, with results that are more accurate and useful than those of alternative computational fluid dynamics, or CFD, methods.
We currently focus primarily on the ground transportation market, including manufacturers in the passenger vehicle, highway truck, off-highway vehicle and train markets, as well as their suppliers. Over 125 manufacturers currently utilize our products and services, including 14 of the global top 15 passenger vehicle manufacturers, based on motor vehicle production volume for 2012, as reported by the Organisation Internationale des Constructeurs d’Automobiles, or the International Organization of Vehicle Manufacturers. Global vehicle manufacturers face increasing pressure, from government mandates as well as from consumers, to improve the efficiency of their products. This requires different powertrain choices, changes in the shape of the vehicle, and reductions in vehicle weight, all of which we believe favor the adoption of simulation-driven design.
We are also beginning to explore other markets in which we believe the capabilities of PowerFLOW have broad application, such as the aerospace, oil and gas production, chemical processing, architecture engineering and construction, power generation, biomedical and electronics industries. We offer our solutions through annual capacity-based licenses, either as software-only, to be run on the customer’s own computer hardware, or in the form of software-as-a-service, via our hosted PowerFLOW OnDemand offering. We sell our products and services primarily through our direct sales force, including sales executives and applications engineering teams deployed near our customers in the United States, Europe, Japan, Korea and China, through a distributor in India and through a sales agent in Brazil.
We have a predictable business model based on recurring revenue from a growing customer base. For fiscal year 2014, we recorded total revenues, net loss and Adjusted EBITDA of $54.5 million, $0.7 million and $3.3 million, respectively. Since generating our first commercial revenue in 1994, our annual revenue has increased for 20 consecutive years. Our total revenues in fiscal year 2014 increased 11.6%, compared with fiscal year 2013. On a constant currency basis, our total revenues in fiscal year 2014 increased 14.3%, compared with fiscal year 2013. Adjusted EBITDA and revenue on a constant currency basis are non-GAAP financial measures.
For definitions of Adjusted EBITDA and revenue on a constant currency basis, an explanation of our management’s use of these measures and a reconciliation of our Adjusted EBITDA to our net income, please see “-Non-GAAP Measures,” below.
Seasonality
We have experienced and expect to continue to experience seasonal variations in the timing of customers’ purchases of our software products. Many customers make purchase decisions based on their budget cycles, which typically coincide with the calendar year, except in Japan, where our customers’ budget cycle typically begins on April 1. Because our software products are sold pursuant to annual subscription agreements and we recognize revenue from these subscriptions over the term of the agreement, downturns or upturns in sales may not be immediately reflected in our operating results. However, these seasonal trends materially affect the timing of our cash flows, as we generally receive the annual license fee at the time the license term commences, or shortly thereafter. As a result, our cash flows from operations are typically highest in the first quarter of each fiscal year.
Results of Operations
The following tables set forth, for the periods presented, data from our consolidated statements of operation, as well as that data as a percentage of revenues. The information contained in these tables should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
(1) Amounts include stock-based compensation expense as follows:
(2) Includes amortization expense related to intangible assets as follows:
Due to rounding, totals may not equal the sum of line items in the table above.
Comparison of Fiscal Years Ended January 31, 2014 and 2013
Revenue
License revenue increased 8.3%, from $41.2 million in fiscal year 2013 to $44.6 million in fiscal year 2014. The $3.4 million increase was driven almost entirely by increased consumption of simulation capacity by existing customers and the addition of 17 new license customers. Project revenue increased $2.2 million during fiscal year 2014 compared to fiscal year 2013 due to expanded sales and greater activity with existing customers.
Foreign exchange fluctuations, particularly the weakness of the Japanese yen, negatively impacted total revenue in fiscal year 2014 by $1.3 million as compared to fiscal year 2013. On a constant currency basis, our total revenues in fiscal year 2014 increased 14.3%, compared with fiscal year 2013.
Cost of revenue
Cost of revenue for fiscal year 2014 was $16.0 million, an increase of $1.8 million, or 12.8%, compared with $14.2 million during fiscal year 2013. As a percentage of revenues, cost of revenues increased to 29.3% for fiscal year 2014 from 29.0% for fiscal year 2013. Payroll and employee related costs, including travel, accounted for approximately $1.5 million of the increase, primarily as a result of the net addition of 10 new application engineers, merit increases for existing personnel, increased stock compensation expense and increased travel due to expanded service and support efforts. In addition, capacity expansions at our New Jersey data center and our opening of a new data center in France, together resulted in increased facility costs of $0.4 million, including hosting fees, rent, utilities and depreciation. These increases were partially offset by approximately $0.1 million of reduced expenditures for consulting professionals.
Sales and marketing
Sales and marketing expenses for fiscal year 2014 were $9.5 million, an increase of $2.4 million, or 34.1% compared with $7.1 million for fiscal year 2013. As a percentage of revenues, sales and marketing expenses increased to 17.5% for fiscal year 2014 from 14.6% for fiscal year 2013. Increased non-commission payroll and employee related costs, including travel, accounted for approximately $1.2 million of the increase, primarily due to the net addition of 1 new sales person in fiscal year 2014, merit increases for existing personnel and increased payroll taxes associated with the increased payroll and commission levels. Commission expense increased by approximately $1.1 million due to an increase in invoicing levels during fiscal year 2014 as compared to fiscal year 2013. The balance of the increase is primarily attributed to the addition of consultants to expand our sales efforts in targeted areas.
Research and development
Research and development expenses for fiscal year 2014 were $18.2 million, an increase of $1.6 million, or 9.3%, compared with $16.7 million for fiscal year 2013. As a percentage of revenues, research and development expense decreased to 33.5% for fiscal year 2014 from 34.1% for fiscal year 2013. Payroll and employee related costs, including travel-related expenses, accounted for approximately $1.2 million of the increase, primarily as a result of the net addition of 7 new scientists and software engineers and merit increases for existing personnel. In addition, capacity expansions at our New Jersey data center and our opening of a new data center in France, together resulted in increased facility costs of $0.5 million, including hosting fees, rent, utilities and depreciation. These increases were partially offset by approximately $0.1 million of reduced expenditures for consulting professionals and academic sponsorship costs.
General and administrative
General and administrative expenses for fiscal year 2014 were $10.9 million, an increase of $1.9 million, or 21.7%, compared with $9.0 million for fiscal year 2013. As a percentage of revenues, general and administrative expenses increased to 20.0% for fiscal year 2014, from 18.3% for fiscal year 2013. Increased payroll and employee related costs, including travel, accounted for approximately $1.0 million of the increase, primarily as a result of the addition of our chief accounting officer at the end of the third quarter of fiscal year 2013, merit-based and incentive-based compensation increases for existing personnel, increased stock-based compensation for existing personnel and certain members of our board of directors and recruiting and severance costs associated with our departing chief financial officer. Approximately $0.8 million of the increase is primarily attributed to increased professional costs and costs associated with being a public company after our initial public offering, which occurred on July 3, 2012, including increased audit and legal fees, investor relations fees, filing fees, insurance premiums and franchise taxes. In addition, during fiscal year 2013, we released a $0.3 million sales tax reserve after a state-by-state customer review determined that the reserve was no longer required, resulting in a positive impact that did not recur in fiscal year 2014. The above increases were partially offset by approximately $0.2 million in cost savings primarily associated with our facilities.
Other expense, net
Total other expense, net for fiscal year 2014 was $1.5 million, a decrease of $0.4 million, or 38.9%, from $1.1 million for fiscal year 2013. Other expense, net for fiscal year 2014 primarily consists of a $0.8 million loss from the extinguishment of debt related to the repayment of all outstanding obligations under our former loan and security agreement in May 2013 and interest expense of $0.7 million. Other expense net, for fiscal year 2013 primarily consists of interest expense of $1.6 million, offset by $0.5 million in gains relating to the marking to market of our former equity participation right and our former preferred stock warrant liability. As a result of the
May 2013 repayment of debt, we saved cash interest which would otherwise have been incurred under the agreement of approximately $0.4 million in fiscal year 2014 and we expect to save $0.4 million and $0.2 million of cash interest in fiscal years 2015 and 2016, respectively.
Benefit (provision) for income taxes
Income taxes changed from a provision of $0.1 million in fiscal year 2013 to a benefit of $0.9 million in fiscal year 2014, and our effective tax rate changed from 12.8% to 56.5%. For fiscal year 2014, the effective income tax rate differed from the federal statutory rate mainly due to nondeductible compensation offset by the tax benefit of federal and state research and development credits. For fiscal years ended January 31, 2014 and 2013, the effective income tax rate was impacted discretely by loss on extinguishment of debt, and for 2013 only, mark-to-market adjustments on our former warrants and equity participation right, for which there was no tax provision.
We do not expect that our unrecognized tax benefit will change significantly within the next twelve months. We and our subsidiaries file United States federal income tax returns and tax returns in various state and foreign jurisdictions. With limited exceptions, we are no longer subject to federal, state, local or foreign examinations for years prior to January 31, 2009. However, carryforward attributes that were generated prior to January 31, 2010 may still be adjusted upon examination by federal, state and local tax authorities if they either have been or will be used in a future period.
Under Section 382 of the Internal Revenue Code of 1986, as amended, substantial changes in our ownership may limit the amount of net operating loss carryforwards that could be utilized annually in the future to offset our taxable income. Specifically, this limitation may arise in the event of a cumulative change in ownership of our company of more than 50% within a three-year period. Any such annual limitation may significantly reduce the utilization of our net operating loss carryforwards before they expire. We performed an analysis as of January 31, 2014, and determined that we had not experienced an ownership change for purposes of Section 382. However, future transactions in our common stock could trigger an ownership change for purposes of Section 382, which could limit the amount of net operating loss carryforwards and other attributes that could be utilized annually in the future to offset our taxable income, if any. Any such limitation, whether as the result of sales of common stock by our existing stockholders or sales of common stock by us, could have a material adverse effect on our results of operations in future years.
Comparison of Fiscal Years Ended January 31, 2013 and 2012
Revenue
License revenue increased 6.2%, from $38.8 million in fiscal year 2012 to $41.2 million in fiscal year 2013. The net increase was due to $0.6 million in sales of simulation capacity to new customers and a $1.9 million increase in consumption of simulation capacity by existing customers. License revenue growth was impacted by
the loss of one significant motorsport customer which contributed to revenue in fiscal year 2012, but has since closed its motorsport division. Project revenue increased $0.5 million during fiscal year 2013 compared to fiscal year 2012 due to increased project activity and the addition of new project clients.
Foreign exchange fluctuations, particularly the weakness of the Euro, negatively impacted total revenue in fiscal year 2013 by $1.5 million as compared to fiscal year 2012. On a constant currency basis, our total revenues in fiscal year 2013 increased 9.6%, compared with fiscal year 2012.
Cost of revenue
Cost of revenue for fiscal year 2013 was $14.2 million, an increase of $2.1 million, or 17.2%, compared with $12.1 million during fiscal year 2012. As a percentage of revenues, cost of revenues increased to 29.0% for fiscal year 2013 from 26.3% for fiscal year 2012. Payroll and employee related costs, including travel, accounted for approximately $2.3 million of the increase, primarily as a result of the net addition of 27 new application engineers, merit increases for existing personnel, a reinstated 401k employer match in fiscal year 2013, increased stock compensation expense and increased travel due to expanded service and support efforts. In addition, capacity expansions at our New Jersey data center resulted in increased facility costs of $0.5 million, including hosting fees, rent, utilities and depreciation. These increases were partially offset by a $0.8 million decrease in royalty costs. The decrease in royalty costs was the result of our acquisition from science + computing AG in November 2011 of certain intellectual property assets related to our PowerVIZ product on which we had previously paid royalties.
Sales and marketing
Sales and marketing expenses for fiscal year 2013 were $7.1 million, an increase of $0.9 million, or 14.2% compared with $6.2 million for fiscal year 2012. As a percentage of revenues, sales and marketing expenses increased to 14.6% for fiscal year 2013 from 13.6% for fiscal year 2012. Non-commission payroll and employee related costs, including travel, accounted for approximately $1.2 million of the increase, primarily due to the net addition of 6 new salespeople in fiscal year 2013, merit increases for existing personnel, a reinstated 401k employer match in fiscal year 2013, increased stock compensation expense and increased travel due to expanded sales efforts. Commission expense decreased by approximately $0.4 million, primarily due to revisions in our commission policies that impacted fiscal year 2013. We also expanded our sales and marketing facilities in Michigan during fiscal year 2013, which resulted in increased facility costs of approximately $0.1 million.
Research and development
Research and development expenses for fiscal year 2013 were $16.7 million, an increase of $2.2 million, or 15.5%, compared with $14.4 million for fiscal year 2012. As a percentage of revenues, research and development expense increased to 34.1% for fiscal year 2013 from 31.5% for fiscal year 2012. Payroll and employee related costs, including travel, accounted for approximately $2.0 million of the increase, primarily as a result of the net addition of 8 new scientists and software engineers, merit increases for existing personnel and a reinstated 401k employer match in fiscal year 2013. In addition, data center costs and processing fees increased by approximately $0.2 million due to expanded efforts in product development.
General and administrative
General and administrative expenses for fiscal year 2013 were $9.0 million, an increase of $0.8 million, or 10.0%, compared with $8.1 million for fiscal year 2012. As a percentage of revenues, general and administrative expenses increased to 18.3% for fiscal year 2013, from 17.7% for fiscal year 2012. Payroll and employee related costs, including travel, accounted for approximately $0.3 million of the increase, primarily as a result of the net addition of 3 new employees in fiscal year 2013 (including our chief accounting officer at the end of the third quarter of fiscal year 2013), merit increases for existing personnel, a reinstated 401k employer match in fiscal year 2013, increased stock compensation expense and increased travel and related costs due to activities associated with going public. In addition, approximately $0.4 million of the increase relates to professional costs associated with being a public company, including investor relations, filing fees and insurance premiums. Lastly, approximately $0.3 million of the increase relates to increased depreciation and amortization expense associated with our capital expenditures and amortization of the intellectual property assets acquired from science + computing AG in November 2011. These increases were partially offset by reductions in other business expenses of $0.2 million.
Other expense, net
Total other expense, net for fiscal year 2013 was $1.1 million, a decrease of $0.5 million, or 32.3%, from $1.6 million for fiscal year 2012. Gain increases of $0.1 million relating to foreign exchange movement and $0.7 million relating to the marking to market of our former equity participation right and our former preferred stock warrant liability were partially offset by a $0.3 million increase in interest expense due to increased borrowing levels.
(Provision) benefit for income taxes
Income taxes changed from a benefit of $10.7 million in fiscal year 2012 to a provision of $0.1 million in fiscal year 2013, and our effective tax rate changed from (311.9)% to 12.8%. The change in the tax provision relates primarily to the release of the valuation allowance on our United States deferred tax assets in the amount of $12.5 million that occurred in fiscal year 2012. The release of the valuation allowance was based upon our
cumulative history of earnings before taxes for financial reporting purposes over the three-year period ending on January 31, 2012 and our expectation that we will achieve profit before taxes in future periods. The benefit from income taxes in the amount of $10.7 million recorded in fiscal year 2012 had a significant favorable impact on our net income in fiscal year 2012, which did not recur in fiscal year 2013 and which we do not expect to recur in future periods.
Non-GAAP Measures
From time to time we provide certain non-GAAP financial measures to investors as additional information in order to supplement our consolidated financial statements, which are presented in accordance with accounting principles generally accepted in the United States, or GAAP. The non-GAAP financial information presented here should be considered in conjunction with, and not as a substitute for or superior to the financial information presented in accordance with GAAP and should not be considered a measure of our liquidity. There are significant limitations associated with the use of non-GAAP financial measures. Further, these measures may differ from the non-GAAP information, even where similarly titled or used by other companies and therefore should not be used to compare our performance to that of other companies.
Revenue on a constant currency basis. Our international operations generate and incur expenses that are denominated in foreign currencies, and changes in currency exchange rates can materially affect our consolidated results of operations. Our principal exposures are to fluctuations in exchange rates for the United States dollar versus the British pound, Chinese yuan, Euro, Japanese yen, and Korean won. To provide investors with information concerning underlying trends in our business, we disclose revenue on a constant currency basis, which we define as GAAP revenue, adjusted to reverse the impact of changes in the exchange rates of the principal currencies in which our international operations generated revenue and incurred expenses. We calculate revenue on a constant currency basis for 2014 by converting revenue that was generated in the currencies specified above during fiscal year 2014 to United States Dollars at assumed exchange rates equal to the exchange rates in effect for such currencies during fiscal year 2013, rather than the exchange rates actually in effect during fiscal year 2014.
Adjusted EBITDA. We define Adjusted EBITDA as EBITDA, excluding stock-based compensation expense. We define EBITDA as net income, excluding depreciation and amortization, interest expense, loss on extinguishment of debt, other income (expense), foreign exchange gain (loss) and benefit (provision) for income taxes. The GAAP measure most comparable to Adjusted EBITDA is GAAP net income.
Non-GAAP operating income. We define non-GAAP operating income as GAAP operating income excluding stock-based compensation expense and amortization of acquired intangible assets. The GAAP measure most comparable to non-GAAP operating income is GAAP operating income.
Non-GAAP net (loss) income. We define non-GAAP net (loss) income as GAAP net (loss) income excluding the after tax impact of stock-based compensation expense and amortization of acquired intangible assets. The GAAP measure most comparable to non-GAAP net (loss) income is net (loss) income.
Non-GAAP net (loss) income per diluted share. We define non-GAAP net (loss) income per diluted share as GAAP net (loss) income per diluted share excluding the after tax impact of stock-based compensation expense and amortization of acquired intangible assets. The GAAP measure most comparable to non-GAAP net (loss) income per diluted share is GAAP net (loss) income per diluted share.
Our management uses these non-GAAP financial measures to evaluate our operating performance and for internal planning and forecasting purposes. We believe that these measures help identify underlying trends in our business, are useful for comparing current results with prior period results, and are helpful to investors and financial analysts in assessing our operating performance. For example, our management considers Adjusted EBITDA to be an important indicator of our operational strength and the performance of our business and a good measure of our historical operating trends. However, each of these non-GAAP financial measures may have limitations as an analytical tool.
In considering our Adjusted EBITDA, non-GAAP operating income, non-GAAP net (loss) income and non-GAAP net (loss) income per diluted share, investors should take into account the following reconciliations of these non-GAAP financial measures to the comparable GAAP financial measures:
(1) The tax effect of non-cash stock-based compensation expense and non-cash amortization of acquired intangibles is estimated using a blended rate equivalent to our annual estimated United States federal tax rate and our state tax rate, exclusive of our net federal benefit. This rate is based on our estimated annual GAAP income tax rate forecast. Our estimated tax rate on non-GAAP income is determined annually and may be adjusted during the year to take into account events or trends that we believe materially impact the estimated annual rate including, but not limited to, significant changes resulting from tax legislation, revenues and expenses and other significant events. Due to the differences in the tax treatment of items excluded from non-GAAP earnings, as well as the methodology applied to our estimated annual tax rates as described above, our estimated tax rate on non-GAAP income may differ from our GAAP tax rate and from our actual tax liabilities .
(2) Share amounts utilized on a fully diluted basis were approximately 13.3 million, 12.9 million amd 10.3 million for the fiscal years ended January 31, 2014, 2013 and 2012, respectively.
(3) Due to rounding, totals may not equal the sum of line items in the table above.
Liquidity
Overview
Our primary sources of liquidity during the fiscal year 2014 were cash and cash equivalents on hand and cash flows provided by operating activities. Our primary uses of cash during the fiscal year 2014 were capital expenditures and repayments of our term loan and capital lease obligations. As of January 31, 2014, we had $28.8 million in cash and cash equivalents.
On May 31, 2013 we repaid, with available cash on hand, all outstanding obligations under our Loan and Security Agreement dated January 28, 2011 with Gold Hill Capital 2008, L.P. and Massachusetts Capital Resource Company. The repayment amount included $6.9 million of remaining outstanding principal, $0.1 million of accrued interest and $0.2 million of deferred origination fees that were accrued for in other long-term liabilities. In addition, in accordance with the agreement terms, we incurred and paid a prepayment interest penalty of $0.3 million, representing 3% of the amount advanced to us under the agreement in January 2011 and 4% of the amount advanced to us under the agreement in March 2012. We recognized a loss from the extinguishment of this debt of $0.8 million during the second quarter of fiscal year 2014, representing the prepayment interest penalty and the write-off of unamortized debt discount. As a result of this repayment, we saved cash interest of approximately $0.4 million for the remainder of fiscal year 2014, and expect to save $0.4 million and $0.2 million of cash interest in fiscal years 2015 and 2016, respectively.
On December 10, 2013, we filed a shelf registration statement on Form S-3, which included a base prospectus relating to, among other things, the registration of $75 million of our common stock that may be offered and sold by us from time to time pursuant to Rule 415 promulgated under the Act, in amounts, at prices and on terms to be determined at the time of the offering.
Net Cash Flows from Operating Activities
Variations in the amount of our net cash provided or used by operating activities are primarily the result of changes in the amount of our working capital accounts, mainly accounts receivable and deferred revenue, the timing of cash payments from our customers and of our cash expenditures, principally employee salaries, accounts payable and payments of value added taxes and consumption taxes on the receivables of our foreign subsidiaries.
Cash payments from our customers fluctuate due to timing of new and renewal license sales, which typically coincide with our customers’ budget cycles. The fourth quarter of each fiscal year generally has the highest license sales, with payment of the license fee becoming due at the commencement of the license term. As a
result, our cash flows from operations are typically highest in the first quarter of each fiscal year. Generally, customers are invoiced in advance for their annual subscription fee and the invoices are recorded in accounts receivable and deferred revenue, with deferred revenues being recognized ratably over the term of the subscription agreement. Increases in deferred revenue are attributable to growth in new business, offset by the related license revenues that are recognized ratably over time.
For fiscal year 2014, net cash provided by operating activities totaled $8.4 million, and was primarily the result of a $0.6 million decrease in accounts receivable, a $2.9 million increase in accrued expenses and a $4.8 million increase in deferred revenue.
For fiscal year 2013, net cash used in operating activities totaled $9.4 million, and was primarily the result of an $8.6 million increase in accounts receivable associated with the timing of collections from certain large customers and a decrease of $2.6 million in deferred revenue.
For fiscal year 2012, our operating activities provided net cash of $9.0 million, consisting primarily of a $4.2 million decrease in accounts receivable due to the timing of collection of a significant renewal order, $14.1 million of net income and an increase of $2.4 million and $1.9 million in other assets and accounts payable, respectively, due to the deferral of costs related to our initial public offering and a decrease of $0.2 million in accrued expenses related to value added tax payments made in connection with the customer collection described above.
Net Cash Flows from Investing Activities
Net cash used for investing activities for fiscal years 2014, 2013 and 2012 was $0.7 million, $0.4 million and $3.7 million, respectively. Expenditures for purchases of property and equipment to support the growth in our business operations for fiscal years 2014, 2013 and 2012 were $0.7 million, $0.4 million and $0.1 million, respectively. Net cash used for investing activities in fiscal year 2012 also included $3.5 million in cash paid in connection with our acquisition of certain intellectual property assets relating to our PowerVIZ product from science + computing AG.
Net Cash Flows from Financing Activities
For fiscal year 2014, net cash used for financing activities was $9.5 million, which consists primarily of long-term debt repayments of $7.4 million, including the final repayment in May 2013 and payments on our capital lease obligations of $2.1 million.
For fiscal year 2013, our financing activities provided net cash of $28.9 million, primarily attributable to proceeds from our initial public offering of common stock of $34.6 million and proceeds from long-term debt borrowings of $3.5 million, partially offset by payments on our line of credit of $7.0 million, payments on our capital lease obligations of $1.0 million and payments on our long-term debt of $1.1 million.
For fiscal year 2012, our financing activities provided net cash of $3.3 million, primarily attributable to proceeds received from our line of credit of $4.0 million, offset by payments on our capital lease obligations of $0.6 million.
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as of January 31, 2014 or 2013.
Contractual Commitments
Our contractual obligations as of January 31, 2014 are summarized below:
(1) Includes scheduled interest payments of $0.3 million, $0.2 million, $0.0 million and $0.0 million, respectively.
The contractual obligations table above does not include $0.5 million of net unrecognized tax benefits at January 31, 2014, as we are unable to estimate the period of cash settlement with the respective tax authorities.
Critical Accounting Policies and Estimates
This Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue recognition and allowance for doubtful accounts, stock- based compensation expense, intangible assets, and other long-lived assets, in-process research and development and income taxes. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect the most significant judgments, assumptions and estimates we use in preparing our consolidated financial statements:
Revenue Recognition
We generate revenues from the licensing of our software products, typically in the form of one-year term “subscription” or capacity-based licenses that have a defined term, and from project fees for consulting services and training. Licenses for our software products may be software to be run on the customer’s own computer hardware, or provided in the form of software-as-a-service, via our hosted PowerFLOW OnDemand offering.
Software
We recognize revenues from licensing our software products in accordance with ASC 985-605, Software Revenue Recognition. Term licenses typically have a term of one year and allow the customer to buy simulation in the form of a limited amount of simulation capacity on customer installed software and are sold based upon simulation capacity expected to be used within a certain time period-typically not exceeding one year.
We typically sell term and capacity-based software licenses combined in a bundled sale. For instance, when customers purchase simulation capacity, they typically also purchase a number of term-based licenses for preparation and analysis software. All of our software licenses include multiple elements such as support and
maintenance. Pursuant to the guidance within ASC 985-605, we have determined that since we do not have vendor-specific objective evidence of the fair value of the individual elements contained in a bundled sale of term and capacity-based software licenses, the arrangement is treated as a single unit of accounting and revenue is recognized ratably on a daily basis over the term of the license agreement, which coincides with the duration of the maintenance and support services. Our arrangements typically do not include rights to carryover any unused capacity beyond the contractual license term or any customer right of return.
Licenses have finite terms that are not extendible at their expiration, and capacity usage is limited by contract to the amount specified. Our practice is not to modify existing capacity-based licenses to allow simulation capacity to be added to an existing arrangement. A customer desiring to purchase additional simulation capacity or to license additional users of our preparation and analysis software during the term of the original simulation license does so by entering into a separate arrangement. Revenue from these new arrangements is recognized over the term of the new agreements, which include bundled maintenance and support, and are for a term of less than twelve months, coterminous with the remaining term of the original simulation license.
We commence recognition of term license revenue when persuasive evidence of an arrangement exists; delivery of the software or license keys has occurred and all service elements, if bundled or linked, have commenced; payment is fixed or determinable; and collection of the resulting receivable is considered probable by management. Payments received from customers in advance of revenue recognition are treated as deferred revenue.
If training or consulting service projects are bundled with a software license sale or, as a result of specific facts and circumstances, are determined to be linked with a software license sale, we treat this as one arrangement and recognize revenue ratably on a daily basis over the license period provided that delivery of all elements of the arrangement have commenced.
Software as a service (OnDemand)
We recognize revenue from software as a service arrangement in accordance with ASC 605. Capacity-based licenses allow the customer to buy simulation capacity as a service hosted by us and are sold based upon simulation capacity expected to be used within a certain time period-typically not exceeding one year. The contracts have finite terms that are not extendible at their expiration, and capacity usage is limited by contract to the amount specified. Our practice is not to modify existing capacity-based licenses to allow simulation capacity to be added to an existing arrangement. A customer desiring to purchase additional simulation capacity or to license additional users of our preparation and analysis software during the term of the original simulation license must do so by entering into a separate arrangement. Revenue from these arrangements is recognized as the capacity is used. In the event that any capacity remains unused at the end of the term of the arrangement, it is recognized as revenue at that time.
Projects
We also derive revenue from fees for separate, project-based services. Our projects are typically short term in nature and usually complete in less than 90 days. Project pricing is generally either fixed fee or time and material based. We recognize revenue from these service arrangements in accordance with ASC 605. Projects are either sold as one deliverable, or as multiple deliverables with stand-alone value. For single deliverable projects, to the extent that adequate project reporting of time incurred and time to complete records exist, we recognize consulting services revenue as the services are performed under the proportionate performance method. In other situations, for example, providing a customer with an on-site engineer for a defined period of time to provide services at the customer’s direction, we recognize revenue ratably over the service period. In situations where we are unable to utilize the proportional performance method, for example due to either the lack of adequate documentation of time incurred or to be incurred or a lack of a defined service, period revenue is deferred until the contract is completed.
For projects which have multiple deliverables, each with stand-alone value, we recognize revenue based on ASC 605 and allocate the arrangement consideration based on the relative selling price of the deliverables. For our project deliverables, we use best estimated selling price (“BESP”) as our selling price if vendor-specific objective evidence (“VSOE”) or third-party evidence of selling price (“TPE”) do not exist. If each deliverable does not have stand-alone value, revenue recognition is deferred until the completion of the entire project.
Multiple element arrangements
Multiple element arrangements may include customer rights to any combination of software, project deliverables, software as a service, maintenance and training.
When more than one element are contained in a single arrangement, we first allocate revenue based upon the relative selling price into two categories: (1) non-software components, such as services under projects or software as a service and (2) software components, such as software applications and related items, such as post-contract customer support and other services.
Revenue allocated to products sold which meet the definition of software components is recognized based on software accounting guidance provided for in ASC 985-605. Under this guidance, we must use the residual method to recognize revenue when a multiple element arrangement includes one or more software related elements to be delivered at a future date and VSOE of fair value of all undelivered elements exists (typically maintenance and other services), but does not exist for the delivered elements (typically the software). Since we cannot establish VSOE for the undelivered elements, the entire arrangement is deferred and recognized ratably over the contract (maintenance) period.
Revenue allocated to non-software services is recognized based on ASC 605 and the arrangement consideration is allocated based on the relative selling price of the deliverables. For our non-software deliverables, we use best estimated selling price (“BESP”) as our selling price if vendor-specific objective evidence (“VSOE”) or third-party evidence of selling price (“TPE”) do not exist.
Income Taxes
Income taxes are accounted for in accordance with ASC 740, Income Taxes. ASC 740 requires that deferred tax assets and liabilities are recorded based on temporary differences between the financial statement amounts and the tax basis of assets and liabilities, measured using enacted tax rates in effect for the year in which the differences are expected to reverse. We routinely assess the likelihood that we will be able to realize our deferred tax assets.
During fiscal year 2012, we determined that it was more likely than not that we would be able to realize certain of our deferred tax assets primarily as a result of expected future taxable income. Accordingly, we reversed $12.5 million of our valuation allowance during fiscal year 2012.
During fiscal year 2013, we reassessed our state tax profile and state apportionment. As a result, we recorded a valuation allowance against certain state investment tax credits and R&D credits in the amount of $0.2 million. This was due to the fact that management determined it was more likely than not that these assets would not be realized as of January 31, 2013.
During fiscal year 2014, we updated our assessment of the realizability of our deferred tax assets, considering new state tax credits and expiring state net operating loss carryforwards, and reduced our valuation allowance by $0.1 million.
We follow ASC 740-10 (formerly FASB Interpretation No. 48 or FIN 48) with regards to accounting for uncertain tax positions, which prescribes a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken within an income tax return. For each tax position, the enterprise must determine whether it is more likely than not that the position will be sustained upon examination based on
the technical merits of the position, including resolution of any related appeals or litigation. A tax position that meets the more likely than not recognition threshold is then measured to determine the amount of benefit to recognize within the financial statements. No benefits may be recognized for tax positions that do not meet the more likely than not threshold. Our adoption of FIN 48 resulted in no effect on our financial position or results of operations in the year of adoption as we had a full valuation allowance against our deferred tax assets due to the uncertainty surrounding the realization of such assets.
Our current intention is to reinvest the total amount of our unremitted foreign earnings in the local international jurisdictions, except for instances where we can remit such earnings to the U.S. without an associated net tax cost. As a result, we do not provide for United States taxes on the unremitted earnings of our international subsidiaries.
Stock-Based Compensation
We account for stock based compensation in accordance with ASC 718, Compensation-Stock Compensation. ASC 718 establishes accounting for stock-based awards exchanged for employee services. Under the fair value recognition provisions of ASC 718, share based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service / vesting period. Determining the appropriate fair value model and calculating the fair value of stock-based payment awards require the use of highly subjective assumptions, including the expected life of the stock-based payment awards and stock price volatility.
We estimate the grant date fair value of stock options and the related compensation expense, using the Black-Scholes option valuation model. This option valuation model requires the input of subjective assumptions including: (1) expected life (estimated period of time outstanding) of the options granted, (2) volatility, (3) risk-free rate and (4) dividends. Because share-based compensation expense is based on awards ultimately expected to vest, it is reduced for estimated forfeitures. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeiture rates differ from those estimates. We have estimated expected forfeitures of stock options based on our historical turnover rate and used these rates in developing a future forfeiture rate. If our actual forfeiture rate varies from our estimates, additional adjustments to compensation expense may be required in future periods. In general, the assumptions used in calculating the fair value of stock-based payment awards represent management’s best estimates, but the estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.
As we do not have a trading history for our common stock prior to our initial public offering or a significant trading range for our common stock trading since our initial public offering, we estimate the expected price volatility for our common stock by taking the average historic price volatility for selected industry peers based on daily price observations over a period equivalent to the expected term of the stock options granted. Our industry peers consist of several public companies similar to us in size, stage of life cycle and financial leverage. We intend to consistently apply this process using the same public companies until a sufficient amount of historical information regarding the volatility of our common stock becomes available, or unless circumstances change such that the currently utilized companies are no longer similar to us, in which case, we will identify and utilize more suitable companies with publicly available share prices in the calculation.
Research and Development Expenses
Research and development expense includes costs incurred to develop intellectual property. The costs for the development of new software and substantial enhancements to existing software are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capitalized. We have determined that technological feasibility is established at the time a working model of software is completed. Because we believe that under our current process for developing software completion of the software occurs essentially concurrently with the establishment of technological feasibility, no costs have been capitalized to date.
Foreign Currency Translation
We have subsidiaries in England, France, Germany, Italy, Japan, Korea and China. Foreign subsidiary records are maintained in the local currency. Through fiscal 2010, our foreign subsidiaries used the United States dollar as their functional currency in accordance with ASC 830, Foreign Currency Matters. Accordingly, we re-measured all assets and liabilities of the subsidiaries into United States dollars, with any resulting unrealized gains or losses being recorded as a component of other income (expense), net in the accompanying consolidated statements of operations. We review the functional currency of our subsidiaries on an annual basis in accordance with the “Foreign/Parent Currency” indicators outlined in Appendix A to ASC 830 to determine if the functional currency should be changed to the local currency.
For fiscal years 2014, 2013 and 2012, other than for our subsidiary in England, the functional currency for all subsidiaries is the respective local currency. The resulting gains and losses from translation are included as a component of other comprehensive income. Transaction gains and losses and re-measurement of assets and liabilities denominated in currencies other than an entity’s functional currency are included in other income (expense), net.
Valuation of Equity Participation Right
In connection with a bridge financing provided by a stockholder, FMR LLC, in 2009, we granted to FMR LLC the right, which we refer to as the “equity participation right,” to invest up to $10.0 million at a 15% discount in our next equity investment round (if any), either by converting the existing debt or by participating with a cash investment. The equity participation right terminated upon the closing of our initial public offering in July 2012. Because there are no observable inputs into the valuation of the equity participation right, at each reporting period, the equity participation right was valued based on our best estimate of inputs that market participants would use for pricing the liability at each measurement date, including assumptions about risk. We calculated the fair value of the equity participation right by applying the estimated probability of the right becoming exercisable to the instrument’s maximum intrinsic value of $1.8 million and discounting that value using a credit-adjusted interest rate of 5% to arrive at its present value.
At the inception of the equity participation right, we considered the probability of exercise to be remote and ascribed no value to the right. Based on our potential financing activities at the time, our assessment was that there was no expectation that the right would become exercisable prior to its original expiration date. In April 2010, the expiration of the equity participation right was extended until such time as an appropriate financing occurs or an initial public offering of our common stock, at which time the right expires. Due to this extension of the expiration date of the equity participation right, we determined that there was an approximately 33% chance that the equity participation right would become exercisable. Based upon that probability, we ascribed a fair value of $0.6 million to the instrument, and recorded the full amount to other long-term liabilities and interest expense. As the equity instrument is deemed to be a derivative, it is marked to market at each reporting period.
As of January 31, 2012, we assessed the probability of the equity participation right becoming exercisable prior to an initial public offering of our common stock and after considering the status of our pending registration statement on Form S-1, determined that the probability of exercise had declined to approximately 16.5%, resulting in a $0.3 million reduction in the fair value of the equity participation right during fiscal year 2012.
Effective upon consummation of our initial public offering on July 3, 2012, the equity participation right expired, and the remaining fair value was reduced to zero.
Valuation of Acquired Intangible Assets
Our intangible assets, which were acquired as part of a business combination, are valued based on estimates of future cash flows and amortized over their estimated useful lives. We evaluate intangible assets when events occur or circumstances change that may reduce the value of the asset below its carrying amount using forecasts
of discounted future cash flows. Intangible assets totaled $2.7 million and $3.1 million, respectively, at January 31, 2014 and January 31, 2013. Estimates of future cash flows require assumptions related to revenue and operating income growth, asset-related expenditures, working capital levels and other factors. Different assumptions from those made in our analysis could materially affect projected cash flows and our evaluation of impairment. Should the fair value of our finite-lived intangible assets decline because of reduced operating performance, market declines, or other indicators of impairment, or as a result of changes in the discount rate, charges for impairment may be necessary.
Recent Accounting Pronouncements
In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210)-Disclosures about Offsetting Assets and Liabilities. The update requires entities to disclose information about offsetting and related arrangements of financial instruments and derivative instruments. We adopted ASU 2011-11 on February 1, 2013. This adoption did not have a material impact on our consolidated financial statements.
In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. ASU 2013-02 requires companies to provide information about the amounts reclassified out of accumulated other comprehensive income by component. Companies are also required to disclose these reclassifications by each respective line item on their statements of operations. ASU 2013-02 is effective prospectively for annual reporting periods beginning after December 15, 2012, and interim periods within those annual periods. We adopted ASU 2013-02 on February 1, 2013. This adoption did not have a material impact on our consolidated financial statements.
In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU 2013-11 clarifies guidance and eliminates diversity in practice on the presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. This new guidance is effective for us in the first quarter of fiscal year 2015. We adopted ASU 2013-11 on February 1, 2014. This adoption did not have a material impact on our consolidated financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Exchange Risk
As we conduct business in multiple international currencies throughout the world, our international operations generate and incur expenses that are denominated in foreign currencies. These amounts could be materially affected by currency fluctuations. Our principal exposures are to fluctuations in exchange rates for the United States dollar versus the Euro, British pound, Japanese yen, Chinese yuan and Korean won. Changes in currency exchange rates could adversely affect our consolidated results of operations or financial position. Additionally, our international operations maintain cash balances denominated in foreign currencies. To reduce the risk associated with translation of foreign cash balances into our reporting currency, we typically avoid maintaining excess cash balances in foreign currencies. To date, we have not hedged our exposure to changes in foreign currency exchange rates and, as a result, we could incur unanticipated translation gains and losses.
The Euro was approximately 2.9% stronger on average, for fiscal year 2014, when compared to the U.S. dollar for fiscal year 2013. The net overall impact to revenue and operating expense was an increase of approximately $0.6 million and $0.4 million, respectively, during fiscal year 2014.
The exchange rate impact of other currencies for fiscal year 2014, primarily driven by a weaker Japanese yen, was a decrease to revenue and operating expense of approximately $1.9 million and $1.2 million, respectively.
For fiscal year 2014, a 10% increase in the exchange rates for the United States dollar versus the Euro, British pound, Japanese yen, Chinese yuan and Korean won would have resulted in a $3.0 million decrease in revenue.
Interest Rate Sensitivity
Our outstanding long-term debt carried interest at a fixed rate. Our revolving bank line of credit bore interest at a floating rate. We had no outstanding borrowings under our revolving bank line of credit as of January 31, 2013 or at any time during fiscal year 2014. On May 23, 2013, the line of credit expired in accordance with its terms and on May 31, 2013 we repaid, with available cash on hand, all outstanding obligations under our Loan and Security Agreement with Gold Hill Capital 2008, L.P. and Massachusetts Capital Resource Company. As a result, we do not believe that we are exposed to material interest rate risk at this time. Interest income is sensitive to changes in the general level of United States and international interest rates. The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. Our cash and short-term investments are relatively insensitive to interest rate changes. In future periods, we will continue to evaluate our investment policy in order to ensure that we continue to meet our overall objectives.
We do not believe that a 10% change in interest rates would have a material impact on our financial position or results of operations.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE OF
EXA CORPORATION
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Exa Corporation:
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Exa Corporation and its subsidiaries at January 31, 2014 and January 31, 2013, and the results of their operations and their cash flows for each of the three years in the period ended January 31, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Boston, MA
March 26, 2014
EXA CORPORATION
Consolidated Balance Sheets
(in thousands, except share and per share data)
(1) Includes amounts due to a related party, as follows:
The accompanying notes are an integral part of the consolidated financial statements
EXA CORPORATION
Consolidated Statements of Operations
(in thousands, except share and per share data)
The accompanying notes are an integral part of the consolidated financial statements
EXA CORPORATION
Consolidated Statements of Comprehensive (Loss) Income
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements
EXA CORPORATION
Consolidated Statements of Stockholders’ Equity (Deficit)
(in thousands, except share data)
The acccompanying notes are an integral part of the consolidated financial statements
EXA CORPORATION
Consolidated Statements of Cash Flows
(in thousands)
The accompanying notes are an integral part of the consolidated financial statements
EXA CORPORATION
Notes to Consolidated Financial Statements
(dollars in thousands except per share amounts)
1. Description of Business
Exa Corporation (the “Company” or “Exa”), a Delaware corporation, develops, sells and supports simulation software and services that vehicle manufacturers use to enhance the performance of their products, reduce product development costs and improve the efficiency of their design and engineering processes. The Company’s solutions enable engineers and designers to augment or replace conventional methods of evaluating designs that rely on expensive and inefficient physical prototypes and test facilities with accurate digital simulations that are more useful, cost effective and timely. The Company’s simulation solutions enable customers to gain crucial insights about design performance early in the design cycle, reducing the likelihood of expensive redesigns and late-stage engineering changes, which result in cost savings and fundamental improvements in the development process. The Company is primarily focused on the ground transportation market, but is also beginning to explore the application of its capabilities in the aerospace, oil and gas production, chemical processing, architecture, engineering and construction, power generation, biomedical and electronics industries.
Exa has offices and sells directly in the United States and through subsidiaries in France, Germany, Italy, Japan, Korea, China, and the United Kingdom. The Company also conducts business in Sweden, India, Brazil, Russia, Canada, Finland, Spain and Australia.
The Company is subject to a number of risks common to companies in similar stages of development, including dependence on a small number of significant customers for a substantial portion of its revenues, the ability to attract and retain key personnel, competition from substitute products and services from larger companies, the need to continually develop commercially viable products, and risks associated with changes in information technology.
Initial Public Offering
On July 3, 2012, the Company completed its initial public offering in which it issued and sold 4,166,667 shares of common stock at a public offering price of $10.00 per share. The Company received net proceeds of $34,576 after deducting underwriting discounts and commissions of $2,917 and other offering expenses of approximately $4,174. Upon the closing of the initial public offering, each share of the Company’s preferred stock was converted into two thirteenths of a share of the Company’s common stock.
2. Summary of Significant Accounting Policies
Applicable Accounting Guidance
These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). Any reference in these notes to applicable accounting guidance is meant to refer to the authoritative nongovernmental United States generally accepted accounting principles as found in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”).
Basis of Presentation and Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All inter-company balances and transactions have been eliminated in consolidation.
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
Use of Estimates
The preparation of financial statements in conformity with United States GAAP requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Although the Company regularly assesses these estimates, actual results could differ materially from these estimates. On an on-going basis, the Company evaluates its estimates and judgments, including those related to revenue recognition and allowance for doubtful accounts, stock- based compensation expense, intangible assets, and other long-lived assets, in-process research and development and income taxes. Changes in estimates are recorded in the period in which they become known.
The Company bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances. Actual results could differ from management’s estimates if future events differ substantially from past experience, or other assumptions, while reasonable when made, do not turn out to be substantially accurate.
Change in Estimates
Property and equipment are stated at cost. Major renewals, additions and betterments are charged to equipment accounts while replacements, maintenance and repairs which do not improve or extend the lives of the respective assets are expensed in the period incurred. Upon retirement or sale, the cost of the assets disposed of and the related accumulated depreciation are eliminated from the accounts and any resulting gain or loss is reflected in income from operations. Depreciation is computed using the straight-line method over the estimated useful life of each asset.
The Company periodically reviews the estimated useful lives of property and equipment. Changes to the estimated useful lives are recorded prospectively from the date of the change. During the first quarter of fiscal year 2014, the Company reevaluated its network assets, consisting primarily of server equipment utilized in its data centers, and determined that the expected average useful life of those assets had increased from three to five years, due to advances in technology and increased durability of the server equipment. The net book value of server assets placed in service as of February 1, 2013 was approximately $2,755. This change resulted in a decrease in depreciation expense on these assets of approximately $456, or $0.03 per share, on an after-tax basis, for the fiscal year ended January 31, 2014.
Revenue Recognition
The Company generates revenues from the licensing of its software products, typically in the form of one-year term “subscription” or capacity-based licenses that have a defined term, and from project fees for consulting services and training. Licenses for the Company’s software products may be software to be run on the customer’s own computer hardware, or provided in the form of software-as-a-service, via the Company’s hosted PowerFLOW OnDemand offering.
Software
The Company recognizes revenues from licensing the software products in accordance with ASC 985-605, Software Revenue Recognition. Term licenses typically have a term of one year and allow the customer to buy simulation in the form of a limited amount of simulation capacity on customer installed software and are sold based upon simulation capacity expected to be used within a certain time period-typically not exceeding one year.
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
The Company typically sells term and capacity-based software licenses combined in a bundled sale. For instance, when customers purchase simulation capacity, they typically also purchase a number of term-based licenses for preparation and analysis software. All of the Company’s software licenses include multiple elements such as support and maintenance. Pursuant to the guidance within ASC 985-605, the Company determined that since it does not have vendor-specific objective evidence of the fair value of the individual elements contained in a bundled sale of term and capacity-based software licenses, the arrangement is treated as a single unit of accounting and revenue is recognized ratably on a daily basis over the term of the license agreement, which coincides with the duration of the maintenance and support services. The Company’s arrangements typically do not include rights to carryover any unused capacity beyond the contractual license term or any customer right of return.
Licenses have finite terms that are not extendible at their expiration, and capacity usage is limited by contract to the amount specified. The Company’s practice is not to modify existing capacity-based licenses to allow simulation capacity to be added to an existing arrangement. A customer desiring to purchase additional simulation capacity or to license additional users of the Company’s preparation and analysis software during the term of the original simulation license does so by entering into a separate arrangement. Revenue from these new arrangements is recognized over the term of the new agreements, which include bundled maintenance and support, and are for a term of less than twelve months, coterminous with the remaining term of the original simulation license.
The Company commences recognition of term license revenue when persuasive evidence of an arrangement exists; delivery of the software or license keys has occurred and all service elements, if bundled or linked, have commenced; payment is fixed or determinable; and collection of the resulting receivable is considered probable by management. Payments received from customers in advance of revenue recognition are treated as deferred revenue.
If training or consulting service projects are bundled with a software license sale or, as a result of specific facts and circumstances, are determined to be linked with a software license sale, the Company treats this as one arrangement and recognizes revenue ratably on a daily basis over the license period provided that delivery of all elements of the arrangement have commenced.
Software as a service (OnDemand)
The Company recognizes revenue from software as a service arrangement’s in accordance with ASC 605. Capacity-based licenses allow the customer to buy simulation capacity as a service hosted by the Company and are sold based upon simulation capacity expected to be used within a certain time period-typically not exceeding one year. The contracts have finite terms that are not extendible at their expiration, and capacity usage is limited by contract to the amount specified. The Company’s practice is not to modify existing capacity-based licenses to allow simulation capacity to be added to an existing arrangement. A customer desiring to purchase additional simulation capacity or to license additional users of the Company’s preparation and analysis software during the term of the original simulation license must do so by entering into a separate arrangement. Revenue from these arrangements is recognized as the capacity is used. In the event that any capacity remains unused at the end of the term of the arrangement, it is recognized as revenue at that time.
Projects
The Company also derives revenue from fees for separate, project-based services. The Company’s projects are typically short term in nature and usually complete in less than 90 days. Project pricing is generally either
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
fixed fee or time and material based. The Company recognizes revenue from these service arrangements in accordance with ASC 605. Projects are either sold as one deliverable, or as multiple deliverables with stand-alone value. For single deliverable projects, to the extent that adequate project reporting of time incurred and time to complete records exist, the Company recognizes consulting services revenue as the services are performed under the proportionate performance method. In other situations, for example, providing a customer with an on-site engineer for a defined period of time to provide services at the customer’s direction, the Company recognizes revenue ratably over the service period. In situations where the Company is unable to utilize the proportional performance method, for example due to either the lack of adequate documentation of time incurred or to be incurred or a lack of a defined service, period revenue is deferred until the contract is completed.
For projects which have multiple deliverables, each with stand alone value, the Company recognizes revenue based on ASC 605 and allocates the arrangement consideration based on the relative selling price of the deliverables. For the Company’s project deliverables, it uses best estimated selling price (“BESP”) as its selling price if vendor-specific objective evidence (“VSOE”) or third-party evidence of selling price (“TPE”) do not exist. If each deliverable does not have stand alone value, revenue recognition is deferred until the completion of the entire project.
Multiple element arrangements
Multiple element arrangements may include customer rights to any combination of software, project deliverables, software as a service, maintenance and training.
When more than one element is contained in a single arrangement, the Company first allocates revenue based upon the relative selling price into two categories: (1) non-software components, such as services under projects or software as a service and (2) software components, such as software applications and related items, such as post-contract customer support and other services.
Revenue allocated to non-software services is recognized based on ASC 605 and the arrangement consideration is allocated based on the relative selling price of the deliverables. For the Company’s non-software deliverables, it uses best estimated selling price (“BESP”) as its selling price if vendor-specific objective evidence (“VSOE”) or third-party evidence of selling price (“TPE”) do not exist.
Revenue allocated to products sold which meet the definition of software components is recognized based on software accounting guidance provided for in ASC 985-605. Under this guidance, the Company must use the residual method to recognize revenue when a multiple element arrangement includes one or more software related elements to be delivered at a future date and VSOE of fair value of all undelivered elements exists (typically maintenance and other services), but does not exist for the delivered elements (typically the software). Since the Company cannot establish VSOE for the undelivered elements, the entire arrangement is deferred and recognized ratably over the contract (maintenance) period.
Foreign Currency Translation
The Company has foreign subsidiaries in England, France, Germany, Italy, Japan, Korea and China. For fiscal 2014, all of the Company’s foreign subsidiaries (excluding that in England) used their local currency as their functional currency in accordance with ASC 830, Foreign Currency Matters. Foreign subsidiary records are maintained in the local currency. Beginning in fiscal 2011, the Company’s French, German, Japanese and Korean subsidiaries began to translate their assets and liabilities denominated in their functional currency at current rates of exchange in effect at the balance sheet date. Beginning in fiscal 2012, the Company’s Italian subsidiary began
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
to translate its assets and liabilities denominated in its functional currency at current rates of exchange in effect at the balance sheet date. During the first quarter of fiscal year 2013, the Company established a subsidiary in China. The Company’s review of the operations of this subsidiary indicated that it should use the local currency as its functional currency. As a result, the Company’s Chinese subsidiary translates its assets and liabilities denominated in its functional currency at current rates of exchange in effect at the balance sheet date. The resulting gains and losses from translation are included as a component of other comprehensive income. Transaction gains and losses and re-measurement of assets and liabilities denominated in currencies other than a subsidiary’s functional currency are included in other expense, net. Foreign currency (loss) gain included in other expense, net for the years ended January 31, 2014, 2013 and 2012 was $(83), $17 and $(106), respectively.
Concentration of Credit Risk and Significant Customers
Financial instruments that potentially subject the Company to concentration of credit risks are principally cash and cash equivalents and accounts receivable. The Company invests its cash and cash equivalents with high credit quality financial institutions, and consequently, the Company believes that such funds are subject to minimal credit risk. The Company maintains its cash in bank deposit accounts, which at times may exceed federally insured limits, but management believes that the deposits are not exposed to significant credit risk due to the financial position of the depository institutions in which those financial instruments are held.
Concentrated credit risk with respect to accounts receivable is limited to large creditworthy customers. The Company periodically assesses the financial strength of its customers and believes that its accounts receivable credit risk exposure is minimal.
The Company typically does not require collateral from its customers for sales on account. The Company has not experienced significant losses related to receivables from individual customers or groups of customers in any specific industry or geographic region.
The following table provides information concerning customers that individually accounted for greater than 10% of total revenues or 10% of accounts receivable, and their respective percentages of total revenues and accounts receivable, as of January 31, 2014, 2013 and 2012:
* less than 10%
Concentration of Other Risks
The Company has one main data center provider, and several support providers (which handle overflow), to host or provide access to hardware for the Company’s OnDemand application service to customers. The disruption of these services could have a material adverse effect on the Company’s business, financial position, and results of operations.
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
Cash and Cash Equivalents and Restricted Cash
The Company considers all highly liquid investments purchased with an original maturity of 90 days or less, that are not restricted as to withdrawal, to be the equivalent of cash for the purpose of balance sheet and statement of cash flows presentation. Cash equivalents consisted of money market accounts as of January 31, 2014 and 2013. The Company maintains $525 of restricted cash related to an operating lease, which has been recorded within other long-term assets.
Accounts Receivable and Allowances for Doubtful Accounts
Accounts receivable are stated at the amount management expects to collect from outstanding balances. An allowance for doubtful accounts is provided to the extent that specific accounts receivable are considered to be uncollectible, based on historical experience, known collection issues, and management’s evaluation of outstanding accounts receivable at the end of the year. Uncollectible amounts, if any, are written-off against the allowance after all collection efforts have been exhausted. During the fiscal year ended January 31, 2014, the Company recorded $21 of net bad debt expense relating to write-offs of uncollectible receivables. Based on management’s analysis of its outstanding accounts receivable, and customers’ creditworthiness and collection history, the Company concluded that an allowance was not necessary as of January 31, 2014 and 2013.
Property and Equipment, net
Property and equipment, net is stated at cost. Major renewals, additions and betterments are charged to property accounts while replacements, maintenance and repairs which do not improve or extend the lives of the respective assets are expensed in the period incurred. Upon retirement or sale, the cost of the assets disposed of and the related accumulated depreciation are eliminated from the accounts and any resulting gain or loss is reflected in the consolidated statement of operations. Depreciation is computed using the straight-line method over the estimated useful life of each asset, generally as follows:
Leasehold improvements and assets acquired under capital leases are typically amortized using the straight-line method over the shorter of the estimated useful life of the asset or the term of the lease. However, assets acquired under capital leases that contain bargain purchase options that are typically exercised are amortized over the estimated useful life of the asset. Amortization of leasehold improvements and assets acquired under capital leases is included in depreciation expense.
Impairment of Long-Lived Assets
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amounts to the future undiscounted cash flows the assets are expected to generate. If any long-lived assets are considered to be impaired, the impairment recognized equals the amount by
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
which the carrying value of the assets exceeds its estimated fair value. The Company did not identify any indicators of impairment of its long-lived assets during the fiscal years ended January 31, 2014 and 2013.
In fiscal year 2012, the Company determined that it would not re-enter space currently under sublease and therefore took an impairment charge through depreciation expense of $0.3 million for leasehold improvements.
Research and Development Expenses
Research and development expense includes costs incurred to develop intellectual property and are charged to expense as incurred. The costs for the development of new software and substantial enhancements to existing software are expensed as incurred until technological feasibility has been established, at which time any additional costs are capitalized. The Company has determined that technological feasibility is established at the time a working model of software is completed. Because the Company believes that, under its current process for developing software, completion of the software is essentially concurrent with the establishment of technological feasibility, no costs have been capitalized to date.
Advertising Costs
Advertising costs are expensed as incurred. To date, the Company has not incurred significant advertising costs.
Income Taxes
Income taxes are accounted for in accordance with ASC 740, Income Taxes. ASC 740 requires that deferred tax assets and liabilities are recorded based on temporary differences between the financial statement amounts and the tax basis of assets and liabilities, measured using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company routinely assesses the likelihood that it will be able to realize its deferred tax assets.
During fiscal year 2012, the Company determined that it was more likely than not that it would be able to realize certain of its deferred tax assets primarily as a result of expected future taxable income. Accordingly, the Company reversed $12,501 of its valuation allowance during fiscal year 2012.
During fiscal year 2013, the Company reassessed its state tax profile and state apportionment. As a result, the Company recorded a valuation allowance against certain state investment tax credits and R&D credits in the amount of $155. This was due to the fact that management determined as of January 31, 2013 it was more likely than not that these assets would not be realized.
During fiscal year 2014, the Company updated its assessment of the realizability of the deferred tax assets, considering new state tax credits and expiring state net operating loss carryforwards, and reduced the valuation allowance by $104.
The Company follows ASC 740-10 (formerly FASB Interpretation No. 48 or FIN 48) with regards to accounting for uncertain tax positions, which prescribes a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken within an income tax return. For each tax position, the enterprise must determine whether it is more likely than not that the position will be sustained upon examination based on the technical merits of the position, including resolution of any related appeals or litigation. A tax position that meets the more likely than not recognition threshold is then measured to determine
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
the amount of benefit to recognize within the financial statements. No benefits may be recognized for tax positions that do not meet the more likely than not threshold. The Company’s adoption of FIN 48 resulted in no effect on its financial position or results of operations in the year of adoption as the Company had a full valuation allowance against its deferred tax assets due to the uncertainty surrounding the realization of such assets.
The Company’s intention is to indefinitely reinvest the total amount of its unremitted foreign earnings in the local international jurisdictions, except for instances where the Company can remit such earnings to the United States without an associated net tax cost. As a result, the Company currently does not provide for United States taxes on the unremitted earnings of its international subsidiaries.
Comprehensive Income and Accumulated Comprehensive Income
ASC 220, Comprehensive Income requires the reporting and display of comprehensive income and its components. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions, and other events and circumstances from non-owner sources. Accumulated other comprehensive income consists entirely of foreign currency translation adjustments at January 31, 2014, 2013, and 2012.
Fair Value of Common Stock prior to Initial Public Offering
Prior to the Company’s initial public offering in July 2012, estimates of the fair value of the shares of its common stock were historically performed by the Company’s board of directors based upon information available to them at the time of grant. Prior to January 31, 2011, the Company’s board of directors did not conduct any formal valuation procedure or commission any third party valuation or appraisal in connection with its determinations of the fair value of its common stock. The Company’s board of directors considered the most persuasive evidence of fair value to be the prices at which the Company’s securities were sold in actual arms’ length transactions. The Company’s board of directors also considered numerous other objective and subjective factors in the assessment of fair value, including reviews of the Company’s business and financial condition, the conditions of the industry in which the Company operates and the markets that the Company serves and general economic, market and United States and global capital market conditions, an analysis of publicly traded peer companies, the lack of marketability of the Company’s common stock, the likelihood of achieving a liquidity event for the shares of common stock underlying its stock options, such as an initial public offering or sale of the Company, the preferences and privileges of the Company’s preferred stock over the rights of the Company’s common stock, the status of strategic initiatives being undertaken by the Company’s management and board of directors and, after January 31, 2011, independent third party valuations of the Company’s common stock. All options have been granted at exercise prices not less than the fair value of the underlying shares on the date of grant.
In considering the fair value of the Company’s common stock, the Company’s board of directors and management considered the impact of the accumulated liquidation preferences of the Company’s preferred stock. The Company’s board recognized that any sale or other exit scenario other than an initial public offering at a valuation less than the accumulated liquidation preference would result in the receipt by common stockholders of no consideration. However, when estimating the fair value of the Company’s common stock for purposes of equity-based compensation, the Company’s board also took into account the alternative that all outstanding shares of preferred stock would convert to common stock prior to the exit transaction, such that the accumulated liquidation preferences would not factor into the fair value of the common stock.
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with ASC 718, Compensation-Stock Compensation. Under the fair value recognition provisions of ASC 718, share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service or vesting period. Determining the fair value of equity awards at the grant date requires judgment. The Company estimates the grant date fair value of stock options using the Black-Scholes option valuation model. This option valuation model requires the input of subjective assumptions including: (1) expected life (estimated period of time outstanding) of the options granted, (2) volatility, (3) risk-free rate, (4) dividends and (5) the fair value of the Company’s common stock. Because share-based compensation expense is based on awards ultimately expected to vest, it is reduced for estimated forfeitures.
ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures rates differ from those estimates. Forfeitures are estimated based on historical experience.
The Company recognizes windfall tax benefits associated with the exercise of stock options or release of restricted stock units directly to stockholders’ equity only when realized. A windfall tax benefit occurs when the actual tax benefit realized by the Company upon an employee’s disposition of a share-based award exceeds the deferred tax asset, if any, associated with the award that we had recorded. When assessing whether a tax benefit relating to share-based compensation has been realized, the Company follows the “with-and-without” method. Under the with-and-without method, the windfall is considered realized and recognized for financial statement purposes only when an incremental benefit is provided after considering all other tax benefits including the Company’s net operating losses. The with-and-without method results in the windfall from share-based compensation awards always being effectively the last tax benefit to be considered. Consequently, the windfall attributable to share-based compensation will not be considered realized in instances where our net operating loss carryover (that is unrelated to windfalls) is sufficient to offset the current year’s taxable income before considering the effects of current-year windfalls.
Net (Loss) Income per Share
Net (loss) income per share is computed using the weighted average number of shares of common stock outstanding during each period. Diluted amounts per share include the impact of the Company’s outstanding potential common shares, such as shares issuable upon exercise of in-the-money stock options or warrants or upon conversion of convertible preferred stock, when dilutive. Potential common shares that are anti-dilutive are excluded from the calculation of diluted net (loss) income per common share. The impact of the accretion of unpaid and undeclared dividends was not reflected in the weighted average shares used to compute diluted net (loss) income per share as the former convertible preferred stock was not entitled to receive undeclared dividends upon such conversion.
Recent Accounting Pronouncements
In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210)-Disclosures about Offsetting Assets and Liabilities (ASU No 2011-11). The update requires entities to disclose information about offsetting and related arrangements of financial instruments and derivative instruments. The Company adopted ASU 2011-11 on February 1, 2013. This adoption did not have a material impact on the Company’s consolidated financial statements.
In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (ASU 2013-02). ASU 2013-02 requires
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
companies to provide information about the amounts reclassified out of accumulated other comprehensive income by component. Companies are also required to disclose these reclassifications by each respective line item on the statements of operations. ASU 2013-02 is effective prospectively for annual reporting periods beginning after December 15, 2012, and interim periods within those annual periods. The Company adopted ASU 2013-02 on February 1, 2013. This adoption did not have a material impact on the Company’s consolidated financial statements.
In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (ASU 2013-11). ASU 2013-11 clarifies guidance and eliminates diversity in practice on the presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. This new guidance is effective for the Company in the first quarter of fiscal year 2015. The Company adopted ASU 2013-11 on February 1, 2014. This adoption did not have a material impact on the Company’s consolidated financial statements.
3. Property and Equipment, net
Property and equipment, net consist of the following:
Depreciation expense was $1,834, $1,626 and $1,438 for the fiscal years ended January 31, 2014, 2013 and 2012, respectively.
Included in computer software and equipment and office equipment and furniture is equipment held pursuant to capital leases with costs of $16,802 and $14,450 and accumulated amortization of $10,997 and $9,752 as of January 31, 2014 and 2013, respectively.
4. Acquired Intangible Assets
Intangible assets acquired in a business combination are recorded under the purchase method of accounting at their estimated fair values at the date of acquisition. The Company amortizes acquired intangible assets over their estimated useful lives. The following table reflects the fair value of certain identifiable intangible assets acquired from science + computing AG on November 30, 2011 and related estimates of useful lives:
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
The following table reflects the carrying value of intangible assets as of January 31, 2014:
The following table reflects the carrying value of intangible assets as of January 31, 2013:
Amortization expense of intangible assets was $351, $383 and $64 for the fiscal years ended January 31, 2014, 2013 and 2012, respectively.
The following table presents the expected future amortization expense related to the Company’s acquired intangible assets for the next five fiscal years and thereafter as of January 31, 2014:
5. Fair Value Measurements
Financial instruments consist primarily of cash and cash equivalents, accounts receivable, capital lease obligations and debt. As of January 31, 2014 and 2013, the carrying amounts of these instruments approximate their fair values. The estimated fair values have been determined from information obtained from market sources and management estimates.
In determining the fair value of its financial assets and liabilities, the Company uses various valuation approaches. ASC 820, Fair Value Measurements and Disclosures, establishes a hierarchy of inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the inputs that market participants would use in pricing the asset or liability, and are developed based on the best information available in the circumstances. The fair value hierarchy is broken down into three levels based on the source of inputs as follows:
Level 1-Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
Level 2-Valuations based on quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and models for which all significant inputs are observable, either directly or indirectly.
Level 3-Valuations based on inputs that are unobservable and significant to the overall fair value measurement and that are based on management’s best estimate of inputs market participants would use for pricing the asset or liability at the measurement date, including assumptions about risk.
The availability of observable inputs can vary among the various types of financial assets and liabilities. To the extent that the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for financial statement disclosure purposes, the level in the fair value hierarchy within which the fair value measurement is categorized is based on the lowest level input that is significant to the overall fair value measurement.
The following table summarizes the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value as of January 31, 2014:
6. Accrued Expenses
Accrued expenses consist of the following:
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
7. Deferred Rent
In connection with its corporate headquarters lease entered into in July 2008, the Company received a tenant improvement allowance of $1,958 from the landlord. This lease incentive was recorded as leasehold improvements and deferred rent and is being amortized as part of rent expense on a straight-line basis over the life of the lease. The Company’s subsidiary Euroxa S.a.r.l. entered into a new office lease in Paris France in May 2012 with a landlord incentive totaling $148 related to four months free rent, which is also being amortized as part of rent expense on a straight line basis over the life of the lease. In addition, the Company’s facility leases typically contain other straight-line payment features. The difference between the straight-line rent expense of the lease and the cash payments is recorded as deferred rent. Deferred rent at January 31, 2014 and January 31, 2013 is as follows:
8. Debt
Loan and Security Agreement
On January 28, 2011, the Company entered into a Loan and Security Agreement with Gold Hill Capital 2008, L.P. (“Gold Hill”) and Massachusetts Capital Resource Company (the “Loan and Security Agreement”), which provided for term loans of up to $8,500, of which $1,000 was with a related party. On May 31, 2013, as described more fully below, the Company repaid, with available cash on hand, all outstanding obligations under the Loan and Security Agreement.
Under the Loan and Security Agreement, which was subsequently amended and extended at various times through January 30, 2012, the Company borrowed $5,000 on January 28, 2011 and an additional $3,500 on March 30, 2012, for a total borrowed amount of $8,500. The Loan and Security Agreement contained customary representations, warranties and reporting requirements, but no financial covenants. The term was for 54 months from the borrowing dates (the January 28, 2011 draw matured on August 1, 2015 and the March 30, 2012 draw matured on October 1, 2016) and the loans bore interest at 10.5% per annum. An additional 2.5% ($125 on the January 28, 2011 draw and $87 on the March 30, 2012 draw) was due at maturity and was originally recorded as a long-term liability and a debt discount. Interest only payments were payable during the first twelve months with principal and interest payments required for forty-two months thereafter. Included in interest expense in the accompanying consolidated statements of operations was interest paid to related parties under the Loan and Security Agreement of $26, $97 and $138 for the fiscal years ended January 31, 2014, 2013 and 2012, respectively.
On May 31, 2013 the Company repaid, with available cash on hand, all outstanding obligations under the Loan and Security Agreement. The repayment amount included $6,852 of outstanding principal, $60 of accrued interest and $213 of deferred origination fees that were accrued for in other long-term liabilities in the accompanying consolidated balance sheet. In addition, in accordance with the terms of the agreement, the Company paid a prepayment interest penalty of $290, representing 3% of the amount advanced to the Company under the agreement in January 2011 and 4% of the amount advanced to the Company under the agreement in
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
March 2012. The Company recognized a loss from the extinguishment of this debt of $755 during the second quarter of fiscal year 2014, representing the prepayment interest penalty and the write-off of unamortized debt discount. As a result of this repayment, the Company saved cash interest which would otherwise have been incurred under the agreement of approximately $429 for the remainder of fiscal year 2014, and $428, $170 and $31 for fiscal years 2015, 2016 and 2017, respectively.
In connection with the Loan and Security Agreement, and its subsequent amendments and extensions, the Company issued warrants to purchase shares of the Company’s Series G Convertible Preferred Stock (see Note 9). The Company recorded the original fair value of the warrants as debt discount with an offset to preferred stock warrant liability. The debt discount was amortized over the term of the loans using the effective interest method, with the unamortized debt discount as of the date of early payoff being written off to loss from the extinguishment of debt. For the fiscal years ended January 31, 2014, 2013 and 2012, the Company recorded $131, $478 and $295, respectively, in non-cash interest expense relating to this debt discount.
Line of Credit
In May 2010, the Company secured a $10,000 line of credit agreement with a bank bearing interest at the bank’s prime rate plus 1.50% on existing accounts receivable and 2.5% on certain forecasted renewal invoices, expiring one year from closing. In May 2011, the line of credit was extended for two additional years and on May 23, 2013, the line of credit expired in accordance with its terms.
The line of credit agreement required collateral of specific accounts receivable and a first priority security interest in all assets of the Company. The Company was required to pay a collateral handing fee of 0.25% per month on outstanding balances from existing accounts receivable, and 0.375% per month on certain forecasted renewal invoices. The agreement contained certain restrictive financial covenants requiring the maintenance of an adjusted quick ratio, and the Company complied with these covenants throughout the term of the agreement.
All amounts outstanding under the agreement were paid in full by the end of the first quarter of fiscal year 2013, and no subsequent borrowings or repayments occurred.
9. Warrants for Preferred Stock
In connection with the Loan and Security Agreement, and its subsequent amendments and extensions (see Note 8), the Company issued various warrants to purchase an aggregate 1,190,000 shares of the Company’s Series G Convertible Preferred Stock at an exercise price of $0.94 per share. The warrants were issued at various times during the fiscal years ended January 31, 2011 and 2012 and had terms ranging from nine to ten years. The Company calculated the fair value of the warrants utilizing the Black-Scholes option pricing model with the following ranges of assumptions: volatility of 54.92% to 55.73%, term of nine to ten years, risk-free interest rate of 1.83% to 3.36%, and a dividend yield of 0%. The Company recorded the original fair value of the warrants, aggregating $1,049, as debt discount with an offset to preferred stock warrant liability. The preferred stock warrant liability was marked to market on a quarterly basis with the offsetting adjustment reflected in other income (expense), net in the accompanying consolidated statements of operations.
As a result of the 1-for-6.5 reverse stock split effected with respect to the Company’s common stock on June 8, 2012, and the conversion to common stock of all outstanding shares of preferred stock upon the closing of the Company’s initial public offering on July 3, 2012, the warrants became exercisable for 183,076 shares of common stock at an exercise price of $6.11 per share. In addition, upon the closing of the initial public offering, the Company performed a final mark-to-market adjustment of the fair value of the warrants and recorded a gain
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
of $165 to other income (expense), net in the second quarter of fiscal year 2013. Lastly, upon closing of the initial public offering, the warrants were no longer required to be classified as a liability and the final warrant fair value of $1,324 was reclassified to additional paid-in capital.
On July 6, 2012, Gold Hill exercised warrants on a cashless basis to purchase an aggregate 161,538 shares of common stock, as a result of which the Company issued 67,268 shares of common stock.
As of January 31, 2014 and 2013, warrants to purchase 21,538 shares of common stock remain outstanding.
10. Equity Participation Right
In July 2009, the Company entered into a Bridge Loan and Security Agreement with a related party. In connection with its entry into that agreement, the Company granted to the related party the right to invest up to $10,000 at a 15% discount in the next equity investment round of the Company (if any), by either converting the existing debt or participating with a cash investment (the “Equity Participation Right”). The Equity Participation Right was deemed to be a derivative instrument and was recorded as a liability with a carrying amount equal to its fair value.
Effective upon the consummation of the Company’s initial public offering on July 3, 2012, the Equity Participation Right expired, and the remaining fair value was reduced to zero, resulting in a $276 gain recorded in other income (expense), net in the accompanying consolidated statement of operations for the fiscal year ended January 31, 2013.
11. Commitments and Contingencies
Capital Leases
The Company leases certain equipment under capital leases expiring on various dates through fiscal 2018. Future minimum lease payments under capital lease commitments as of January 31, 2014 are as follows:
Operating Leases
The Company has a lease for the rental of office space for its corporate headquarters, which was entered into in July 2008. The lease covers the rental of up to 65,941 square feet available to the Company at certain time periods over eight years, expiring in 2016. In connection with the lease, the Company entered into a letter of credit agreement with a bank that allows the landlord, under certain default conditions, to draw up to $525. The
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
Company deposited $525 into a restricted cash account as security for the letter of credit. This amount is included in other assets (non-current) in the consolidated balance sheets as of January 31, 2014 and 2013.
The Company leases office facilities for all its other locations under operating leases expiring on various dates through April 2021. The Company also leases certain office equipment under operating leases that expire on various dates through June 2016. Future minimum lease payments under operating lease commitments as of January 31, 2014 are as follows:
Rent expense is calculated on a straight-line basis over the term of the lease. Rent expense recognized under all operating leases totaled $2,823, $2,720 and $2,481 for the fiscal years ended January 31, 2014, 2013 and 2012, respectively. The Company entered into a new sub-rental lease agreement effective January 1, 2014 with a third party which expires on March 31, 2016. Sub-rental income was $324, $318 and $318 for the fiscal years ended January 31, 2014, 2013 and 2012, respectively.
Purchase Obligations
As of January 31, 2014, the Company has purchase obligations payable in fiscal years 2015, 2016, 2017 and 2018 as follows: $2,087, $2,060, $1,142 and $600, respectively.
Legal Contingencies
From time to time the Company is involved in legal proceedings arising in the ordinary course of business. There is no litigation pending that could, individually or in the aggregate, have a material adverse effect on the Company’s financial position, results of operations, or cash flows.
In 2011, the Company was notified by the Massachusetts Institute of Technology, or MIT, that MIT believes that Exa is utilizing the intellectual property covered by a license agreement between the Company and MIT, and therefore is in arrears in the payment of royalties under the agreement. The Company has advised MIT that it does not believe that the Company utilized the underlying technology at any time since at least 1998, or that any royalties are owed under the agreement.
As of January 31, 2014, MIT has not commenced suit against the Company with respect to its claims, and if any such suit is commenced by MIT, the Company intends to defend it vigorously. The Company believes that if MIT were to prevail in any such litigation, the royalties due under the terms of the license agreement, after giving effect to the approximately $200 in minimum royalties that the Company has already paid, would not exceed approximately $0 to $2,600 (excluding any interest or costs of litigation). The Company is not able to determine whether a loss is probable or estimate the reasonably possible or probable amount of such loss, therefore we have recorded a liability of $0, equal to the low end of the range.
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
Guarantees and Indemnification Obligations
The Company enters into standard indemnification agreements in the ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally the Company’s business partners or customers, in connection with any United States patent, or any copyright or other intellectual property infringement claim by any third party with respect to the Company’s products. The term of these indemnification provisions is generally perpetual after execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these agreements is unlimited.
Based on historical experience and information known as of January 31, 2014 and 2013, the Company has not recorded any liabilities for the above guarantees and indemnities.
12. Convertible Preferred Stock
Prior to the consummation of the Company’s initial public offering on July 3, 2012, the Company was authorized to issue up to 77,835,000 shares of $0.001 par value preferred stock. On July 3, 2012, in connection with the Company’s initial public offering of common stock, all of the Company’s then outstanding preferred stock was converted into 8,529,366 shares of common stock, and the Company’s certificate of incorporation was amended to, among other things, provide that the Company is authorized to issue up to 5,000,000 shares of $0.001 par value preferred stock.
13. Stockholders’ Equity (Deficit)
Initial Public Offering
On July 3, 2012, the Company completed its initial public offering in which it issued and sold 4,166,667 shares of common stock at a public offering price of $10.00 per share. The Company received net proceeds of $34,576 after deducting underwriting discounts and commissions of approximately $2,917 and other offering expenses of approximately $4,157. As of January 31, 2012, approximately $2,315 of these offering expenses were deferred and included in other long-term assets in the accompanying consolidated balance sheet. Upon the closing of the initial public offering, each share of the Company’s preferred stock was converted into two thirteenths of a share of the Company’s common stock.
Reverse Stock Split
On June 8, 2012, the Company effected a 1-for 6.5 reverse stock split of its common stock whereby each share of common stock, $0.001 par value, outstanding immediately prior to that date was combined, reclassified and changed into two-thirteenths (2/13) of a fully paid and non-assessable share of common stock. Except as noted, all share and per share information in the accompanying consolidated financial statements has been retroactively adjusted to reflect the stock split for all periods presented.
14. Stock Based Compensation
Summary of Plans
The Company’s equity compensation plans generally provide the board of directors the authority to grant incentive stock options, nonqualified stock options, restricted stock awards, unrestricted stock awards, performance share awards, restricted stock units, and stock appreciation rights (collectively, options) and to select the employees and consultants to whom options are granted and determine the terms of each option,
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
including (i) the number of shares of common or preferred stock subject to the option, (ii) when the option becomes exercisable, (iii) the option exercise price, which, in the case of incentive stock options, must be at least 100% (110% in the case of incentive stock options granted to a stockholder owning in excess of 10% of the Company’s common stock) of the fair market value of the stock as of the date of grant and (iv) the duration of the option (which, in the case of incentive stock options, may not be less than five years or exceed 10 years). Options generally expire 10 years from the date of issuance.
The Company’s common and preferred stock incentive plans are summarized as follows (the table reflects options for preferred stock on an as converted to common stock basis):
(1) Effective upon the consummation of its initial public offering on July 3, 2012, the Company ceased issuing awards under any plan other than its 2011 Stock Incentive Plan.
(2) Outstanding awards include 5,224 restricted stock units granted for the first time in September 2013 to certain members of the board of directors, which will fully vest in June 2014.
Grant-Date Fair Value
Prior to the consummation of the Company’s initial public offering on July 3, 2012, the fair value of the shares of common stock that underlie the stock options granted under the various plans outstanding was historically determined by the Company’s board of directors based upon information available to it at the time of grant. Prior to the Company’s initial public offering, there was no public market for its common stock, and the board of directors determined the fair value of the common stock by utilizing, among other things, recent or contemporaneous valuation information available to it. All options have been granted at exercise prices not less than the fair value of the underlying shares on the date of grant.
The Company uses the Black-Scholes option pricing model to calculate the grant-date fair value of stock options issued. The Black-Scholes model requires estimates regarding volatility, expected life of the award, the risk-free rate of return, dividend yields, and estimated forfeitures of awards during the service period.
The Company computes volatility under the “calculated value method” of ASC 718, Compensation-Stock Compensation. As the Company does not have a trading history for its common stock prior to its initial public offering or a significant trading range for its common stock trading since the initial public offering, the Company estimates the expected price volatility for its common stock by taking the average historic price volatility for selected industry peers based on daily price observations over a period equivalent to the expected term of the stock options granted. The Company’s industry peers consist of several public companies that are similar to the Company in size, stage of life cycle and financial leverage. The Company intends to consistently apply this process using the same or similar public companies until a sufficient amount of historical information regarding the volatility of its common stock becomes available, or unless circumstances change such that the currently utilized companies are no longer similar to the Company, in which case, more suitable companies with publicly available share prices will be utilized in the calculation.
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
Since adopting ASC 718, the Company has been unable to use historical employee exercise and option expiration data to estimate the expected term assumption for the Black-Scholes grant-date valuation. As such, the Company has utilized the “simplified” method, as prescribed by Staff Accounting Bulletin No. 107, Share-Based Payment, to estimate on a formula basis the expected term of its stock options considered to have “plain vanilla” characteristics.
The Company utilizes the Federal Reserve Board’s published Treasury Constant Maturity rate which most closely matches the option term. As an example, for a 6.25 year term, the Company would use the 7-year rate coinciding with the option issuance date.
The Company has never paid dividends and does not currently intend to pay dividends, and thus has assumed a dividend yield of zero.
The Company estimates potential forfeitures of stock grants and adjusts compensation cost recorded accordingly. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of stock compensation expense to be recognized in future periods.
The Company considers the indirect effect of income tax benefits from stock-based compensation in arriving at its income tax provision. In addition, the Company has elected to recognize excess income tax benefits from stock-based compensation as an addition to paid-in capital only if an incremental income tax benefit would be realized by applying the with-and-without method. Under this method, the excess tax benefit is considered realized and recognized for financial statement purposes only when an incremental benefit is provided after considering all other tax benefits including the Company’s net operating losses. The Company measures the tax benefit associated with excess tax deductions by multiplying the excess tax over book deduction by the statutory tax rates.
The fair value of stock option awards was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
A summary of the changes in common and preferred stock options issued under all of the existing stock option plans is as follows (the table reflects options for preferred stock on an as converted to common stock basis):
(1) The aggregate intrinsic value was calculated based on the positive difference between the fair value of the Company’s stock on January 31, 2014 and the exercise price of the underlying options.
The number of options exercised during the year ended January 31, 2014 includes 4,170 options included in a cashless exercise, which allowed the optionee to pay the exercise price by surrendering options to the Company. The net shares of common stock resulting from option exercises is 68,997 as reflected in the consolidated statement of shareholder’s equity.
The following table summarizes information relating to stock options granted and exercised:
(1) The aggregate intrinsic value was calculated based on the positive difference between the fair value of the Company’s stock at exercise and the exercise price of the underlying options.
The Company also granted 5,224 restricted stock units for the first time in September 2013 to certain members of the board of directors, which will fully vest in June 2014.
Stock-Based Compensation Expense
The Company records stock-based compensation expense over the estimated service/vesting period. The amount of stock-based compensation expense recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest.
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
Total stock-based compensation expense was recorded within the consolidated statement of operations for the fiscal years ended January 31, 2014, 2013 and 2012 as follows:
The total unrecognized compensation cost related to outstanding stock options is $2.4 million at January 31, 2014. This amount is expected to be recognized over a weighted-average period of 2.7 years.
15. Income Taxes
The components of (loss) income before income taxes are as follows:
The Company’s effective tax rate varies from the U.S. federal statutory rate follows:
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
Significant components of the Company’s deferred tax assets and liabilities are as follows:
The components of the benefit (provision) for income taxes are as follows:
The need to establish valuation allowances for deferred tax assets is assessed periodically by the Company based on the ASC 740, Income Taxes, more-likely-than-not realization threshold criterion. The realizability of the deferred tax assets is evaluated quarterly. At January 31, 2014 and 2013, the Company’s net deferred tax assets totaled $15,310 and $13,139, respectively. The Company reviews all available evidence to evaluate the recoverability of its United States federal, state and foreign deferred tax assets, including net operating losses and research and development tax credits.
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
Based upon the Company’s cumulative history of earnings before taxes for financial reporting purposes over a 12-quarter period ending on January 31, 2012 and an assessment of the Company’s expected future results of operations as of January 31 2012, the Company determined that it was more likely than not that it would realize most of its United States net operating losses and other deferred tax assets prior to their expiration. As a result, during the fourth quarter of fiscal year 2012, the Company reversed a total of $12,501 of its deferred tax asset valuation allowances. The entire amount of the $12,501 valuation allowance release was recorded as a discrete benefit for income taxes in the Company’s consolidated statement of operations in the fourth quarter of fiscal year 2012.
During fiscal year 2013, the Company reassessed its state tax profile and state apportionment. As a result, the Company recorded a valuation allowance against certain state investment tax credits and R&D credits in the amount of $155. This was due to the fact that as of January 31, 2013, management determined it was more likely than not that these assets would not be realized.
During fiscal year 2014, the Company updated its assessment of the realizability of the deferred tax assets, considering new state tax credits and expiring state net operating loss carryforwards, and reduced the valuation allowance by $104.
As of January 31, 2014, the Company had United States federal net operating loss carryforwards of $27,118, which will begin to expire in 2017, and state net operating loss carryforwards of $1,195, which will begin to expire in 2015. The Company has an additional $115 of federal and state net operating losses not reflected above (net of tax), that are attributable to stock option exercises, which will be recorded as an increase in additional paid-in capital on the Company’s consolidated balance sheet once they are “realized” in accordance with ASC 718, Compensation-Stock Compensation. As of January 31, 2014, the Company had federal tax credit carryforwards of approximately $4,145, which will begin to expire in 2017, and state tax research and development credit carryforwards of approximately $1,134, which will begin to expire in 2021.
Under Section 382 of the Internal Revenue Code of 1986, as amended, substantial changes in the Company’s ownership may limit the amount of net operating loss carryforwards that could be utilized annually in the future to offset its taxable income. Specifically, this limitation may arise in the event of a cumulative change in ownership of the Company of more than 50% within a three-year period. Any such annual limitation may significantly reduce the utilization of the Company’s net operating loss carryforwards before they expire. The Company performed an analysis as of January 31, 2014, and determined that it had not experienced an ownership change for purposes of Section 382. However, future transactions in the Company’s common stock could trigger an ownership change for purposes of Section 382, which could limit the amount of net operating loss carryforwards and other attributes that could be utilized annually in the future to offset the Company’s taxable income, if any. Any such limitation, whether as the result of sales of common stock by the Company’s existing stockholders or sales of common stock by the Company, could have a material adverse effect on the Company’s results of operations in future years.
The Company considers the indirect effect of income tax benefits from stock-based compensation in arriving at its income tax provision. The Company recognizes windfall tax benefits associated with the exercise of stock options or release of restricted stock units directly to stockholders’ equity only when realized. A windfall tax benefit occurs when the actual tax benefit realized by the Company upon an employee’s disposition of a share-based award exceeds the deferred tax asset, if any, associated with the award that we had recorded. When assessing whether a tax benefit relating to share-based compensation has been realized, the Company follows the “with-and-without” method. Under the with-and-without method, the windfall is considered realized and recognized for financial statement purposes only when an incremental benefit is provided after considering all
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
other tax benefits including the Company’s net operating losses. The with-and-without method results in the windfall from share-based compensation awards always being effectively the last tax benefit to be considered. Consequently, the windfall attributable to share-based compensation will not be considered realized in instances where our net operating loss carryover (that is unrelated to windfalls) is sufficient to offset the current year’s taxable income before considering the effects of current-year windfalls.
Accounting for income taxes requires a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if, based on the technical merits, it is more likely than not that the position will be sustained upon audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. The Company reevaluates these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit and new audit activity. Any changes in these factors could result in the recognition of a tax benefit or an additional charge to the tax provision. The Company has gross unrecognized tax benefits of $2,167 and $2,259 at January 31, 2014 and 2013, respectively. These amounts represent the amount of unrecognized tax benefits that, if recognized, would result in a reduction of the Company’s effective tax rate.
A tabular roll forward of the Company’s uncertainties in its income tax provision liability is presented below:
The Company classifies interest and penalties related to unrecognized tax benefits as income tax expense. These amounts are not reflected in the reconciliation above. The total amount of interest and penalties related to uncertain tax positions and recognized in the balance sheet as of January 31, 2014 and 2013 was $59 and $40, respectively.
The Company does not expect that the unrecognized tax benefit will change significantly within the next twelve months. The Company and one or more of its subsidiaries file United States federal income tax returns and tax returns in various state and foreign jurisdictions. With limited exceptions, the Company is no longer subject to federal, state or local examinations for years prior to January 31, 2009. However, carryforward attributes that were generated prior to January 31, 2010 may still be adjusted upon examination by federal, state or local tax authorities if they either have been or will be used in a future period.
The Company’s current intention is to indefinitely reinvest the total amount of its unremitted earnings in the local international jurisdiction, except for instances in which the Company can remit such earnings to the United States without an associated net tax cost. Events that could trigger a tax might include United States acquisitions or other investments funded by cash distributions or loans from a foreign subsidiary. Because of the complexity of United States and foreign tax rules applicable to the distribution of earnings from foreign subsidiaries to United States legal entities, the determination of the unrecognized deferred tax liability on these earnings is not practicable. The Company has not provided for United States taxes on the unremitted earnings of its international subsidiaries of $4,050.
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
16. Net (Loss) Income per Share
Net (loss) income per share has been computed using the weighted average number of shares of common stock outstanding during each period. Diluted amounts per share include the impact of the Company’s outstanding potential common shares, such as shares issuable upon exercise of in-the-money stock options or warrants, when dilutive. Potential common shares that are anti-dilutive are excluded from the calculation of diluted net (loss) income per common share.
The following table sets forth the components of the computation of basic and diluted net (loss) income per common share for the periods indicated:
The following outstanding options, awards and warrants were excluded from the computation of diluted net (loss) income per share for the periods indicated because including them would have had an anti-dilutive effect:
17. Geographic and Segment Information
ASC 280, Segment Reporting establishes standards for reporting information regarding operating segments in annual financial statements and requires selected information of those segments to be presented in annual and interim reports issued to stockholders. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision-maker, or decision-making group, in making decisions on how to allocate resources and assess performance. The Company’s chief decision maker, as defined under ASC 280, is a combination of the chief executive officer and the chief operating officer. The Company views its operations and manages its business as one operating segment.
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
Revenues by geographic location in total and as a percentage of total revenues are as follows:
Net long-lived assets, consisting of property and equipment, net, are subject to geographic risks because they are generally difficult to move and to effectively utilize in another geographic area in a reasonable time period and because they are relatively illiquid. Net long-lived assets by principal geographic area were as follows:
18. Employee Benefit Plans
401(k) Plan
The Company has an employee benefit plan for its United States-based employees under Section 401(k) of the Internal Revenue Code. The Plan allows all eligible employees to make contributions up to a specified percentage of their compensation. Under the Plan, the Company may, but is not obligated to, match a portion of the employee contribution up to a defined maximum. For the year ended January 31, 2014, the Company made a total contribution of $468. For the year ended January 31, 2013, the Company made a total contribution of $498. The Company made no matching contribution for the year ended January 31, 2012.
Foreign Defined Contribution Plans
The Company, through its wholly owned subsidiaries, contributes to local defined contribution plans that provide retirement benefits for the Company’s foreign based employees. For the years ended January 31, 2014, 2013 and 2012, the Company, through its subsidiaries, made contributions of $976, $826, and $680, respectively, to these plans.
EXA CORPORATION
Notes to Consolidated Financial Statements-(Continued)
(dollars in thousands except per share amounts)
19. Quarterly Results of Operations (Unaudited)
The following table sets forth the Company’s unaudited operating results for each of the eight quarters in the two-year period ended January 31, 2014. The information is derived from the Company’s unaudited financial statements. In the opinion of management, the Company’s unaudited financial statements include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation thereof. The financial information presented for the interim periods has been prepared in a manner consistent with the Company’s accounting policies described in Note 2 and should be read in conjunction therewith. Operating results for interim periods are not necessarily indicative of the results that may be expected for a full-year period or any future period.
Schedule II
Valuation and Qualifying Accounts
For the years ended January 31, 2014, 2013 and 2012
(1) Deductions consist of amounts written off during the period.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to us, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and we necessarily were required to apply our judgment in evaluating whether the benefits of the controls and procedures that we adopt outweigh their costs.
As required by Rule 13a-15(b) under the Exchange Act, an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of January 31, 2014 was conducted under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of January 31, 2014.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Our internal control system was designed to provide reasonable assurance to our management and board of directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on our financial statements.
Our management previously reported that we had the following material weaknesses in our internal control over financial reporting:
(1) we did not have the appropriate resources and controls to properly account for taxes and
(2) we did not have adequate oversight and controls related to the accounting for complex equity arrangements.
These deficiencies were due to the fact that we did not have the appropriate resources with the appropriate level of experience and technical expertise to account for taxes and complex equity arrangements. As disclosed in our Annual Report on Form 10-K for the fiscal year ended January 31, 2013 and our Quarterly Reports on
Form 10-Q for the quarters ended April 30, 2013, July 31, 2013 and October 31, 2013, we implemented changes in our internal control over financial reporting in accordance with our remediation plan. These changes included the following:
•
we hired a Chief Accounting Officer at the end of the third quarter of fiscal year 2013 and an assistant corporate controller in February 2013 to augment our current staff and to improve the effectiveness of our financial statement close process, and we will continue to assess any additional staffing needs;
•
we engaged an external tax advisor to augment our current staff and improve the effectiveness of our tax accounting process; and
•
we formalized our accounting policies and internal controls documentation and strengthened supervisory reviews by our management.
Our management assessed the effectiveness of our internal control over financial reporting as of January 31, 2014. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (1992). Based on this assessment, and taking into account the remedial actions described above, our management determined that as of January 31, 2014, our internal control over financial reporting is effective.
Changes in Internal Control over Financial Reporting
Except for those remedial actions described above, there was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item will be set forth under the captions “Election of Directors,” “Executive Officers,” “Code of Ethics,” “Directors-Audit Committee Financial Expert” and “Corporate Governance” in our definitive proxy statement for the fiscal year 2014 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission no later than 120 days after the end of our fiscal year (the “2014 Proxy Statement”), and is incorporated herein by reference.
We are also required under Item 405 of Regulation S-K to provide information concerning delinquent filers of reports under Section 16 of the Securities and Exchange Act of 1934, as amended. This information will be set forth under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in our 2014 Proxy Statement, and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will be set forth under the captions “Executive Officers-Executive Compensation” in our 2014 Proxy Statement and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by Item 403 of Regulation S-K will be set forth under the caption “Security Ownership of Certain Beneficial Owners and Management” in our 2014 Proxy Statement, and is incorporated herein by reference.
We have two equity compensation plans under which awards are currently authorized for issuance, our 2011 Stock Incentive Plan, or our 2011 Plan, and our 2011 Employee Stock Purchase Plan, or our 2011 ESPP. In connection with the consummation of our initial public offering in July 2012, our board of directors terminated any new offerings under our 1999 Series G Convertible Preferred Nonqualified Stock Option Plan, or our 1999 Plan, our 2005 Series G Convertible Preferred Stock Incentive Plan, or our 2005 Plan, and our 2007 Stock Incentive Plan, or our 2007 Plan. Each of our 2011 Plan, 2011 ESPP, 2007 Plan and 2005 Plan was approved by our stockholders prior to our initial public offering in 2012. Our 1999 Plan was not approved by our stockholders. The following table provides information regarding securities authorized for issuance as of January 31, 2014 under our equity compensation plans.
(1) Includes 480,979 shares issuable under our 2011 Stock Incentive Plan, which may be issued in the form of options, restricted stock, unrestricted stock, performance share awards or other equity-based awards.
(2) Includes 461,538 shares issuable under our 2011 Employee Stock Purchase Plan.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTORS INDEPENDENCE
The information required by this item will be set forth under the caption “Executive Officers-Certain Relationships and Related Transactions” and “Corporate Governance” in our 2014 Proxy Statement, and is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item will be set forth under the caption “Independent Registered Public Accounting Firm” in our 2014 Proxy Statement, is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as a part of this Report:
(1) Financial Statements-See Index to Consolidated Financial Statements and Financial Statement Schedule at Item 8 on page 55 of this Annual Report on Form 10-K.
(2) Financial Statement Schedules-See Index to Consolidated Financial Statements and Financial Statement Schedule at Item 8 on page 55 of this Annual Report on Form 10-K. All other schedules are omitted because they are not applicable or not required.
(3) Index to Exhibits.
* Indicates management contract or compensatory plan or arrangement.
 We have omitted portions of this exhibit which have been granted confidential treatment.
 Portions of this exhibit have been omitted subject to a pending request for confidential treatment under 24b-2 under the Securities Exchange Act of 1934, and in connection with that request, an unredacted copy of this exhibit has been filed with the SEC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
EXA CORPORATION
By:
/s/ Stephen A. Remondi
Stephen A. Remondi
Chief Executive Officer, President and Director
(Principal Executive Officer)
Date: March 26, 2014
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.