<PAGE>   1

                UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K
(Mark One)
[X]  Annual Report Pursuant to Section 13 or 15(d) of the Securities
     Exchange Act of 1934

                      FOR THE YEAR ENDED DECEMBER 31, 1997

                                       OR

[ ]  Transition Report Pursuant to Section 13 or 15(d) of the Securities
     Exchange Act of 1934 For the transition period

                         from ___________ to ___________

                        Commission File Number: 000-21283


                            SIMULATION SCIENCES INC.
--------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)


            Delaware(State or other jurisdiction of incorporation or
      organization) 601 Valencia Avenue, Suite 100, Brea, California 92823
               (Address of principal executive offices) (Zip Code)


                 95-2487793 (I.R.S. Employer Identification No.)

       Registrant's telephone number, including area code: (714) 579-0412

        Securities registered pursuant to Section 12(b) of the Act: NONE
           Securities registered pursuant to Section 12(g) of the Act:
                    Common Stock, $.001 par value per share
           Preferred Share Purchase Rights, $.001 par value per share

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past ninety (90) days. Yes  X  No
                                                       ---    ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
                             ----

The aggregate market value of the voting stock held by non-affiliates of the
registrant at March 16, 1998 was $132,642,242 based on a total of 14,140,964
shares held by non-affiliates and the closing price reported on the Nasdaq
National Market on that date, which was $9.38 per share.

The registrant had 14,143,609 shares of common stock, $.001 par value,
outstanding as of March 16, 1998.

                       DOCUMENTS INCORPORATED BY REFERENCE

Certain information required by Part III is incorporated by reference to
portions of the registrant's Proxy Statement for the 1998 Annual Meeting of
Stockholders' to be filed pursuant to Regulation 14A.


<PAGE>   2

                                     PART I

ITEM 1.  BUSINESS

         Simulation Sciences Inc. ("SimSci" or the "Company") is a leading
provider of commercial application software and related services to the
petroleum, petrochemical, industrial chemical and other process industries, as
well as the engineering and construction firms that support those industries.
SimSci's software products are designed to increase customers' profitability by
reducing their capital investment costs, increasing yields, improving product
quality and enhancing management decision making. The Company's core simulation
technology includes a substantial collection of physical property data and
modeling algorithms used to calculate physical and chemical characteristics of
materials under a broad set of operating conditions. Key applications addressed
by SimSci's products and services include oil and gas production optimization,
process design, operational analysis, process information management, on-line
modeling and optimization, plant performance monitoring, data reconciliation,
and environmental compliance. SimSci provides support and service to more than
650 customers in over 65 countries.

INDUSTRY BACKGROUND

         SimSci provides commercial simulation software and related services to
the process industries worldwide. According to industry sources, the aggregate
number of processing facilities in the process industries is approximately
14,000 worldwide. Companies in these capital-intensive process industries must
continually seek ways to increase the efficiency of their plant designs and
production operations to increase profitability and improve return on
investment. Because plants in these industries process very large volumes of
materials, even slight increases in efficiency may result in significant
increases in profitability. For example, a sixteen-cent per barrel reduction in
oil processing costs would yield an $8.8 million annual increase in profits for
a typical oil refinery that processes 150,000 barrels per day. Furthermore,
increasingly intense global competition and stringent environmental and safety
regulations have placed additional pressure on companies in the process
industries to optimize the conversion of raw materials into finished products.

         Process industry plant operations are comprised of a series of distinct
process steps that involve different chemical reactions and physical processes.
The chemistry and physics of these individual process steps can be modeled in
software using sophisticated mathematical techniques. To simulate the
performance of specific plants, engineers link mathematical models of each step
into overall processes that represent the physical configuration of the plant.
Due to the number and complexity of the variables involved, such as the specific
chemical properties of the raw materials and the volume, temperature and
pressure at which various processes occur, process simulation software is
complex and calculation intensive. Engineers use simulation software to analyze
the design and operation of the plant and conduct studies to understand process
results, operational efficiencies and the economics of production.

         Historically, simulation software was custom designed by each company
and operated on large mainframe computers. Because of the restricted
capabilities of these computers, early software models had a limited range of
application and required substantial company resources to maintain and support.
The time required to process a new scenario was often many hours, resulting in
the modeling of operations using non-current data, with an attendant inability
to determine optimal plant settings in a timely way. Because of the time
required to simulate production processes in this off-line manner, operations
personnel were unable to use these models in production decisions. Further, this
proprietary software was not designed for widespread use within a company,
making consistency in results throughout an enterprise difficult to achieve. In
addition, this software was focused primarily on process design rather than
ongoing operations or management and had highly technical interfaces that
required specialized programming knowledge and chemical engineering skills to
operate. Furthermore, these software models were not designed for sharing of
data over networked computers.


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<PAGE>   3

        In recent years, more powerful computers and advances in software
technology have resulted in improved simulation capabilities. However, many
process industry companies still use non-object-oriented, proprietary software
that implements simplistic models in an off-line environment primarily for
design purposes.

         Today's process industry managers are increasingly seeking to use
software modeling for both process design and operations to improve the
efficiency of their ongoing operations and to manage their overall plants more
profitably. To achieve this, simulation software must have easy to use
interfaces, allow information to be distributed to managers throughout an
organization, process new scenarios based on real-time plant operations data and
integrate with other control and data systems. In addition, simulation software
must use highly sophisticated models based on rigorous mathematics to generate
more accurate information that can be used by different departments throughout
an enterprise to provide both managers and engineers with timely, consistent
information.

THE SIMSCI SOLUTION

         SimSci's products and services are designed to increase process
manufacturers' profitability by enabling the accurate, reliable design of more
efficient processes and the use of better decision-support tools to improve
plant operations. The Company's principal product has an easy-to-use Graphical
User Interface ("GUI") and operates on industry standard hardware and software
platforms. This product's open, object-based architecture facilitates
interoperability with customer-developed applications and enables the effective
use of simulation technology throughout the enterprise. The Company's core
simulation technology includes a substantial proprietary collection of physical
property data and modeling algorithms used to calculate physical and chemical
characteristics of materials under a broad set of operating conditions. Because
SimSci's software modules are readily applicable in multiple applications,
different departments within an enterprise can share common models, thus
increasing the accuracy, timeliness and consistency of information use across
multiple departments. The Company's software provides both managers and
engineers with critical process information necessary to make more informed
decisions.

        Design. The Company's products allow design engineers to predict the
        behavior of chemical and physical processes, shorten the time required
        to design new processes or improve existing processes, achieve more
        efficient designs, decrease the cost of constructing or improving
        plants, and more easily comply with environmental and safety
        requirements.

        Operate. Operations engineers use SimSci products to improve a
        manufacturer's cost structure and profitability by modifying plant
        processes to reduce raw material requirements, save energy, maintain
        quality, enhance product yield and increase throughput. The Company also
        delivers customized, turn-key solutions, for example, through its
        production accounting ("OpenYield") and Rigorous On-line Modeling
        ("ROM") service offerings. OpenYield uses reconciled plant data to
        measure plant performance and ROM uses on-line links to plant data for
        improving operations without interrupting the ongoing stream of
        materials.

        Manage. The Company's easy-to-use products enable corporate decision
        makers to base business and financial decisions on a more accurate and
        complete understanding of their operations, including operating and
        profit margins, return on capital equipment, raw materials selection,
        throughput, product quality and market timing.

        Information gathered in the design, operation and management functions
can be used in an iterative way to further improve processing of materials,
management of the enterprise, use of the Company's products and the design of
new plants.


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<PAGE>   4

STRATEGY

        The Company's objective is to expand and extend the use of its
simulation technology and solutions for design, operations and management
functions throughout the process industries. The key components of the Company's
strategy to achieve this objective include the following:

        Leverage Core Simulation Technology. Over the last three decades, the
Company has created proprietary algorithms, designed process unit models and
developed physical and chemical property prediction methods for rigorous process
simulation. In addition, the Company has extended the visibility of its products
by developing an interactive GUI as well as the Open Software Application
Framework ("OSAF") architecture. The Company intends to continue to leverage
this core technology to broaden the use of its products from the design of
processes to the optimization of operations and the management of the
enterprise.

        Integrate Core Products into the Open Software Application Framework.
The Company's integration tools and OSAF architecture enable customers to adapt
their in-house and legacy software to interoperate with software from the
Company or other third parties. As a result, customers can increase engineering
productivity and expand the value of their existing technologies.

        Expand Operations Improvement Capabilities. The Company intends to
continue developing turn-key solutions to enable engineers and managers to
better operate and manage plant processes. SimSci's yield accounting solution
combines current database technology with SimSci's data reconciliation
technology to deliver an accurate and reliable plant performance monitoring
system. On-line models of specific operating plants may be created by utilizing
the Company's ROM services to create rigorous models that use real-time plant
data and current economic objectives to determine more profitable process
settings. The Company, in a joint development arrangement with Shell, is
developing a new product to enable the use of common models for both off-line
and on-line applications.

        Penetrate Additional Process Industries. To date, the majority of the
Company's revenue has been derived from sales to companies in the refining
industry. The Company is seeking to increase sales of its products in additional
process industries, including the upstream petroleum, petrochemicals,
pharmaceuticals, and chemicals industries, by offering additional product
functionality. For example, the Company recently acquired process information
management software to facilitate increased penetration of the Company's
products and services in the petrochemical and chemical industries.

        Acquire Complementary Businesses, Products and Technologies. The Company
continually monitors developments in the process industries and seeks to acquire
complementary businesses, products or technologies. During 1997, the Company
completed eight acquisitions of assets, licenses and technology and the related
hiring of approximately 75 new employees.

        Promote Strategic Relationships. SimSci has developed a network of
alliances with a select group of customers that meet with SimSci senior
technical and business management to help influence future technical direction.
In addition, the Company has entered into strategic alliances with key customers
and vendors to enhance SimSci's technology content and deliver more complete
technology solutions. Customers and vendors with which the Company has alliances
include Bayer, Fluor Daniel, IBM, Mobil, SAP AG and Shell.

TECHNOLOGY

        The Company believes that it has developed significant expertise in core
simulation and mathematical technologies that allow customers to define, model,
simulate, analyze and understand the behavior of complex processes. The core
technology required to support the Company's customers includes software and
chemical engineering, process analysis, heat and mass transfer, thermodynamics,
fluid flow and solution algorithms related to the delivery of these competencies
to the customer.


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<PAGE>   5

        Open Software Application Framework. SimSci's Open Software Application
Framework is an architecture for integrating a GUI with application software
components, proprietary simulation programs, engineering databases and other
software applications used in the process industry. OSAF is implemented through
SimSci GUI and integration technology which includes the PROVISION and Simply
Visual Software.

        Engineering Models of Plant Process Equipment. Plant process equipment
performs a variety of manufacturing functions, including heat exchange,
distillation, chemical reaction, pumping and compressing. The Company's
engineering models of such equipment are based on fundamental laws of chemistry
and physics, including laws governing material and energy balances, chemical and
thermodynamic equilibrium, rates of heat and mass transfer and chemical
reaction. The Company's products incorporate models for substantially all
standard process plant equipment types.

        Physical Property Data and Modeling Algorithms. The Company's library of
physical property data and modeling algorithms includes thermodynamic
properties, such as enthalpy, entropy and heats of formation, as well as
transport properties, including viscosity, thermal conductivity and
diffusivities. The Company's data and models have been developed over more than
20 years and are capable of representing a wide range of physical systems, such
as those used in petroleum processes. The Company's data tables contain data for
approximately 1,700 chemical components and are supplemented by methods for
estimating property data for unknown or unusual compounds based on functional
groups and utilities for regression analysis of experimental laboratory or plant
data. In addition, the Company has substantial proprietary banks of chemical
component interaction data to enhance the accuracy of simulation models.

        Solution Algorithms. Process simulation models require the solution of
complex algebraic and partial differential equations that are often highly
nonlinear and therefore difficult to solve. Also, optimization functions employ
sequential quadratic programming techniques to solve these difficult equation
sets. The Company's principal simulation software product, PRO/II, is based on a
sequential modular solution technique, by which process unit models are solved
sequentially in the most efficient order. In addition to utilizing a sequential
modular technique, one of the Company's principal products under development,
ROMeo, employs an equation-based solution technique in which the equations for
multiple process models are solved simultaneously. Offering products that are
based on both modeling techniques will allow the Company's customers to address
a broader range of problems.

PRODUCTS AND SERVICES

        SimSci's strategy is to develop, market and sell products and services
that help customers increase engineering productivity, leverage existing
technology and improve plant profitability. SimSci's products are designed to
run on industry-standard platforms and software environments, including Windows
NT and UNIX, and utilize an easy-to-use GUI. The following table sets forth
certain information with respect to the Company's products, service offerings
and products under development.


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<PAGE>   6

<TABLE>
<CAPTION>
                                                                              PRODUCT
APPLICATIONS AND PRODUCTS           PRODUCT DESCRIPTION                 DEVELOPMENT STATUS
-------------------------           -------------------                 ------------------
<S>                           <C>                                       <C>
Process Engineering:

    PRO/II                    General-purpose simulation software with  Currently available
                              graphical flowcharting environment for
                              processes in steady-state

    HEXTRAN                   Heat transfer simulation software         Currently available

    DATACON                   Data reconciliation software for process  Currently available
                              data

Production Management:

    AIM-Supervisor System     Open VMS-based process information        Currently available
                              management software for continuous and
                              batch processes

    OpenYield                 Integrated data reconciliation and yield  Currently available
                              accounting software

    AIM\AT                    Windows NT based process information      Under development
                              management software for continuous and
                              batch processes

    PLANit                    Software for planning and scheduling      Under development
                              applications which involve single and
                              multiple plant sites

Oil & Gas Production:

    PIPEPHASE                 Simulation software for oil and gas       Currently available
                              gathering networks

    NETOPT                    Software for optimizing the production    Currently available
                              of oil and gas fields

    PIPEPHASE-TACITE          Software to address the simulation of     Currently available
                              transient conditions in pipeline
                              networks

Plant Safety and Regulatory Compliance:

    INPLANT                   Simulation software for plant piping      Currently available
                              systems

    Visual Flow Suite         Simulation program that enables the       Currently available
                              design and modeling of safety systems
                              and pressure relief networks

Model-based Control & Optimization:

    ROM                       Rigorous on-line modeling (ROM) and       Currently available
                              optimization service utilizing several
                              of the Company's products

    FACS                      Implementation services and technology    Currently available
                              for online soft sensors based on
                              rigorous dynamic models
</TABLE>


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<PAGE>   7

<TABLE>
<CAPTION>

                                                                             PRODUCT
APPLICATIONS AND PRODUCTS           PRODUCT DESCRIPTION                 DEVELOPMENT STATUS
-------------------------           -------------------                 ------------------
<S>                           <C>                                       <C>
    ROMeo                     Integrated system for performing          Under development
                              off-line and on-line process simulation
                              and optimization

    QDMC/PCTP                 Multi-variable process control software   Under development
                              with enhanced model development,
                              implementation and maintenance utilities

Application Integration:

    Simply Visual             Single software interface for process     Currently available
                              industry applications based on Windows
                              technology

    Simulation Manager        Integration and execution control         Under development
                              software for the simultaneous
                              application of separate software to
                              problems spanning multiple process
                              units. Programs may run on different
                              platforms in a networked environment
</TABLE>


Products and Services

        PRO/II. PRO/II is a steady-state simulation program that enables process
engineers to rigorously model a wide range of organic and inorganic chemical
processes, such as those found in oil and gas, chemical and petrochemical
industries. Engineers use PRO/II to design new processes or to troubleshoot,
debottleneck and retrofit existing operations and assess compliance with safety
and environmental regulations. PRO/II has an intuitive and easy-to-use GUI
through PROVISION.

        The Company derives a substantial portion of its total revenue from
sales of its PRO/II simulation product. Revenue attributable to sales of PRO/II
accounted for approximately 70% of the Company's total revenue in each of the
last three years. The Company currently expects PRO/II, individually or
integrated with other products, to account for a significant portion of the
Company's total revenue in the future. See "Factors That May Affect Future
Results of Operations Product Concentration."

        HEXTRAN. HEXTRAN is a steady-state simulation program that enables
engineers to perform energy audits to monitor and optimize the performance of
existing heat exchange network configurations and to design new systems.

        DATACON. DATACON is a data reconciliation program that enables users to
turn real time process data into consistent and reliable information. DATACON
reconciles flow, temperature and composition measurements to satisfy material
and energy balances around each unit in a process plant, detects gross errors in
measurements, pinpoints the errors' locations and confirms the presence or
absence of measurement redundancy.

        AIM-Supervisor System. AIM-Supervisor System is a suite of process
information management software which provides a full complement of process
analysis tools for effectively troubleshooting process problems, uncovering
cause-and-effect relationships and improving product quality.

        OpenYield. OpenYield is an integrated data reconciliation and production
accounting system designed to improve plant performance. OpenYield tracks the
movements of material through a process, identifies sources of material
imbalance and reduces the uncertainty of material loss calculations. OpenYield
utilizes the Company's data reconciliation technology to improve the accuracy of
plant data used in yield calculations by applying


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<PAGE>   8
statistical techniques to reconcile material balances on a unit-by-unit and
plant-wide basis. The Company is currently enhancing its OpenYield offering to
include links to enterprise management software, such as that offered by SAP AG,
to provide an integrated plant performance and yield accounting system.

        PIPEPHASE. PIPEPHASE is a steady-state simulation program that enables
engineers to simulate multiphase fluid flow in pipelines, networks and
production transmission systems and is typically utilized to simulate the flow
of gas or oil from the well to the processing complex.

        NETOPT. NETOPT is a program designed to optimize the design, production
and planning of oil and gas networks and enhanced oil recovery enabling the
management of assets from the reservoir to the refinery. NETOPT has been
developed in conjunction with Mobil Oil Corporation.

        PIPEPHASE-TACITE. This product expands the benefits of PIPEPHASE to
address the simulation of transient conditions in pipeline networks.
PIPEPHASE-TACITE is the result of a joint development and marketing agreement
with Institut Francais Petrole ("IFP").

        INPLANT. INPLANT is a steady-state simulation program for designing,
rating and analyzing plant piping systems. Utilizing INPLANT, engineers can
efficiently rate and analyze the safety of plant piping systems as well as
design new piping systems and revamp a wide variety of existing systems.

        Visual Flow Suite. Visual Flow Suite is a simulation program that
enables process safety engineers to design and model safety systems and pressure
relief networks in processing facilities.

        ROM. ROM involves the development of on-line software models of existing
process units. SimSci's core products, such as PRO/II and DATACON, are used by
ROM engineers to develop on-line models. ROM provides operations personnel with
highly accurate models for performing case studies and for determining how to
improve operating profits. ROM combines real-time plant data with current
economic objectives to precisely replicate plant operations and is designed to
provide a real-world model of an actual operating facility, calculate new
process setpoints to improve performance, and help determine the location and
cause of operating problems.

        FACS. FACS is a control and optimization system for refinery process
units. It incorporates a rigorous, self-adapting, dynamic model for composition
estimation. FACS systems can provide accurate on-line feed characterization and
material property calculations during process disturbances and operational
changes.

        Simply Visual. Simply Visual is a tool designed to upgrade legacy code
to modern architectural standards to view and analyze historical and live
process data, and to integrate critical applications through a single window
interface. Simply Visual combines drawing and graphical capabilities with binary
data transfer to form an effective interface between integrated applications.


Products Under Development

        AIM\AT Suite. The AIM\AT Suite is a Windows NT-based process information
management system for manufacturing enterprises that is secure, scalable and
highly flexible, providing open connectivity from control systems to business
management systems.

        PLANit. PLANit is based on technology currently in use at multiple Shell
refineries. It provides business managers with information designed to increase
operating profits throughout a refinery and across multiple refineries. PLANit
provides simulation-based decision support to operating managers by selecting
optimal product manufacturing plans, including product selection, intermediates
staging and feedstock procurement.


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<PAGE>   9

        ROMeo. ROMeo ("Rigorous On-line Modeling and Equation-based
Optimization") is a software application that has been jointly developed by the
Company and Shell Oil Company and is designed to enable engineers to rigorously
model and optimize plant operations on a unit, multi-unit and plant-wide basis,
enhancing decision support at all business levels. ROMeo is designed to provide
a united framework for data reconciliation, parameter estimation and process
optimization. It will automatically retrieve pertinent plant data from the
control system and use the information to predict new process setpoints rapidly
and accurately to achieve optimum performance. The ROMeo system is based on an
object-oriented design and will include a commercial database, facilitating data
transfer between applications and enhancing application interoperability.

        QDMC/PCTP. QDMC is a multivariable controller that is used on-line to
overcome process disturbances, predict future performance and determine the
adjustments required to keep the process controlled within certain limits.
Shell's PCTP tools include advanced algorithms to improve the accuracy,
implementation and maintenance of multivariable controllers. The Company has
acquired certain exclusive worldwide marketing rights and the right to purchase
such technology from Shell.

        Simulation Manager. Simulation Manager orchestrates the application of
multiple independent programs to large optimization problems, uniting both
commercial and legacy software into a cross platform solution tool. Simulation
Manager is used to solve extensive, plant-wide simulation problems, running
applications in parallel across heterogeneous networked computing environments.


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<PAGE>   10

CUSTOMERS

        SimSci currently has over 650 customers across the major process
industries, including the petroleum, petrochemical and chemical industries, and
the engineering and construction industry that supports them. In 1995, 1996 and
1997, 64%, 67% and 62%, respectively, of SimSci's total revenue was generated
from customers outside of the United States.

        The following table sets forth selected customers of the Company,
categorized by process industry, whose current license and service agreements
with the Company have a total contract value of at least $100,000, and selected
academic institutions that use the Company's software for chemical engineering
education:

<TABLE>
<CAPTION>

                                 CHEMICAL AND OTHER              ENGINEERING &
PETROLEUM INDUSTRY               INDUSTRIES                      CONSTRUCTION INDUSTRY
------------------               ------------------              ---------------------
<S>                              <C>                             <C>
Agip SpA
Amerada Hess Corporation         Abbott Laboratories             ABB Lummus Global, Inc.
Amoco Corporation                Allied Signal Inc.              Bechtel Corporation
Atlantic Richfield Company       Bayer Corporation               Brown & Root, Inc.
BP Oil Company                   Cabot Corporation               Chisso Corporation
Chevron U.S.A.  Inc.             Eastman Kodak Company           Edeleanu GmbH
Citgo Petroleum Company          Eli Lilly & Company             Fluor Daniel, Inc.
Den Norske Stats                 Enichem SpA                     Foster Wheeler U.S.A.
  Oljeselskap a.s. (Statoil      General Electric Plastics         Corporation
a.s.)                              Company                       IBB GmbH
Exxon Oil Corporation            Henkel KGaA                     Idemitsu Engineering
Hindustan Petroleum              Hoechst AG                        Company, Ltd.
  Corp.  Ltd.                    Imperial Chemical               Ishikawajima-Harima Heavy
Kuwait National Petroleum          Industries PLC                  Industries Co.  Ltd.
  Company KSC                    Kimberley Clark Corporation     Jacobs Engineering Group, Inc.
Mobil Oil Corporation            Mitsubishi Chemical             JGC Corporation
Pemex                              Corporation                   John Brown Engineers and
Pertamina                        Monsanto Company                  Constructors B.V.
Petroleo Brasileiro-Petrobras    Nippon Sanso Corporation        KTI BV
Petrolios de Venezuela           Nova Chemical Ltd.              Kvaerner Engineering AS
Saudi Arabian Oil Co.            Saudi Basic Industries Corp.    M.W.  Kellogg Company Ltd.
Scientific Computing             Tokuyama Corporation            Niigata Construction Co. Ltd.
  Consulting Ltd.  - Vniigas                                     Nippon Oil Engineering
Shell Internationale Petroleum   ACADEMIC INSTITUTIONS             and Construction Co. Ltd.
  Maatschappij B.V.                                              Raytheon Engineers &
Sun Refining and Marketing Co.   Carnegie-Mellon                   Constructors
Texaco Group Inc.                Fachhochschule Ostfriesland     Snamprogetti SpA
Unocal Corporation               Indian Institute of Technology  Stone & Webster
                                 Louisiana State University        Engineering Ltd.
                                 University of Oklahoma          Toyo Engineering Corporation
                                 Pennsylvania State University
                                 University of Calgary
                                 University of Southern
                                   California
                                 University of Wisconsin
</TABLE>

        Customers typically license SimSci's software for terms of one to five
years. During the past five years, the substantial majority of all licenses have
been renewed. Currently, the approximate annualized cost for the typical license
by a single U.S. corporate user of one of SimSci's core products ranges from
$10,000 to $50,000, depending on the product and options selected. The license
fees charged by SimSci for each of its core products


                                       10


<PAGE>   11

are typically based on the number of licensed users, with the cost per user
declining as the customer increases the total number of licensed users. More
than 95% of the Company's license contracts entered into before 1996 did not
separately identify both software license fees and charges for customer support
obligations. In 1996, the Company began increasing the number of new and renewed
contracts that separately identify software license fees and maintenance and
support fees. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."

        The Company ships software products within a short period after receipt
of an order and typically does not have a material backlog of unfilled orders.
Total revenue in any quarter is dependent (and has become substantially
dependent as the Company has increased the number of contracts for new and
renewing customers that result in the recognition of license revenue upon
shipment) on orders booked and contract renewals in that quarter and are not
predictable with any degree of certainty. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

        The Company derives a significant portion of its total revenue from
software licenses to companies in the petroleum industry, which is highly
cyclical. Accordingly, the Company's future success is dependent upon the
continued demand for process engineering software by companies in the petroleum
industry. The Company believes that pricing pressures experienced by petroleum
companies in connection with cost containment measures have led to delays and
reductions in certain capital and operating expenditures by many of such
companies in the past, and such delays or reductions could recur in the future.
Any such delays, reductions or fluctuations could have a material adverse effect
on the Company's business, operating results and financial condition. Further,
the Company's revenue has in the past been, and may in the future be, subject to
substantial period-to-period fluctuations as a consequence of general domestic
and foreign economic conditions, political developments and other factors
affecting spending in the petroleum industry. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Factors That May
Affect Future Results of Operations - Concentration of Revenue in the Petroleum
Industry."

        A significant portion of the Company's total revenue is derived from
customers outside the United States, and the Company anticipates that
international revenue will continue to be significant in the future. Revenue
from customers outside the United States accounted for 64%, 67% and 62% of total
revenue in 1995, 1996 and 1997, respectively. The Company's international
operations are subject to risks inherent in the conduct of international
business, including unexpected changes in regulatory requirements, exchange
rates, export license requirements, tariffs and other barriers, political and
economic instability, limited intellectual property protection, difficulties in
collecting payments due from sales agents or customers, difficulties in managing
distributors or representatives, difficulties in staffing and managing foreign
subsidiary operations, and potentially adverse tax consequences. The Company
derives substantial revenue from the sale of products to customers in the Middle
East and in the past has been required to discontinue shipments to such
customers due to trade embargoes imposed by the United States. There can be no
assurance that future trade embargoes or any of the other foregoing factors will
not have a material adverse effect on the Company's international operations and
therefore its business, operating results and financial condition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Factors That May Affect Future Results of Operations - Risks
Associated With International Operations."

SALES AND MARKETING

        SimSci markets its products and services through its direct sales
organization complemented by sales agents and distributors. As of December 31,
1997, the Company's global direct sales force included personnel located in
three sales and support offices in the United States and international sales
offices in Brazil, Dubai, Germany, Japan, Singapore, the United Kingdom and
Venezuela. The Company currently intends to add to its direct sales and support
force in the United States and internationally. In addition, the Company devotes
a significant portion of its sales and marketing efforts to increasing
penetration of its products with new and existing large multinational customers.
Due to their size and geographically dispersed installations and decision-making
process, the Company assigns one senior sales representative world-wide
responsibility for sales to these customers.


                                       11


<PAGE>   12

        In support of these sales efforts, the Company conducts marketing
programs intended to position and promote its products and services. SimSci
markets its products at a substantial discount to universities for use in
teaching and research. The Company participates in industry tradeshows,
publishes articles and advertisements in industry publications, conducts direct
mail campaigns, and sponsors industry conferences and seminars.

STRATEGIC ALLIANCES

        SimSci has entered into a number of strategic alliances with respect to
its core products, new products and product enhancements, including a
development arrangement with Mobil with respect to NETOPT; a joint development
arrangement with Shell with respect to ROMeo; a general cooperation agreement
with Bayer AG with respect to Simulation Manager; a development and marketing
agreement with IFP with respect to PIPEPHASE-TACITE; and a marketing agreement
with Japan National Oil Corporation ("JNOC") with respect to the integration of
PIPEPHASE with JNOC's well simulation program. The Company also has entered into
cooperation agreements with Fluor Daniel, IBM and SAP AG.

CUSTOMER SUPPORT

        Substantially all of the Company's term license contracts to customers
include maintenance and support contracts, which typically range from 12 to 60
months and entitle the customer to product updates and to technical support. In
addition, the Company offers instruction in the use of its products for various
levels of student proficiency. Users of the Company's products can also attend
user group conferences held at various times and locations worldwide.

PRODUCT DEVELOPMENT

        The Company's development efforts are focused on expanding SimSci's
simulation software product line, designing enhancements to the Company's core
technology, and integrating existing and new products into the Company's Open
Software Application Framework. The Company has made substantial investments in
product development, and SimSci currently has several products under
development. The Company's development efforts may also be enhanced by joint
development and license agreements with selected technology partners. The
Company believes that its future performance will depend in large part on its
ability to maintain and enhance its current product line, develop new and
acquired technologies into commercial products that achieve market acceptance,
maintain technological competitiveness and meet an expanding range of customer
requirements. The Company's research and development expenditures in 1995, 1996
and 1997 were $8.6 million, $12.2 million and $16.9 million, respectively, and
represented 26%, 26% and 28%, respectively, of total revenue in such periods.
The Company expects that it will continue to commit substantial resources to
product development in the future. See " - Products and Services - Products
Under Development."

        The software market in which the Company competes is subject to rapid
technological change, frequent introductions of new products, changes in
customer demand and evolving industry standards. The introduction of products
embodying new technologies and the emergence of new industry standards can
render existing products obsolete and unmarketable. The Company's future results
of operations will depend in part upon its ability to address the increasingly
sophisticated needs of its customers by supporting existing and emerging
hardware, software, database and networking platforms and by developing and
introducing enhancements to its existing products and new products on a timely
basis that keep pace with such technological developments, emerging industry
standards and customer requirements. In addition, an important part of the
Company's product development strategy is to acquire or obtain rights to new
technologies from third parties to enhance the Company's existing products or to
develop into new products. In this regard, during 1997, the Company completed
eight acquisitions of assets, licenses and technology, including technology that
will require significant additional development before release in commercial
products. There can be no assurance that the Company will be successful in
acquiring, developing and marketing products or enhancements that respond to
technological


                                       12


<PAGE>   13

change, evolving industry standards or customer requirements, that the Company
will not experience difficulties that could delay or prevent the successful
acquisition, development, introduction and sale of such products or enhancements
or that such products or enhancements will adequately meet the requirements of
the marketplace and achieve market acceptance. The Company has in the past
experienced delays in the release dates of certain of its new products and
enhancements to certain of its existing products. If release dates of any new
significant products or product enhancements are delayed or if they fail to
achieve market acceptance, the Company's business, operating results and
financial condition would be materially adversely affected. In addition, the
introduction or announcement of new product offerings or enhancements by the
Company or the Company's competitors may cause customers to defer or forgo
purchases of current versions of its products, which could in turn have a
material adverse effect on the Company's business, operating results and
financial condition.

COMPETITION

        The market for commercial simulation software used in the petroleum,
chemical and other process industries is intensely competitive and characterized
by rapidly changing technology, evolving industry standards, frequent new
product introductions and rapidly changing customer requirements. The Company
experiences significant competition from potential customers' decisions to
internally develop their own process design, simulation and optimization
applications as opposed to purchasing commercial software products such as the
Company's. As a result, the Company must continuously educate existing and
prospective customers about the advantages of the Company's products. There can
be no assurance that these customers or potential customers will perceive
sufficient value in the Company's products to justify purchasing them. In
addition, customers or potential customers could enter into strategic
relationships with one or more of the Company's competitors to develop, market
and sell competing products and services.

        The Company has experienced and expects to continue to experience
competition from current and future competitors, some of whom have significantly
greater financial, technical, marketing and other resources than the Company.
The Company's current direct competitors include Aspen Technology, Inc.
("Aspen"), Hyprotech, Ltd. and Chemstations, Inc., and, with respect to the
Company's technology and consulting services, the Hi-Spec division of Honeywell,
Inc., the Advanced Control and Optimization Division of Aspen and ABB Simcon
Inc. Certain of the Company's competitors may be able to respond more quickly to
new or emerging technologies and changes in customer requirements or to devote
greater resources to the development, promotion and sale of their products than
can the Company. Also, certain of the Company's current and potential
competitors have greater name recognition, larger installed bases and more
diversified product lines that could be leveraged to increase market share to
the Company's detriment. The Company expects to face increased competition as
other established and emerging companies enter the commercial simulation
software market in the process industries and new products and technologies are
introduced. Increased competition could result in price reductions, fewer
customer orders, reduction in license renewals and loss of market share, any of
which could materially adversely affect the Company's business, operating
results and financial condition. In addition, current and potential competitors
have in the recent past, and may in the future, make strategic acquisitions,
merge or establish cooperative relationships among themselves or with third
parties, thereby increasing the ability of their products to address the needs
of the Company's current or prospective customers. Such competition could
materially adversely affect the Company's ability to sell new or renewal
licenses and maintenance and service agreements on terms favorable to the
Company. Further, competitive pressures could require the Company to reduce the
price of licenses for its products and related services, which could materially
adversely effect the Company's business, operating results and financial
condition. There can be no assurance that the Company will be able to compete
successfully against current and future competitors, and the failure to do so
would have a material adverse effect upon the Company's business, operating
results and financial condition.

        The principal competitive factors in the Company's markets include:
accuracy of modeling, enhancing the technology's ease of use, the ability to
continually meet the customers' needs to leverage process information across the
enterprise and to link operations information with enterprise applications,
continually increase the size and complexity of processes that can be modeled
accurately and in a timely manner, the need to continue to leverage the
customers' operations and information technology strategies, customer support,
price, hardware


                                       13


<PAGE>   14

flexibility and vendor financial stability. The Company believes that the
required knowledge of evolving software and hardware technologies and the need
to leverage these, the level of development effort, and the chemical engineering
and modeling expertise required to enter and succeed in the simulation
technology industry represent significant barriers to entry.

PROPRIETARY RIGHTS

        To date, the Company has relied upon a combination of copyright, trade
secret and trademark laws to protect its proprietary technology. SIMSCI, PRO/II,
PROVISION, HEXTRAN, PIPEPHASE, THE SIMULATOR, OpenYield, AIM, AIM-Supervisor,
AIM\AT Suite, FACS, INPLANT, BATCHSIM, DATACON, ROM, ROMeo, VISUAL FLARE, VISUAL
FLOW SUITE, VISUAL NETWORK and NETOPT are trademarks of the Company. The Company
enters into confidentiality agreements with its employees, developers,
distributors and customers and limits access to and distribution of the source
code to its software and other proprietary information. Policing unauthorized
use of the Company's products is difficult. There can be no assurance that the
steps taken by the Company in this regard will be adequate to prevent
misappropriation of its technology or that the Company's competitors will not
independently develop technologies that are substantially equivalent or superior
to the Company's technology.

        In the future, the Company may receive communications from third parties
or have other reasons to seek licenses under third-party intellectual property
rights. In such cases, the Company may evaluate whether to obtain such licenses.
However, there can be no assurance that such licenses will be available or if
such licenses are made available, that the terms will not have a material
adverse effect on the Company's results of operations.

        Certain technology used in the Company's products is licensed from third
parties. These licenses may require the Company to pay royalties and to fulfill
confidentiality obligations. The Company believes that there are alternative
sources for each of the material components of technology licensed by the
Company from third parties. However, the termination of any of such licenses, or
the failure of the third party licensors to adequately maintain or update their
products, could result in delay in the Company's ability to ship certain of its
products while it seeks to implement technology offered by alternative sources.
Any required replacement licenses could prove costly. Also, any such delay, to
the extent it becomes extended or occurs at or near the end of a fiscal quarter,
could result in a material adverse effect on the Company's results of
operations. While it may be necessary or desirable in the future to obtain other
licenses relating to one or more of the Company's products or relating to
current or future technologies, there can be no assurance that the Company will
be able to do so on commercially reasonable terms or at all.

EMPLOYEES

        As of December 31, 1997, the Company had a total of 368 employees,
including 161 in research and development, 139 in sales and marketing and
related customer support services and 68 in general and administrative. Of these
employees, 306 were located in the United States, 30 in Europe, 8 in South
America and 24 in Asia. The Company also employs contract and temporary
employees from time to time. None of the Company's employees is represented by a
collective bargaining agreement, nor has the Company experienced any work
stoppage. The Company considers its relations with its employees to be good.

        The Company currently subcontracts certain aspects of its research and
development to outside contractors. The Company may in the future experience
problems with its contractors, such as quality or on-time delivery problems. In
addition, certain of these contractors are located outside the United States,
and the Company may therefore suffer adverse consequences as a result of
communication, cultural or political barriers or because the laws of other
countries may be less protective of the Company's intellectual property than are
the laws of the United States. In addition, the Company may in the future
experience pricing pressure from its contractors. To date, the Company has had
only limited experience with the use of research and development contractors.
There can be no assurance that the Company will be able to manage its contract
developers effectively or that these developers will meet the Company's future
requirements for timely delivery of high-quality products.


                                       14


<PAGE>   15

ITEM 2. PROPERTIES

        The Company's principal administrative, sales, marketing and product
development facility occupies approximately 60,000 square feet in Brea,
California pursuant to a lease that expires in April 2008. The Company also
occupies approximately 45,000 square feet of office space for its operations in
Houston, Texas pursuant to leases that expire through August 2000. In addition,
the Company also leases sales and support offices in Newtown Square,
Pennsylvania. The Company also maintains international offices in Brazil, Dubai,
Germany, Japan, Singapore, the United Kingdom and Venezuela. The Company
believes that its existing facilities are adequate for its current needs and
that suitable additional or alternative space will be available in the future on
commercially reasonable terms as needed.

        The Company has recently entered into a new lease, which expires in
March 2006, for an approximately 54,000 square foot facility in the Houston,
Texas area and intends to consolidate its Houston-area operations by relocating
them to this facility in the near future. In addition, the Company is currently
seeking alternate space near its Brea, California headquarters and could also
move its Brea operations in the near future. Each move of Company facilities
involves coordination of complex events in order to avoid or minimize disruption
or delay of the Company's operations, including potential delays in product
development or shipment of products. If any of the anticipated facility moves
were to result in significant delays in product development or other disruption
of operations, the Company's business, operating results and financial condition
could be materially adversely affected.


ITEM 3. LEGAL PROCEEDINGS

        The Company is not currently subject to any legal actions that are
expected to have a material adverse effect on the Company's business, operating
results or financial condition.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.



                                       15

<PAGE>   16

                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

        Since October 25, 1996 the Company's Common Stock has traded on the
Nasdaq National Market under the symbol "SMCI." The high and low sales prices
for shares of the Company's Common Stock, as reported on the Nasdaq National
Market are listed below.

<TABLE>
<CAPTION>

    Period                                                High          Low
    -------------------------------------------------------------------------
    <S>                                                   <C>         <C>
    Fourth Quarter 1996 (from October 25, 1996)           $15.00      $  9.25

    First Quarter 1997                                     18.63        10.00
    Second Quarter 1997                                    15.38         9.13
    Third Quarter 1997                                     19.88        12.25
    Fourth Quarter 1997                                    23.38        13.88
</TABLE>

        On March 16, 1998, the closing price for the Company's Common Stock was
$9.38 per share, the Company had 74 stockholders of record and approximately
2,800 beneficial owners of its common stock.

        The Company has not declared or paid any cash dividends on the Common
Stock for more than five years and does not presently intend to pay cash
dividends on the Common Stock in the foreseeable future. The Company's line of
credit agreement prohibits the payment of cash dividends on its capital stock
without the lender's consent. Any payment of cash dividends on shares of Common
Stock will be within the discretion of the Company's Board of Directors and will
depend upon the earnings of the Company, the Company's capital requirements,
restrictions imposed by the Company's lenders, applicable requirements of the
Delaware General Corporation Law and other factors which are considered relevant
by the Company's Board of Directors.



                                       16

<PAGE>   17

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

        The selected consolidated financial data presented below as of December
31, 1996 and 1997, and for the years ended December 31, 1995, 1996 and 1997, are
derived from the Company's consolidated financial statements included elsewhere
in this Form 10-K, which were audited by Deloitte & Touche LLP, independent
auditors. The selected consolidated financial data presented below as of
December 31, 1993, 1994 and 1995 and for the years ended December 31, 1993 and
1994 have been derived from the Company's audited consolidated financial
statements, not included in this Form 10-K. The data set forth below should be
read in conjunction with Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the consolidated financial
statements and related notes included elsewhere in this Form 10-K. Also see Item
7. "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Overview" for a discussion of a change in the Company's license
contract terms that affects the comparability of recent revenue to revenue
earned before June 30, 1996.

<TABLE>
<CAPTION>
                                                                         YEAR ENDED DECEMBER 31,
                                                       -----------------------------------------------------------
                                                          1993         1994        1995        1996        1997
                                                       -----------  ----------  ----------  ----------  ----------
                                                                  (in thousands, except per share data)
<S>                                                    <C>          <C>          <C>         <C>         <C>
Consolidated Statement of Operations Data:
    Revenue:
       Software license revenue                          $ 25,048    $ 25,609    $ 29,889    $ 43,561    $ 57,260
       Services and other revenue                           3,096       2,643       3,230       3,342       3,315
                                                       -----------  ----------  ----------  ----------  ----------
          Total revenue                                    28,144      28,252      33,119      46,903      60,575
    Cost of revenue:
       Cost of software license revenue                     2,886       3,990       3,509       4,275       3,862
       Cost of services and other revenue                   1,244       2,698       3,251       2,653       2,694
                                                       -----------  ----------  ----------  ----------  ----------
          Total cost of revenue                             4,130       6,688       6,760       6,928       6,556
                                                       -----------  ----------  ----------  ----------  ----------
    Gross profit                                           24,014      21,564      26,359. . . 39,975      54,019
    Operating expenses:
       Sales and marketing                                  9,842      10,473      11,662      16,571      19,480
       Research and development                             8,230       9,634       8,621      12,172      16,867
       General and administrative                           3,785       3,858       3,869       7,048      10,741
       In-process research and development and
          other costs                                                                                      17,520
                                                       -----------  ----------  ----------  ----------  ----------
          Total operating expenses                         21,857      23,965      24,152      35,791      64,608
                                                       -----------  ----------  ----------  ----------  ----------
    Income (loss) from operations                           2,157      (2,401)      2,207       4,184     (10,589)
    Interest and other income                                 313         194         100         458       1,931
                                                       -----------  ----------  ----------  ----------  ----------
    Income (loss) before provision (benefit)
      for income taxes                                      2,470      (2,207)      2,307       4,642      (8,658)
    Provision (benefit) for income taxes                      866        (565)        952       1,950       2,463
                                                       -----------  ----------  ----------  ----------  ----------
    Net income (loss)                                     $ 1,604    $ (1,642)    $ 1,355 .   $ 2,692    $(11,121)
                                                       ===========  ==========  ==========  ==========  ==========

    Basic pro forma and net income (loss) per share                                $ 0.20      $ 0.37     $ (1.01)
                                                                                ==========  ==========  ==========
    Basic pro forma and weighted average common shares                              6,667       7,250      11,004
                                                                                ==========  ==========  ==========

    Diluted pro forma and net income (loss) per share                              $ 0.20      $ 0.34     $ (1.01)
                                                                                ==========  ==========  ==========
    Diluted pro forma and weighted average common shares                            6,667       7,978      11,004
                                                                                ==========  ==========  ==========
</TABLE>

<TABLE>
<CAPTION>

                                                                              DECEMBER 31,
                                                       -----------------------------------------------------------
                                                          1993         1994        1995        1996        1997
                                                       -----------  ----------  ----------  ----------  ----------
                                                                             (in thousands)
<S>                                                       <C>         <C>         <C>        <C>         <C>
Consolidated Balance Sheet Data:
    Working capital                                       $ 7,375     $ 5,320     $ 6,415    $ 27,904    $ 58,088
    Total assets                                           16,939      16,293      21,554      53,198     106,753
    Total liabilities                                       6,810       7,806      11,712      14,379      20,993
    Total stockholders' equity (1)                         10,129       8,487       9,842      38,819      85,760
</TABLE>

----------------
    (1) Includes amounts attributable to preferred stock.



                                       17


<PAGE>   18

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
        RESULTS OF OPERATIONS

        The following discussion and analysis should be read in conjunction with
"Selected Consolidated Financial Data" and the Company's Consolidated Financial
Statements and Notes thereto, included elsewhere in this Form 10-K. The
discussion in this Form 10-K contains certain forward-looking statements that
involve risks and uncertainties, such as statements of the Company's plans,
objectives, expectations and intentions. The cautionary statements made in this
Form 10-K should be read as being applicable to all related forward-looking
statements wherever they appear in this Form 10-K or in the documents
incorporated by reference herein. The Company's actual results could differ
materially from those anticipated in such forward-looking statements. Factors
that could cause or contribute to such differences include those discussed in
"Factors That May Affect Future Results of Operations," as well as those
discussed elsewhere herein and in the documents incorporated herein by
reference. The Company assumes no obligation to update such forward-looking
statements or to update the reasons actual results could differ materially from
those anticipated in such forward-looking statements. See "Factors That May
Affect Future Results of Operations" and "Information Regarding Forward-Looking
Statements."

OVERVIEW

        Simulation Sciences Inc. was founded in 1967 to develop simulation
technology and software used in the design of refineries for the petroleum
industry. Thereafter, the Company developed other software products to address
additional needs for plant design and operation within the petroleum industry
and later expanded the application of these software products to other process
industries, including petrochemicals and chemicals. Since 1994, the Company has
been developing products and services that further enhance and optimize plant
operation and enable integrated enterprise management. The Company hired
substantially all of its current executive management team in 1995, except its
current chief financial officer, who joined the Company in October 1997.

        The Company generally licenses its software pursuant to non-cancelable,
one- to five-year term licenses. The Company receives over 90% of its worldwide
revenue from licenses of its software products. These licenses obligate the
Company to provide customer support, maintenance and any product updates. During
the past five years, the substantial majority of all licenses have been renewed.
See "Factors That May Affect Future Results of Operations - Dependence on
Contract Renewals; Need to Achieve Greater Market Penetration."

        Revenue from the Company's primary simulation product, PRO/II, accounted
for approximately 70% of total revenue in each of the last three years. The
remainder of the Company's revenue is derived from the license of other products
and services, including development, integration, ROM and consulting and
training services. International revenue, which includes revenue from
international subsidiaries and export sales, accounted for approximately 64%,
67%, and 62% of total revenue in 1995, 1996 and 1997, respectively.

        The Company recognizes revenue from product licensing agreements in
accordance with the American Institute of Certified Public Accountants Statement
of Position No. 91-1, Software Revenue Recognition ("SOP 91-1"). SOP 91-1
generally requires recognition of license revenue upon shipment or renewal and
recognition of revenue for maintenance and support ratably over the life of the
contract. However, if license fees and maintenance and support charges are not
separately identified, then all revenue from the contract must be recognized
ratably over its life. More than 95% of the Company's license contracts entered
into before 1996 did not separately identify software license fees and charges
for maintenance and support obligations. As a result, the Company recognized
revenue from these contracts ratably over the terms of such contracts in
accordance with SOP 91-1 ("Ratable Revenue"). The remaining contracts identified
the cost of the license fee and maintenance and support separately and, under
SOP 91-1, the Company recognized revenue from the license portion of the
contracts upon shipment or renewal ("License Revenue") and from the maintenance
and support portion of such contracts as Ratable Revenue. Accordingly, the
revenue recognized under a contract resulting in License Revenue recognition
will be higher in the quarter of shipment or renewal, and lower in later
quarters, than that recognized under a contract resulting only in Ratable
Revenue recognition. In order to more closely conform to industry-


                                       18


<PAGE>   19

standard practices regarding licenses and maintenance agreements, in early 1996
the Company began entering into contracts for new and renewing customers that
separately identify software license fees and maintenance and support charges,
resulting in recognition of License Revenue on an increased portion of
contracts. The substantial majority of the Company's new and renewal contracts
now contain terms that result in License Revenue. For this reason, the Company
does not believe that revenue and results of operations for periods ended on or
prior to June 30, 1996 will be directly comparable to results for future
periods. Furthermore, because the Company had only begun to recognize License
Revenue during the quarter ended March 31, 1996, the Company does not believe
that revenue and results of operations for the year ended December 31, 1997 are
directly comparable to the results for the year earlier period. Revenue
recognition on certain service offerings is based on percentage of completion
and on attainment of project milestones.

        The American Institute of Certified Public Accountants recently issued
Statement of Position No. 97-2, Software Revenue Recognition ("SOP 97-2") which
supersedes SOP 91-1. SOP 97-2 is effective for transactions entered into in
fiscal years beginning after December 15, 1997. Retroactive application is
prohibited. Accordingly, the Company will recognize revenue in accordance with
SOP 97-2 for its years beginning January 1, 1998. The Company is reviewing the
impact of SOP 97-2 on its consolidated financial statements.

        In accordance with Financial Accounting Standards Board Statement No.
86, the Company is required to capitalize software development costs incurred
after technological feasibility of the product has been established and prior to
the first shipment of such product. Because the Company believes that its
process for developing software has been essentially completed concurrently with
the establishment of technological feasibility, no costs have been capitalized
to date.

ACQUISITIONS COMPLETED DURING 1997

        During 1997, the Company has pursued a strategy of acquiring
complementary businesses, products and technologies to broaden the Company's
product and service offerings to facilitate market penetration. During 1997, the
Company completed the following eight acquisitions of assets, licenses or
technologies:

        In March 1997, the Company acquired certain assets of Salumunek &
Assoc., Inc. for $870,000 in cash. The acquired assets include a yield
accounting system that has been integrated with the Company's data
reconciliation program, which together comprise the Company's OpenYield product
offering.

        In March 1997, the Company acquired certain assets of Visual Solutions,
Inc. for a total of $5.5 million in cash and Common Stock of the Company. The
Company has developed certain of the acquired technology into its Visual Flow
Suite product, which expands the Company's product offerings to include a
solution that enables plant engineers to model pressure relief networks, and the
Company is currently developing a set of tools based on certain of the acquired
technology that will enable the integration of process industry applications
under a single user interface.

        In May 1997, the Company entered into a research and development
agreement with, and acquired certain technology for $1.0 million in cash from,
Bayer AG. The acquired technology, Simulation Manager, is currently under
development as a product designed to enable customers to leverage their legacy
applications by allowing the simultaneous application of independent software
programs to a single optimization problem.

        In June 1997, the Company acquired certain technology from Raytheon
Engineers & Constructors, Inc. for $1.0 million in cash. The acquired technology
includes the Company's FACS service offering, which provides a soft sensor
solution based on rigorous dynamic models.

        In September 1997, the Company concluded three transactions with Shell
Oil Products Company, a subsidiary of Shell Oil Company (collectively, "Shell"),
for the acquisition and license of certain technology of Shell, including the
acquisition of business planning software for $1.5 million in cash and, for a
payment of $1.0 million in cash, obtaining certain exclusive marketing rights
and the right to purchase Shell's advanced multivariable


                                       19


<PAGE>   20

process control tools. The Company also acquired an irrevocable, perpetual,
exclusive, worldwide, fully-paid, royalty-free license to Shell's OPERA solver
and MITRE modeling environment for a total of $6.0 million in cash and Common
Stock, payable as follows: (i) $1.5 million in cash to be paid on the date that
the Company ships the first commercial version of ROMeo, the Company's product
under development that will integrate OPERA and MITRE and certain of the
Company's own software and (ii) $4.5 million in Common Stock based on the value
of the Company's Common Stock over the ten-day period ending seven days before
such shipment date, which is expected in the first half of 1998.

        In September 1997, the Company acquired certain assets of W.R. Biles &
Associates, Inc. for approximately $5.2 million, including a cash payment of
$2.5 million and the assumption of approximately $2.7 million in net
liabilities. The acquired assets included the Company's AIM\AT product under
development, a Windows NT-based process information management programs for
continuous and batch processes.



                                       20

<PAGE>   21

RESULTS OF OPERATIONS

    The following table sets forth certain items in the Company's Consolidated
Statements of Operations in absolute dollars and as a percentage of total
revenue for the periods indicated.

<TABLE>
<CAPTION>
                                                                          YEAR ENDED DECEMBER 31,
                                                    --------------------------------------------------------------------
                                                            1995                    1996                   1997
                                                    ---------------------  ----------------------  ---------------------
                                                      AMOUNT       %         AMOUNT        %         AMOUNT       %
                                                    ---------------------  ----------------------  ---------------------
                                                                               (in thousands)
<S>                                                  <C>           <C>       <C>          <C>       <C>           <C>
Revenue:
    Software license revenue                         $ 29,889      90.2%    $ 43,561      92.9%    $ 57,260       94.5%
    Services and other revenue                          3,230       9.8        3,342       7.1        3,315        5.5
                                                    ---------------------  ----------------------  ---------------------
       Total revenue                                   33,119     100.0       46,903     100.0       60,575      100.0
Cost of revenue:
    Cost of software license revenue                    3,509      10.6        4,275       9.1        3,862        6.4
    Cost of services and other revenue                  3,251       9.8        2,653       5.7        2,694        4.4
                                                    ---------------------  ----------------------  ---------------------
       Total cost of revenue                            6,760      20.4        6,928      14.8        6,556       10.8
                                                    ---------------------  ----------------------  ---------------------
Gross profit                                           26,359      79.6       39,975      85.2       54,019       89.2
Operating expenses:
    Sales and marketing                                11,662      35.2       16,571      35.3       19,480       32.2
    Research and development                            8,621      26.0       12,172      26.0       16,867       27.9
    General and administrative                          3,869      11.7        7,048      15.0       10,741       17.7
    In-process research and development and
        other costs                                                                                  17,520       28.9
                                                    ---------------------  ----------------------  ---------------------
       Total operating expenses                        24,152      72.9       35,791      76.3       64,608      106.7
                                                    ---------------------  ----------------------  ---------------------
Income (loss) from operations                           2,207       6.7        4,184       8.9      (10,589)     (17.5)
Interest and other income                                 100       0.3          458       1.0        1,931        3.2
                                                    ---------------------  ----------------------  ---------------------
Income (loss) before provision for income taxes         2,307       7.0        4,642       9.9       (8,658)     (14.3)
Provision for income taxes                                952       2.9        1,950       4.2        2,463        4.1
                                                    ---------------------  ----------------------  ---------------------
Net income (loss)                                     $ 1,355       4.1%     $ 2,692       5.7%    $(11,121)     (18.4)%
                                                    =====================  ======================  =====================
</TABLE>

COMPARISON OF 1997 TO 1996

        Total Revenue. Total revenue increased 29% to $60.6 million for the year
ended December 31, 1997 from $46.9 million for the year ended December 31, 1996.
Software license revenue, which includes revenue from software licenses,
maintenance and support fees, increased 31% to $57.3 million for the year ended
December 31, 1997 from $43.6 million for the year ended December 31, 1996. The
increase in software license revenue was primarily attributable to the effect of
the change in contract terms, renewals of licenses for higher fees, addition of
new products and services to renewing contracts and licenses to new customers.
See " - Overview" for discussion of change in contract terms. Services and other
revenue, which includes integration, ROM, consulting and training services, was
$3.3 million for each of the years ended December 31, 1997 and 1996.

        Total Cost of Revenue. Total cost of revenue decreased 5% to $6.6
million for the year ended December 31, 1997 from $6.9 million for the year
ended December 31, 1996. Cost of software license revenue, which includes costs
of production and distribution, customer support and maintenance, and royalties,
decreased 10% to $3.9 million from $4.3 million for the years ended December 31,
1997 and 1996, respectively. Cost of software license revenue as a percentage of
software license revenue was 7% and 10% in the years ended December 31, 1997 and
1996, respectively. The decrease as a percentage of software license revenue was
due primarily to the increase in software license revenue. Cost of services and
other revenue, which includes costs of personnel involved in project execution
and training, as well as travel, third-party professional fees and related
administrative costs, was $2.7 million for each of the years ended December 31,
1997 and 1996. Cost of services and other revenue as a percentage of services
and other revenue increased to 81% from 79% for the years ended December 31,
1997 and 1996, respectively.

        Sales and Marketing. Sales and marketing expenses increased 18% to $19.5
million for the year ended December 31, 1997 from $16.6 million for the year
ended December 31, 1996. Sales and marketing expenses as a percentage of total
revenue were 32% and 35% for the years ended December 31, 1997 and 1996,
respectively. The increase in sales and marketing expenses in dollars was due
primarily to an increase in the number of sales and marketing personnel and
related expenses, including personnel hired in connection with acquisitions. The


                                       21


<PAGE>   22

Company anticipates that sales and marketing expenses will increase in dollars
and may fluctuate as a percentage of total revenue in the future.

        Research and Development. Research and development expenses increased
39% to $16.9 million for the year ended December 31, 1997 from $12.2 million for
the year ended December 31, 1996. Research and development expenses as a
percentage of total revenue were 28% and 26% for the years ended December 31,
1997 and 1996, respectively. The increase in research and development expenses
in dollars was primarily due to an increase in the number of technical
professionals, including support staff, as well as research and development
personnel hired in connection with acquisitions of products and in-process
technologies. The Company expects to continue to devote substantial resources to
its research and development efforts to continue to develop and support the
Company's highly complex software products and products under development,
including those to which the Company acquired the rights to in 1997.
Accordingly, the Company anticipates that research and development expenses will
increase in dollars and may fluctuate as a percentage of total revenue in the
future.

        General and Administrative. General and administrative expenses
increased 52% to $10.7 million for the year ended December 31, 1997 from $7.0
million for the year ended December 31, 1996. General and administrative
expenses as a percentage of total revenue were 18% and 15% in the years ended
December 31, 1997 and 1996, respectively. The increase in general and
administrative expenses in dollars was primarily due to the costs associated
with being a public company, costs associated with the Company's tax planning
program, an increase in expense recorded for bad debts and personnel related
costs, as well as personnel hired in connection with acquisitions. The Company
anticipates that its general and administrative expenses may increase in dollars
and may fluctuate as a percentage of total revenue in the future.

        In-process Research and Development and Other Costs. In-process research
and development expense of $16.2 million for the year ended December 31, 1997
was due to the allocation of a portion of the purchase price of technology
acquired. The amounts allocated to in-process research and development were
based on management's assumptions. Other costs of $1.3 million was due to the
write off of amounts paid in previous years in connection with certain
technology acquired from Shell Oil Products Company. See " - Acquisitions
Completed During 1997" and "Notes to Consolidated Financial Statements -
Acquisitions".

        Interest and Other Income, Net. Interest and other income, net increased
$1.4 million to $1.9 million for the year ended December 31, 1997 from $0.5
million for the year ended December 31, 1996. The increase was primarily
attributable to interest income associated with the proceeds received in the
Company's public offerings and an increase in interest income from the effect of
the change in contract terms, partially offset by the adverse impact of foreign
currency exchange rate fluctuations.

        Provision for Income Taxes. The Company's effective tax rate on pre-tax
income, excluding the in-process research and development and other costs,
decreased to 40% from 42% for the year ended December 31, 1997 and 1996,
respectively.

        Net Income (Loss). Net loss was $(11.1) million for the year ended
December 31, 1997 compared to net income of $2.7 million for the year ended
December 31, 1996.

COMPARISON OF 1996 TO 1995

        Total Revenue. Total revenue increased 42% to $46.9 million for the year
ended December 31, 1996 from $33.1 million for the year ended December 31, 1995.
Software license revenue, which includes revenue from software licenses,
maintenance and support fees, increased 46% to $43.6 million for the year ended
December 31, 1996 from $29.9 million for the year ended December 31, 1995. The
increase in software license revenue was primarily attributable to the effect of
the change in contract terms, renewals of licenses for higher fees, addition of
new products and services to renewing contracts and licenses to new customers.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Overview" for discussion of change in contract


                                       22


<PAGE>   23

terms. Services and other revenue, which includes integration, ROM, consulting
and training services, was $3.3 million and $3.2 million for the years ended
December 31, 1996 and 1995, respectively.

        Total Cost of Revenue. Total cost of revenue increased 2% to $6.9
million for the year ended December 31, 1996 from $6.8 million for the year
ended December 31, 1995. Cost of software license revenue, which includes costs
of production and distribution, customer support and maintenance, and royalties,
increased 22% to $4.3 million from $3.5 million for the years ended December 31,
1996 and 1995, respectively. Cost of software license revenue as a percentage of
software license revenue was 10% and 12% in the years ended December 31, 1996
and 1995, respectively. Such decrease primarily relates to the increase in
software license revenue. Cost of services and other revenue, which includes
costs of personnel involved in training and project execution, as well as
travel, third-party professional fees and related administrative costs,
decreased 18% to $2.7 million from $3.3 million for the years ended December 31,
1996 and 1995, respectively. Cost of services and other revenue as a percentage
of services and other revenue decreased to 79% from 101% for the years ended
December 31, 1996 and 1995, respectively as the Company improved employee
productivity on ROM projects.

        Sales and Marketing. Sales and marketing expenses increased 42% to $16.6
million for the year ended December 31, 1996 from $11.7 million for the year
ended December 31, 1995. Sales and marketing expenses as a percentage of total
revenue were 35% for each of the years ended December 31, 1996 and 1995. The
increase in sales and marketing expenses in dollars was due primarily to an
increase in the number of sales and marketing professionals and related hiring
expenses.

        Research and Development. Research and development expenses increased
41% to $12.2 million for the year ended December 31, 1996 from $8.6 million for
the year ended December 31, 1995. These increases were due to an increase in the
number of engineers and related hiring expenses and third-party contractors
involved in the development of a number of planned upgrades and new products.
Research and development expenses as a percentage of total revenue were 26% for
each of the years ended December 31, 1996 and 1995.

        General and Administrative. General and administrative expenses
increased 82% to $7.0 million for the year ended December 31, 1996 from $3.9
million for the year ended December 31, 1995. General and administrative
expenses as a percentage of total revenue were 15% and 12% in the years ended
December 31, 1996 and 1995, respectively. The increase in general and
administrative expenses in dollars and as a percentage of total revenue was
primarily due to the addition of senior management personnel, as well as the
increase in expense recorded for bad debts.

        Interest and Other Income. Interest and other income increased $358,000
to $458,000 for the year ended December 31, 1996 from $100,000 for the year
ended December 31, 1995. The increase was primarily attributable to interest
income associated with the proceeds received in the Company's initial public
offering in the fourth quarter of 1996 and an increase in interest income from
the effect of the change in contract terms.

        Provision for Income Taxes. The Company's effective tax rate was 42% and
41% for the years ended December 31, 1996 and 1995, respectively.


                                       23

<PAGE>   24

QUARTERLY RESULTS OF OPERATIONS

        The following table sets forth certain unaudited statements of
operations data for each of the quarters in the eight-quarter period ended
December 31, 1997. This data has been derived from unaudited financial
statements that, in the opinion of management, include all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of such information when read in conjunction with the Company's
audited consolidated financial statements and notes thereto. Quarterly operating
results are not necessarily indicative of future results of operations.

<TABLE>
<CAPTION>

                                                                            QUARTER ENDED
                                           -------------------------------------------------------------------------------
                                                            1996                                    1997
                                           --------------------------------------- ---------------------------------------
                                            MAR. 31   JUNE 30   SEPT. 30  DEC. 31   MAR. 31   JUNE 30   SEPT. 30   DEC. 31
                                           --------  --------  --------- --------- --------- --------- ---------  --------
<S>                                        <C>       <C>       <C>       <C>       <C>       <C>       <C>        <C>
Revenue:
    Software license revenue               $ 8,942   $10,695    $11,645   $12,279   $12,697   $14,229   $14,987   $15,347
    Services and other revenue               1,086     1,068        452       736       938       479       765     1,133
                                           --------  --------  --------- --------- --------- --------- ---------  --------
       Total revenue                        10,028    11,763     12,097    13,015    13,635    14,708    15,752    16,480
Cost of revenue:
    Cost of software license revenue         1,017       761      1,154     1,343       905       890       819     1,248
    Cost of services and other revenue         873       680        369       731       846       459       696       693
                                           --------  --------  --------- --------- --------- --------- ---------  --------
       Total cost of revenue                 1,890     1,441      1,523     2,074     1,751     1,349     1,515     1,941
                                           --------  --------  --------- --------- --------- --------- ---------  --------
Gross profit                                 8,138    10,322     10,574    10,941    11,884    13,359    14,237    14,539
Operating expenses:
    Sales and marketing                      3,548     3,791      4,566     4,666     4,202     4,544     4,443     6,291
    Research and development                 2,699     4,146      2,782     2,545     3,420     4,081     4,334     5,032
    General and administrative               1,467     1,599      1,943     2,039     2,162     2,314     2,736     3,529
    In-process research and development
      and other costs                                                                 5,200     1,070    11,250
                                           --------  --------  --------- --------- --------- --------- ---------  --------
       Total operating expenses              7,714     9,536      9,291     9,250    14,984    12,009    22,763    14,852
                                           --------  --------  --------- --------- --------- --------- ---------  --------
Income (loss) from operations                  424       786      1,283     1,691    (3,100)    1,350    (8,526)     (313)
Interest and other income                       28       135        135       160       445       514       480       492
                                           --------  --------  --------- --------- --------- --------- ---------  --------
Income (loss) before provision for
  income taxes                                 452       921      1,418     1,851    (2,655)    1,864    (8,046)      179
Provision for income taxes                     185       378        609       778     1,069     1,144       180        70
                                           --------  --------  --------- --------- --------- --------- ---------  --------
Net income (loss)                            $ 267     $ 543      $ 809   $ 1,073   $(3,724)    $ 720   $(8,226)    $ 109
                                           ========  ========  ========= ========= ========= ========= =========  ========
</TABLE>

        The Company's research and development expense beginning in the quarter
ended March 31, 1997 has increased as a result of an increase in the number of
technical professionals, including support staff, as well as personnel hired in
connection with acquisitions. The Company's general and administrative expense
beginning in the quarter ended March 31, 1996 has increased sequentially due to
the increase in the number of personnel and related costs to support the growth
of the Company. Additionally, general and administrative expense beginning in
the quarter ended March 31, 1997, increased primarily due to costs associated
with being a public company, costs associated with the company's tax planning
program, an increase in expense recorded for bad debts, personnel related costs,
as well as personnel hired in connection with acquisitions. operating expenses
in the quarter ended December 31, 1997, increased at a greater rate than in
prior quarters, primarily due to the personnel hired in connection with the
acquisition of W. R. Biles & Associates, Inc. on September 30, 1997, as well as
increases in sales commissions, expense recorded for bad debts and research and
development costs related to the release of PRO/II Version 5. See " - Factors
That May Affect Future Results of Operations."


                                       24

<PAGE>   25

LIQUIDITY AND CAPITAL RESOURCES

        During the past three years, the Company has satisfied its cash needs
principally through cash generated from operations, if any, existing cash
resources and net proceeds from the Company's initial public offering in October
1996 and secondary public offering in November 1997. Cash used in operating
activities for the year ended December 31, 1997 was $18.6 million, which was
primarily attributable to increases in long-term installments receivable,
unbilled accounts receivable, accounts receivable and deferred income taxes,
partially offset by income, net of the $17.5 million charge for in-process
research and development and other costs. Cash used in operating activities for
the year ended December 31, 1996 was $2.4 million, which was primarily
attributable to increases in long-term installments receivable, unbilled
accounts receivable, partially offset by net income and increases in other
accrued liabilities and income taxes payable. cash provided by operating
activities for the year ended December 31, 1995 was $2.6 million, which was
primarily attributable to net income and increases in deferred revenue,
partially offset by an increase in accounts receivable.

        Cash used in investing activities during the year ended December 31,
1997 was $15.6 million, which was primarily attributable to the acquisition of
certain assets (see "Notes to Consolidated Financial Statements - Acquisitions")
and the purchase of property and equipment. Cash used in investing activities
during the years ended December 31, 1996 and 1995 totaled $2.6 million and $1.1
million, respectively, which was attributable to purchases of property and
equipment related to the opening of new offices and purchases of computer
equipment.

        Cash provided by financing activities of $54.2 million for the year
ended December 31, 1997 was primarily from the net proceeds of $50.4 million
from the Company's secondary public offering in the fourth quarter of 1997 and
$2.2 million from the sale of common stock under stock plans. Cash provided from
financing activities of $26.3 million was primarily from the net proceeds of
$26.0 million from the Company's initial public offering in the fourth quarter
of 1996.

        Available sources of funds at December 31, 1997 consisted of $46.3
million in cash and cash equivalents and a $2.7 million revolving line of
credit, net of $0.3 million in outstanding letters of credit, with a commercial
bank. The revolving line of credit provides for an unsecured line of credit up
to $3.0 million at the bank's prime rate, contains certain restrictive financial
and other covenants (including but not limited to, profitability, tangible net
worth, liquidity and capital expenditures), and expires March 31, 1999. At
December 31, 1997, there were no borrowings outstanding under the agreement.

    The Company currently does not anticipate that capital expenditures in the
foreseeable future will vary materially from amounts incurred in previous years,
except that the company will relocate one or more of its offices in 1998.

    The Company believes that existing cash resources, the existing line of
credit, cash flow from operations, if any, together with the company's borrowing
capacity will be sufficient to fund the Company's operations during the next 12
months.

YEAR 2000 COMPLIANCE

        Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. These date code
fields will need to accept four digit entries, or be modified in some fashion,
to distinguish 21st century dates from 20th century dates. This problem could
force computers to either shut down or provide incorrect data. As a result, in
less than three years, computer systems and software used by many companies may
need to be upgraded to comply with such "Year 2000" requirements. The Company
has examined its products and internal computer systems and contacted its
software providers to determine whether the Company's software applications are
compliant with the Year 2000. While the Company believes that its products and
internal systems are fully Year 2000 compliant, the Company intends to continue
to review its products and internal systems for any problems as well as monitor
its key customers and suppliers for any impact that the Year 2000 may have on
their information systems which in turn could impact the Company. While it is
difficult to quantify the total cost to the company of the Year 2000 compliance
activities, the company's best estimate of expenditures is between $50,000 and
$250,000. However, there can be no guarantee that Year 2000 issue will not have
a material impact on the Company's business, operating results and financial
condition. In addition, the Company believes that the purchasing patterns of
customers and potential customers may be affected by the Year 2000 issues as
companies expend significant resources to correct or patch their current
software systems for Year 2000 compliance. These expenditures may result in
reduced funds available to purchase software products such as those offered by
the Company, which could result in a material adverse effect on the Company's
business, operating results and financial condition.



                                       25


<PAGE>   26

NEW ACCOUNTING PRONOUNCEMENTS

        The Company will adopt SOP 97-2, Software Revenue Recognition, SFAS No.
130, Reporting Comprehensive Income, and SFAS No. 131, Disclosures About
Segments of an Enterprise and Related Information for its years beginning
January 1, 1998. The Company is reviewing the impact of such statements on its
consolidated financial statements.

INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

        When used in this Form 10-K, the words "expects," "anticipates,"
"estimates," and similar expressions are intended to identify forward-looking
statements. Such statements, which include but are not limited to statements
under the captions "Management's Discussion and Analysis of Financial Condition
and Results of Operations," "Business" and elsewhere in this Form 10-K as to the
rate of contract renewals, the Company's ability to integrate acquired assets,
licenses and technology, the timing of availability of products under
development, the ability to commercialize products developed under
collaborations and alliances, the acceptance, performance and utility of the
Company's products and services, the adequacy of capital resources, future
fluctuations in various operating expenses, future capital expenditures, the
sufficiency of existing and potential cash resources, disruptions associated
with facilities moves, and certain products' future percentage contribution to
total revenue are subject to risks and uncertainties that could cause actual
results to differ materially from those projected. These risks and uncertainties
include, but are not limited to, those risks discussed herein and in the
documents incorporated herein by reference. The cautionary statements made in
this Form 10-K should be read as being applicable to all related forward-looking
statements wherever they appear in this Form 10-K. The Company assumes no
obligation to update such forward-looking statements or to update the reasons
actual results could differ materially from those anticipated in such
forward-looking statements. See " - Factors That May Affect Future Results of
Operations."

FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS

        Fluctuations in Future Operating Results. The Company's operating
results have fluctuated in the past and may fluctuate significantly from quarter
to quarter or on an annual basis in the future as a result of a number of
factors, including, but not limited to: the size and timing of customer orders;
changes in license renewal rates, timing of renewals or failure of existing
customers to renew their licenses with the Company when their current licenses
expire; the length of the Company's sales cycle; the timing and structure of
future acquisitions, if any; difficulties in assimilating acquired technologies
and related personnel; level of services and other activity; timing of new
product announcements and introductions by the Company and its competitors; the
Company's ability to develop, introduce and market new products and product
enhancements or service offerings; market acceptance of the Company's products
and products under development; deferrals of customer orders in anticipation of
new products or product enhancements or service offerings; market success of the
Company's service offerings; changes in contract terms (including terms
affecting the timing of recognition of license revenue) and the rate at which
such changes are made; the Company's ability to control costs, including the
need for and degree of use of, third-party contractors and the hiring of new
employees; political instability in, or trade embargoes with respect to, foreign
markets; changes in the Company's management team; and fluctuating economic
conditions. In addition, during the fourth quarter of 1997, a dispute arose
over invoices received by the Company in connection with a development project.
The Company's management believes that such billings, which approximate
$750,000, were outside the scope of the development project and has advised the
service provider of the Company's position. The Company and the service
provider are presently discussing this issue; however, it is not presently
determinable what amounts, if any, will be due related to this matter, which
could have a material adverse effect on the Company's business, operating
results and financial condition.

        The Company ships software products within a short period after receipt
of an order and typically does not have a material backlog of unfilled orders.
Total revenue in any quarter is dependent (and has become substantially
dependent as the Company has increased the number of contracts for new and
renewing customers that result in the recognition of license revenue upon
shipment) on orders booked and contract renewals in that quarter and are not
predictable with any degree of certainty. Since the Company's expense levels are
based in part on management's expectations regarding future revenue, if revenue
is below expectations in any quarter, the adverse effect may be magnified by the
Company's inability to adjust spending in a timely manner to compensate for any
revenue shortfall. In addition, a customer's purchase of the Company's products
generally involves a significant commitment of capital with the attendant
delays frequently associated with authorization procedures for substantial
capital expenditures within large organizations. Moreover, because customers
are purchasing larger and more complex simulation software products, the
average order value has been increasing and purchases of the Company's products
require approval at higher executive levels. For these and other reasons, the
sales cycles for the Company's products can be lengthy and are subject to a
number of significant risks over which the Company has little or no control. As
a result of the large dollar amounts represented by a single order, the timing
of the receipt of an order can have a significant impact on the Company's
revenues and earnings for a particular period. Any significant or ongoing
failure to reach definitive agreements with customers, including renewals of
current licensing agreements upon their expiration, would have a material
adverse effect on the Company's business, operating results and financial
condition.
                                       26


<PAGE>   27

        Product Concentration. The Company derives a substantial portion of its
total revenue from sales of its PRO/II simulation product. The Company currently
expects PRO/II, individually or integrated with other products, to account for a
significant portion of the Company's total revenue in the future. Accordingly,
factors adversely affecting the pricing of or demand for PRO/II, including
products and pricing terms offered by competitors or the demand for simulation
software in general, could have a material adverse effect on the Company's
business, operating results and financial condition.

        Concentration of Revenue in the Petroleum Industry. The Company derives
a substantial majority of its total revenue from software licenses and services
to companies in the highly cyclical petroleum industry. Accordingly, the
Company's future success is dependent upon the continued demand for process
engineering software by companies in the petroleum industry. In addition,
companies in the petroleum industry are experiencing growing pressures to
consolidate in response to the increasing need to reduce costs to remain
competitive. There can be no assurance that consolidation in the petroleum
industry will not result in a loss of customers or revenue or will not otherwise
have a material adverse effect on the Company's business, operating results or
financial condition. The Company intends to develop new products and product
enhancements for other process industries, including the chemical process
industry. However, there can be no assurance that such products or product
enhancements, once introduced, will achieve their intended benefits, compete
successfully with in-house or commercial products that are newly introduced or
more established in such other process industries or that the Company's products
and services will achieve market acceptance in such other process industries.

        Dependence on Contract Renewals. The Company derives a significant
portion of its total revenue from the renewal of license agreements with
existing customers. Since the Company's planned expense levels are based in part
on management's expectations regarding renewal rates and future revenue, if
renewals and revenue are below expectations in any quarter, the adverse effect
may be magnified by the Company's inability to adjust spending in a timely
manner to compensate for the revenue shortfall, which could have a material
adverse effect on the Company's business, operating results and financial
condition. The Company expects contract renewals to account for an increasing
portion of the Company's total revenue in the future as the Company increases
the number of contracts for renewing customers that result in the recognition of
license revenue upon shipment. There can be no assurance that the Company will
be able to maintain its historical renewal rates, and any significant or ongoing
decline in renewal rates could have a material adverse effect on the Company's
business, operating results and financial condition.

        Risks Associated with Past and Future Acquisitions. In recent periods,
the Company completed several acquisitions of assets, licenses or technology and
the related hiring of numerous employees. The integration of the acquired
assets, licenses and technology will involve the assimilation of operations and
products, which could divert the attention of the Company's management team and
may have a material adverse effect on the Company's operating results in future
quarters. In addition, the Company's inability to assimilate acquired licenses
or technologies could result in the potential for one-time charges related to
the write off of amounts capitalized. The Company's strategy includes
consideration of additional acquisitions in the future, although there can be no
assurance that suitable companies, technologies or products will be available
for acquisition. Such acquisitions entail numerous risks, including an inability
to assimilate acquired operations and products successfully, diversion of
management's attention, difficulties and uncertainties in transitioning the
business relationships from the acquired entity to the Company, difficulty in
integrating new employees, and loss of key employees of acquired companies. In
addition, future acquisitions by the Company may result in dilutive issuance of
equity securities, the incurrence of debt, large one-time expenses, royalty
obligations and the creation of goodwill or other intangible assets that could
result in significant amortization expense. Any one or more of these factors
could have a material adverse effect on the Company's business, operating
results and financial condition.

        Need to Achieve Greater Market Penetration. The success of the Company's
strategy is dependent upon increased market acceptance of commercial simulation
software in general, and of the Company's software products and services in
particular, in the process industries. In recent periods, the Company has
increased sales and marketing expenditures and expects to continue to increase
such expenditures in future periods in an effort to achieve greater market
penetration in the process industries. In addition to SimSci's traditional
emphasis on petroleum and petrochemical process industries, the Company is
increasing its marketing and product targeting efforts in the industrial
chemical, pharmaceutical and fine chemical industries. If the Company fails to
increase market acceptance of its products, or if the Company's sales and
marketing efforts do not result in a corresponding


                                       27

<PAGE>   28

increase in total revenue through greater market penetration, the Company's
operating margins and opportunity for future growth would be substantially
restricted and therefore could have a material adverse effect on the Company's
business, operating results and financial condition.

    Competition. The market for commercial simulation software used in the
petroleum, chemical and other process industries is intensely competitive and is
characterized by rapidly changing technology, evolving industry standards,
frequent new product introductions and rapidly changing customer requirements.
There can be no assurance that the Company will be successful in developing and
marketing enhancements that respond to technological change, evolving industry
standards or customer requirements, that the Company will not experience
difficulties that could delay or prevent the successful development,
introduction and sale of such enhancements or that such enhancements will
adequately meet the requirements of the marketplace and achieve market
acceptance.

        The Company experiences its primary competition from potential
customers' decisions to develop their own software internally rather than
purchasing commercial software products such as those offered by the Company. As
a result, the Company must continuously educate existing and prospective
customers about the advantages of purchasing the Company's products and
services. There can be no assurance that these customers or other potential
customers will perceive sufficient value in the Company's products and services
to justify purchasing them. The Company has experienced and expects to continue
to experience competition from current and future competitors, some of which
have significantly greater financial, technical, marketing and other resources
than the Company. The Company's current direct competitors include, among
others, Aspen, Hyprotech Ltd. and Chemstations, Inc., and, with respect to the
Company's technology and consulting services, the Hi-Spec division of Honeywell,
Inc., the Advanced Control and Optimization Division of Aspen and ABB Simcon
Inc. There can be no assurance that the Company will be able to compete
successfully against current and future competitors, and the failure to do so
would have a material adverse effect upon the Company's business, operating
results and financial condition.

        Risks Associated with International Operations. A significant portion of
the Company's total revenue is derived from customers outside the United States,
and the Company anticipates that international revenue will continue to be
significant in the future. The Company's international operations are subject to
risks inherent in the conduct of international business, including unexpected
changes in regulatory requirements, exchange rates, export license requirements,
tariffs and other barriers, political and economic instability, limited
intellectual property protection, difficulties in collecting payments due from
sales agents or customers, difficulties in managing distributors or
representatives, difficulties in staffing and managing foreign subsidiary
operations, and potentially adverse tax consequences.

        Certain of the Company's international sales are denominated in local
currencies, and the Company does not currently engage in hedging transactions.
The Company's operating results and financial condition have in the past, and
may be in the future, adversely affected by foreign currency exchange rate
fluctuations which cannot be accurately predicted. The Company may engage in
hedging in the future; however, there can be no assurance that any currency
hedging policies implemented by the Company would be successful.

        Dependence on Strategic Relationships. The Company is dependent in part
on a number of strategic alliances for the joint development or marketing of its
products. For example, the Company has entered into a number of strategic
alliances with respect to its new products and product enhancements, including a
development arrangement with Mobil Oil Corporation with respect to NETOPT; a
joint development arrangement with Shell Oil Products Company, a subsidiary of
Shell Oil Company, with respect to ROMeo; a development and marketing agreement
with IFP with respect to PIPEPHASE-TACITE; a general cooperation agreement with
Bayer AG with respect to Simulation Manager; and a marketing agreement with
Japan National Oil Corporation ("JNOC") with respect to the integration of
PIPEPHASE with JNOC's well simulation program. The Company also has entered into
cooperation agreements with Fluor Daniel, IBM and SAP AG. Failure of one or more
of the Company's strategic alliances to achieve commercial success, or the
termination of one or more of such alliances, could result in delay or
termination of product development projects, reduction in market penetration,
decreased ability to win new customers or loss of confidence by current or
potential customers, any of which could have a material adverse effect on the
Company's business, results of operations or financial condition.


                                       28


<PAGE>   29
        Dependence Upon Product Development; Need to Develop New and Acquired
Technologies. The software market in which the Company competes is subject to
rapid technological change, frequent introductions of new products, changes in
customer demand and evolving industry standards which can render existing
products obsolete and unmarketable. In addition, an important part of the
Company's product development strategy is to acquire or obtain rights to new
technologies from third parties to enhance the Company's existing products or to
develop into new products. In this regard, during 1997, the Company completed
eight acquisitions of assets, licenses and technology, including technology that
will require significant additional development before release in commercial
products. There can be no assurance that the Company will be successful in
acquiring, developing and marketing products or enhancements to existing
products or new products that respond to technological change, evolving industry
standards or customer requirements, that the Company will not experience
difficulties that could delay or prevent the successful acquisition,
development, introduction and sale of such enhancements or new products, or that
such enhancements or new products will adequately meet the requirements of the
marketplace and achieve market acceptance, and the failure to do so would have a
material adverse effect on the Company's business, operating results and
financial condition.

        Management of Growth. The Company's business is currently experiencing a
period of growth that has placed and is expected to continue to place a
significant strain on the Company's personnel and resources. The Company's
recent growth is attributable in part to recent acquisitions of businesses,
products and technologies, and the related hiring of officers and employees of
such acquired businesses. The Company's ability to manage future growth, if any,
will depend on its ability to continue to implement and improve operational,
financial and management information and controls systems on a timely basis,
together with maintaining effective cost controls, and any failure to do so
could have a material adverse effect on the Company's business, operating
results and financial condition. The Company may also experience changes in
senior management that could affect the Company's operations. For example, the
Company's chief financial officer joined the Company in October 1997.

        Limited Protection of Proprietary Rights. The Company relies upon a
combination of copyright, trade secret and trademark laws to protect its
proprietary technology. The Company enters into confidentiality agreements with
its employees, developers, distributors and customers and limits access to and
distribution of the source code to its software and other proprietary
information. However, policing unauthorized use of the Company's products is
difficult. There can be no assurance that the steps taken by the Company in this
regard will be adequate to prevent misappropriation of its technology or that
the Company's competitors will not independently develop technologies that are
substantially equivalent or superior to the Company's technology.

        Certain technology used in the Company's current products and products
under development is licensed from third parties. These licenses may require the
Company to pay royalties and to fulfill confidentiality obligations. The
termination of any such licenses, or the failure of the third party licensors to
adequately maintain or update their products, could result in a material adverse
effect on the Company's business, operating results and financial condition by
delaying the Company's ability to ship products.

        From time to time third parties may assert patent, trademark, copyright
and other intellectual property rights to technologies that are important to the
Company. In such an event, the Company may be required to incur significant
costs in litigating a resolution to the asserted claims. There can be no
assurance that such a resolution would not require that the Company pay damages
or obtain a license of a third party's proprietary rights.

        Dependence on Contract Developers. The Company currently subcontracts
certain aspects of its research and development to outside contractors. There
can be no assurance that the Company will be able to manage its contract
developers effectively or that these developers will meet the Company's future
requirements for timely delivery of high-quality products.

        Year 2000 Compliance. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. These date code fields will need to accept four digit entries, or be
modified in some fashion, to distinguish 21st century dates from 20th century
dates. This problem could force computers to either shut down or provide
incorrect data. As a result, in less than three years, computer systems and
software used by many companies may need to be upgraded to comply with


                                       29


<PAGE>   30
such "Year 2000" requirements. The Company has examined its products and
internal computer systems and contacted its software providers to determine
whether the Company's software applications are compliant with the Year 2000.
While the Company believes that its products and internal systems are fully Year
2000 compliant, the Company intends to continue to review its products and
internal systems for any problems as well as monitor its key customers and
suppliers for any impact that the Year 2000 may have on their information
systems which in turn could impact the Company. While it is difficult to
quantify the total cost to the Company of the Year 2000 Compliance activities,
the Company's best estimate of expenditures is between $50,000 and $250,000.
However, there can be no guarantee that Year 2000 issue will not have a material
impact on the Company's business, operating results and financial condition. In
addition, the Company believes that the purchasing patterns of customers and
potential customers may be affected by the Year 2000 issues as companies expend
significant resources to correct or patch their current software systems for
Year 2000 compliance. These expenditures may result in reduced funds available
to purchase software products such as those offered by the Company, which could
result in a material adverse effect on the Company's business, operating results
and financial condition.

        Volatility of Stock Price. The market price for the Company's Common
Stock has in the past been and in the future could be subject to significant
fluctuations as a result of a number of factors, including the announcement of
new products, product enhancements or new services by the Company or its
competitors, quarterly variations in the Company's results of operations or the
results of operations of the Company's competitors, changes in earnings
estimates or recommendations by securities analysts, developments in the
Company's industry, general market conditions and other factors, including
factors unrelated to the operating performance of the Company or its
competitors. In addition, stock prices for many companies, including SimSci,
have been adversely affected by recent world financial market events, including
significant market volatility in late October 1997. Stock prices for many
companies in the technology and emerging growth sectors have experienced wide
fluctuations that have often been unrelated to the operating performance of such
companies. Such factors and fluctuations may adversely affect the market price
of the Company's Common Stock.

        Product Liability. The Company's license agreements with its customers
typically contain provisions designed to limit the Company's exposure to
potential product liability claims. It is possible, however, that the limitation
of liability provisions contained in the Company's license agreements may not be
effective as a result of existing or future federal, state or local laws or
ordinances or unfavorable judicial decisions. Although the Company has not
experienced any product liability claims to date, the sale and support of its
simulation and optimization software may entail the risk of such claims. A
successful product liability claim brought against the Company in excess of its
insurance coverage or outside the scope of such coverage could have a material
adverse effect upon the Company's business, operating results and financial
condition.

        Potential for Software Defects. Complex software products such as those
offered by the Company may contain undetected errors or failures commonly
referred to as "bugs." There can be no assurance that, despite significant
testing by the Company and by current and potential customers, errors will not
be found in new products or enhancements to existing products after commencement
of commercial shipments.

        Dependence on Key Personnel. The Company's future business results
depend in significant part on the Company's Chief Executive Officer and other
senior management and key employees, including certain technical, managerial and
marketing personnel. The loss of the services of any of these individuals or
groups of individuals could have a material adverse effect on the Company's
business, operating results and financial condition.

        Risks Associated with Facilities Moves. The Company has recently entered
into a new lease for an approximately 54,000 square foot facility in the
Houston, Texas area and intends to consolidate its Houston-area operations by
relocating them to this facility in the near future. In addition, the Company is
currently seeking alternate space near its Brea, California headquarters and
could also move its Brea operations in the near future. Each move of Company
facilities involves coordination of complex events in order to avoid or minimize
disruption or delay of the Company's operations, including potential delays in
product development or shipment of products. If any of the anticipated facility
moves were to result in significant delays in product development or other
disruption of operations, the Company's business, operating results and
financial condition could be materially adversely affected.

        Anti-takeover Effects of the Company's Charter, Bylaws and Delaware Law.
The Company's Board of Directors has the authority to issue up to 5,000,000
shares of Preferred Stock and to fix the rights, preferences, privileges and
restrictions, including voting rights, without any further vote or action by the
stockholders. The rights of the holders of any Common Stock will be subject to,
and may be adversely affected by, the rights of the holders of any Preferred
Stock that may be issued in the future. The issuance of Preferred Stock could
have the effect of delaying, deferring or preventing a change in control of the
Company. In addition, the Company has a


                                       30


<PAGE>   31

Stockholders Rights Agreement that could discourage potential acquisition
proposals and could delay or prevent a change in control of the Company. The
Company is also afforded the protections of the anti-takeover provisions of
Section 203 of the Delaware General Corporation Law ("Section 203"). The
protections of the Company's Stockholder Rights Agreement and Section 203
together with certain other provisions of the Company's charter and bylaws, may
have the effect of discouraging, delaying or preventing a merger, tender offer
or proxy contest, which could adversely affect the market price of the Company's
Common Stock.

INFLATION

        Inflation has not had a significant impact on the Company's operating
results to date, nor does the Company expect it to have a significant impact
during 1998.


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

        Information required by this Item begins on page F-1 and is incorporated
herein by reference.


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

        There have been no changes in or disagreements with accountants on
accounting or financial disclosure matters during the Company's two most recent
fiscal years.


                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         Incorporated by reference from the information contained under the
section captioned "Election of Directors" and "Executive Compensation and Other
Matters - Executive Officers" of the Registrant's Proxy Statement to be filed
with the Securities and Exchange Commission within 120 days after the close of
the Registrant's fiscal year.


ITEM 11. EXECUTIVE COMPENSATION

         Incorporated by reference from the information contained under the
section captioned "Executive Compensation and Other Matters - Executive
Compensation" of the Registrant's Proxy Statement to be filed with the
Securities and Exchange Commission within 120 days after the close of the
Registrant's fiscal year.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         Incorporated by reference from the information contained under the
section captioned "Record Date and Principal Share Ownership" of the
Registrant's Proxy Statement to be filed with the Securities and Exchange
Commission within 120 days after the close of the Registrant's fiscal year.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED ACTIONS

         Incorporated by reference from the information contained under the
section captioned "Executive Compensation and Other Matters - Certain
Transactions" of the Registrant's Proxy Statement to be filed with the
Securities and Exchange Commission within 120 days after the close of the
Registrant's fiscal year.


                                       31

<PAGE>   32

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)     Documents filed as a part of this report:

        (1)    FINANCIAL STATEMENTS
               The financial statements listed in the accompanying Index to
               Consolidated Financial Statements and Schedule are filed as part
               of this report and incorporated herein by reference.

        (2)    FINANCIAL STATEMENT SCHEDULE
               The financial statement schedule listed in the accompanying Index
               to Consolidated Financial Statements and Schedule are filed as
               part of this report and incorporated herein by reference.

        (3)    EXHIBITS
               The exhibits listed on the accompanying Exhibit index are
               incorporated herein by reference.

<TABLE>
<CAPTION>

Exhibit No.    Description of Exhibit
----------     ----------------------
<S>            <C>
 3.1(1)        Amended and Restated Certificate of Incorporation of the
               Registrant, as currently in effect

 3.2(2)        Amended and Restated Bylaws of the Registrant

 4.1(3)        Form of specimen certificate for the Registrant's Common Stock

 4.2(9)        Certificate of Designations of Rights, Preferences and Privileges
               of Series A Participating Preferred Stock

10.1(2)        Form of Indemnification Agreement entered into by the Registrant
               with each of its directors and executive officers

10.2(1)        1994 Stock Option Plan and related agreements

10.3(8)        1996 Stock Option Plan and related agreements as amended

10.4(1)        1996 Employee Stock Purchase Plan for U.S. Employees and related
               agreements

10.5(1)        1996 Employee Stock Purchase Plan for Non-U.S. Employees and
               related agreements

10.6(3)        1996 Director Option Plan and related agreements

10.7(1)        Registration Rights Agreement dated December 17, 1993

10.8(1)        Standard Office Lease dated September 1, 1992 between the
               Registrant and Brea Partners, as amended

10.9(1)        Stock Purchase and Investment Agreement dated December 17, 1993
               by and among the Registrant, certain shareholders and Northern
               Trust Bank of California, N.A. as Trustee of the Registrant's
               Employee Stock Ownership Plan and Money Purchase Pension Plan

10.10(2)*      Software License Agreement dated September 1, 1995 between
               Mobil Oil Corporation and the Registrant

10.11(3)       Form of Separation Agreement between the Registrant and each of
               Katherine S. Abrams, Robert E. Grice, Charles R. Harris, Daniel
               T. Nichols, and Dirk Pfeiffer
</TABLE>


                                       32


<PAGE>   33

<TABLE>
<CAPTION>

Exhibit No.    Description of Exhibit
----------     ----------------------
<S>            <C>
10.12(4)       Asset Purchase Agreement dated March 24, 1997 among the
               Registrant, Visual Solutions, Inc. and John L. Dial, II, Mark G.
               Brosius, Donald L. Miller and Christopher E. Glass

10.13(4)       Registration Rights Agreement dated March 26, 1997 among the
               Registrant, Visual Solutions, Inc. and John L. Dial, II, Mark G.
               Brosius, Donald L. Miller and Christopher E. Glass

10.14(5)*      Software License Agreement dated September 15, 1997 between Shell
               Oil Products Company, acting for itself and as Agent for Shell
               Oil Company, and the Registrant

10.15(5)*      Asset Purchase Agreement dated September 15, 1997 between Shell
               Oil Products Company, acting for itself and as Agent for Shell
               Oil Company, and the Registrant

10.16(5)*      Software Marketing Agreement dated September 15, 1997 between
               Shell Oil Products Company, acting for itself and as Agent for
               Shell Oil Company, and the Registrant

10.17(6)       Asset Purchase Agreement dated as of September 30, 1997 by and
               among Registrant, W.R. Biles & Associates, Inc., a Delaware
               corporation, and William R. Biles , an individual

10.18(7)       Lease Agreement dated September 2, 1997 between Registrant and
               The Prudential Insurance Company of America

21.1           List of Subsidiaries

23.1           Consent of Deloitte & Touche LLP, independent auditors

24.1           Power of Attorney (included on page 34)

27.1           Financial Data Schedule

27.2           Financial Data Schedule as amended

27.3           Financial Data Schedule as amended

</TABLE>

------------------------

 *             Confidential treatment has been granted with respect to portions
               of this agreement

(1)            Incorporated by reference to the Company's Form S-1 filed on
               August 29, 1996, File Number 333-11017

(2)            Incorporated by reference to the Company's Amendment No. 1 to
               Form S-1 filed on September 17, 1996, File Number 333-11017

(3)            Incorporated by reference to the Company's Amendment No. 3 to
               Form S-1 filed on October 17, 1996, File Number 333-11017

(4)            Incorporated by reference to the Company's report on Form 8-K
               dated March 26, 1997, filed on April 10, 1997, File Number
               000-21283

(5)            Incorporated by reference to the Company's report on Form 8-K
               dated September 15, 1997, filed on September 30, 1997, File
               Number 000-21283

(6)            Incorporated by reference to the Company's report on Form 8-K
               dated September 30, 1997, filed on October 14, 1997, File Number
               000-21283

(7)            Incorporated by reference to the Company's report on Form 10-Q
               filed on October 29, 1997

(8)            Incorporated by reference to the Company's report on Form S-8
               filed on December 19, 1997, Registration Number 333-42697

(9)            Incorporated by reference to the Company's Registration Statement
               on Form 8-A, filed on August 14, 1997, File Number 000-21283


(b)  REPORTS ON FORM 8-K

     Reports on Form 8-K and 8-K/A were filed on October 14, 1997 and October
     29, 1997, respectively in connection with the acquisition of substantially
     all of the asets of W.R. Biles & Associates, Inc.

                                       33
<PAGE>   34

                                   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.

                                          Simulation Sciences Inc.
                                         (Registrant)


March 30, 1998                           /s/  Charles R. Harris
                                         ---------------------------------------
                                              Charles R. Harris
                                         President and Chief Executive Officer


                                POWER OF ATTORNEY

        KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints, Charles R. Harris and Robert E. Grice,
Jr. and each one of them, his attorneys-in-fact and agents, each with the power
of substitution, for him and in his name, place and stead, in any and all
capacities, to sign any and all amendments to this Report on Form 10-K, and all
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
that each of said attorneys-in-fact and agents or any of them, or his or their
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of
registrant and in the capacities indicated on March 30, 1998.

<TABLE>
<CAPTION>

               Signature                                         Title(s)
               ---------                                         --------
<S>                                      <C>
/s/       Charles R. Harris              President and Chief Executive Officer (Principal
-------------------------------------    Executive Officer) and Director
          Charles R. Harris


/s/        Robert E. Grice, Jr.          Executive Vice President, Finance and Chief
-------------------------------------    Financial Officer (Principal Financial and
           Robert E. Grice, Jr.          Accounting Officer)


/s/       Narendra K. Gupta              Director
-------------------------------------
          Narendra K. Gupta


/s/      Walter G. Kortschak             Director
-------------------------------------
         Walter G. Kortschak

</TABLE>


                                       34

<PAGE>   35

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

             INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE


<TABLE>
<S>                                                                       <C>
Independent Auditors' Report                                                F-2

Consolidated Balance Sheets as of December 31, 1996 and 1997                F-3

Consolidated Statements of Operations for the years ended
   December 31, 1995, 1996 and 1997                                         F-4

Consolidated Statements of Stockholders' Equity for the years ended
   December 31, 1995, 1996 and 1997                                         F-5

Consolidated Statements of Cash Flows for the years ended
   December 31, 1995, 1996 and 1997                                         F-6

Notes to Consolidated Financial Statements                                  F-7

Schedule II - Valuation and Qualifying Accounts                             S-1
</TABLE>


                                      F-1

<PAGE>   36

                          INDEPENDENT AUDITORS' REPORT



The Board of Directors and Stockholders of
Simulation Sciences Inc.:

         We have audited the accompanying consolidated balance sheets of
Simulation Sciences Inc. and subsidiaries (the Company) as of December 31, 1996
and 1997, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1997. Our audits also included the financial statement schedule listed in
Item 14(a). 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of Simulation Sciences Inc. and
subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
Also, in our opinion, such financial statement schedule, when considered in
relation to the financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.


/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP

Costa Mesa, California
February 6, 1998


                                      F-2

<PAGE>   37

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                                              DECEMBER 31,
                                                                     --------------------------------
                                                                          1996             1997
                                                                     ---------------   --------------
<S>                                                                  <C>               <C>
                             ASSETS

CURRENT ASSETS
    Cash and cash equivalents                                          $ 26,320,519     $ 46,294,916
    Accounts receivable, less allowance for doubtful accounts
        of $722,036 and $1,471,078 at December 31, 1996 and
        1997, respectively                                                8,981,299       14,183,499
    Unbilled accounts receivable                                          3,671,677       11,284,477
    Deferred income taxes                                                 2,930,073        5,335,568
    Prepaid expenses and other current assets                               379,122        1,382,242
                                                                     ---------------   --------------
        Total current assets                                             42,282,690       78,480,702
LONG-TERM INSTALLMENTS RECEIVABLE, net of unamortized discount
    of $1,045,184 and $3,169,923 at December 31, 1996 and 1997,
    respectively                                                          5,126,866       15,299,698
PROPERTY AND EQUIPMENT
    Computer equipment and programs                                       6,523,879        9,408,648
    Furniture and fixtures                                                3,435,485        3,643,063
                                                                     ---------------   --------------
                                                                          9,959,364       13,051,711
    Less accumulated depreciation                                        (5,914,287)      (8,089,775)
                                                                     ---------------   --------------
        Property and equipment, net                                       4,045,077        4,961,936
GOODWILL, net of accumulated amortization of $95,636 at
  December 31, 1997                                                                        1,234,570
OTHER ASSETS, net                                                         1,568,488        6,629,927
DEFERRED INCOME TAXES                                                       174,656          145,796
                                                                     ---------------   --------------
                                                                       $ 53,197,777    $ 106,752,629
                                                                     ===============   ==============


              LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES
    Accounts payable                                                    $ 1,901,847      $ 1,900,607
    Accrued vacation and bonus payable                                    1,564,603        1,789,558
    Other accrued liabilities                                             3,732,078        3,049,038
    Obligations related to acquisitions                                                    6,200,000
    Income taxes payable                                                  2,083,664        1,992,941
    Deferred revenue                                                      5,096,380        5,460,525
                                                                     ---------------   --------------
        Total current liabilities                                        14,378,572       20,392,669
OBLIGATION RELATED TO ACQUISITION                                                            600,000
COMMITMENTS AND CONTINGENCIES
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK,
    $.001 par value; 5,000,000 shares authorized,
    100,000 shares designated as Series A
    Participating Preferred Stock, no shares
    issued and outstanding at December 31,
    1996 and 1997
STOCKHOLDERS' EQUITY
    Common stock - $.001 par value; 30,000,000 shares
    authorized; 9,987,340 and 14,136,809 shares issued
    and outstanding at December 31, 1996 and 1997,
    respectively                                                              9,987           14,137
    Additional paid-in capital                                           32,552,964       90,610,354
    Retained earnings (deficit)                                           6,256,254       (4,864,531)
                                                                     ---------------   --------------
        Total stockholders' equity                                       38,819,205       85,759,960
                                                                     ---------------   --------------
                                                                       $ 53,197,777    $ 106,752,629
                                                                     ===============   ==============
</TABLE>



          See accompanying notes to consolidated financial statements.


                                      F-3


<PAGE>   38

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31,
                                                  --------------------------------------------
                                                       1995           1996           1997
                                                  --------------------------------------------
<S>                                               <C>             <C>            <C>
Revenue
    Software license revenue                      $ 29,888,672    $ 43,561,069   $ 57,260,748
    Services and other revenue                       3,230,639       3,342,314      3,314,826
                                                  -------------  --------------  -------------
       Total revenue                                33,119,311      46,903,383     60,575,574
Cost of revenue
    Cost of software license revenue                 3,509,514       4,275,169      3,862,196
    Cost of services and other revenue               3,250,878       2,653,021      2,694,099
                                                  -------------  --------------  -------------
       Total cost of revenue                         6,760,392       6,928,190      6,556,295
                                                  -------------  --------------  -------------
Gross profit                                        26,358,919      39,975,193     54,019,279
Operating expenses
    Sales and marketing                             11,662,381      16,571,770     19,479,785
    Research and development                         8,621,381      12,171,729     16,866,969
    General and administrative                       3,868,506       7,048,089     10,741,276
    In-process research and development
      and other costs                                                              17,520,000
                                                  -------------  --------------  -------------
       Total operating expenses                     24,152,268      35,791,588     64,608,030
                                                  -------------  --------------  -------------
Income (loss) from operations                        2,206,651       4,183,605    (10,588,751)
Interest and other income                               99,905         458,058      1,930,747
                                                  -------------  --------------  -------------
Income (loss) before provision for income taxes      2,306,556       4,641,663     (8,658,004)
Provision for income taxes                             951,872       1,949,500      2,462,781
                                                  -------------  --------------  -------------
Net income (loss)                                  $ 1,354,684     $ 2,692,163   $ (11,120,785)
                                                  =============  ==============  =============


Basic pro forma and net income (loss) per share         $ 0.20          $ 0.37        $ (1.01)
                                                  =============  ==============  =============
Basic pro forma and weighted average
  common shares                                      6,666,669       7,249,817     11,003,571
                                                  =============  ==============  =============

Diluted pro forma and net income (loss) per share       $ 0.20          $ 0.34        $ (1.01)
                                                  =============  ==============  =============
Diluted pro forma and weighted average common
  shares                                             6,666,669       7,977,765     11,003,571
                                                  =============  ==============  =============
</TABLE>


          See accompanying notes to consolidated financial statements.


                                      F-4


<PAGE>   39

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                    COMMON STOCK        ADDITIONAL    RETAINED       TOTAL
                                               -----------------------   PAID-IN      EARNINGS    STOCKHOLDERS'
                                                 SHARES      AMOUNT      CAPITAL      (DEFICIT)      EQUITY
                                               ------------ ---------- ------------- ------------ -------------
<S>                                            <C>          <C>         <C>          <C>           <C>
Balances as of January 1, 1995                   5,000,001    $ 5,000   $ 1,470,402  $ 2,209,407   $ 3,684,809

    Net income                                                                         1,354,684     1,354,684
                                               ------------ ---------- ------------- ------------ -------------

Balances as of December 31, 1995                 5,000,001      5,000     1,470,402    3,564,091     5,039,493

    Issuance of common stock in a public
        offering                                 3,248,866      3,249    25,939,760                 25,943,009
    Conversion of preferred stock to common
        stock                                    1,666,668      1,666     4,800,454                  4,802,120
    Common stock option exercises                   71,805         72       195,262                    195,334
    Tax benefit related to stock option
        exercises                                                           147,086                    147,086
    Net income                                                                         2,692,163     2,692,163
                                               ------------ ---------- ------------- ------------ -------------

Balances as of December 31, 1996                 9,987,340      9,987    32,552,964    6,256,254    38,819,205

    Issuance of common stock in a public
        offering                                 2,991,818      2,992    50,397,669                 50,400,661
    Issuance of common stock related to
        acquisitions                               379,789        380     3,909,620                  3,910,000
    Issuance of common stock related to
        warrant exercises                          356,038        356          (356)
    Issuance of common stock under stock plans     421,824        422     2,235,443                  2,235,865
    Tax benefit related to stock option
        exercises                                                         1,515,014                  1,515,014
    Net loss                                                                          (11,120,785) (11,120,785)
                                               ------------ ---------- ------------- ------------ -------------

Balances as of December 31, 1997                14,136,809   $ 14,137   $90,610,354    (4,864,531) $85,759,960
                                               ============ ========== ============= ============ =============
</TABLE>



          See accompanying notes to consolidated financial statements.


                                      F-5


<PAGE>   40

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                 YEAR ENDED DECEMBER 31,
                                                                      ---------------------------------------------
                                                                          1995            1996            1997
                                                                      --------------  --------------  -------------
<S>                                                                    <C>             <C>             <C>
Cash flows from operating activities:
    Net income (loss)                                                   $ 1,354,684     $ 2,692,163   $(11,120,785)
    Adjustments to reconcile net income (loss) to net cash
      used in operating activities:
       Depreciation and amortization                                        703,095         975,458      2,476,618
       Provision for doubtful accounts                                       28,443         478,169        749,666
       In-process research and development and other costs                                              17,520,000
       Deferred income taxes                                               (342,382)       (400,797)    (2,376,635)
       Change in operating assets and liabilities, net of
          the effect of acquisitions:
          Short-term investments                                                             14,531
          Accounts receivable                                            (2,897,820)       (613,038)    (4,967,351)
          Unbilled accounts receivable                                     (250,513)     (3,487,342)    (7,749,940)
          Income taxes receivable                                          (254,663)        968,552
          Prepaid expenses and other current assets                         (55,472)         37,899     (1,008,690)
          Other assets                                                      (88,098)       (617,742)      (789,672)
          Long-term installments receivable                                              (5,221,648)   (10,400,697)
          Accounts payable                                                  275,663         490,186        (70,930)
          Accrued vacation and bonus payable                                494,067         460,809        179,715
          Other accrued liabilities                                         690,886       1,253,862     (1,161,140)
          Income taxes payable                                              579,085       1,005,267         (3,007)
          Deferred revenue                                                2,396,701        (459,405)       123,814
                                                                      --------------  --------------  -------------
             Net cash provided by (used in) operating activities          2,633,676      (2,423,076)   (18,599,034)
Cash flow from investing activities:
    Purchases of property and equipment                                  (1,247,458)     (2,640,396)    (2,910,532)
    Proceeds from disposition of property and equipment                      38,024
    Proceeds from sale of marketable securities                             100,000
    Cash paid for acquisitions                                                                         (12,734,439)
                                                                      --------------  --------------  -------------
             Net cash used in investing activities                       (1,109,434)     (2,640,396)   (15,644,971)
Cash flow from financing activities:
    Issuance of common stock in a public offering                                        25,943,009     50,400,661
    Proceeds from the sale of common stock under stock plans                                195,334      2,235,865
    Tax benefit related to stock option exercises                                           147,086      1,515,014
                                                                      --------------  --------------  -------------
             Net cash provided by financing activities                            -      26,285,429     54,151,540
Effect of exchange rate changes on cash and cash equivalents                 12,224        (343,721)        66,862
                                                                      --------------  --------------  -------------
Net increase in cash and cash equivalents                                 1,536,466      20,878,236     19,974,397
Cash and cash equivalents at beginning of period                          3,905,817       5,442,283     26,320,519
                                                                      --------------  --------------  -------------
Cash and cash equivalents at end of period                              $ 5,442,283    $ 26,320,519   $ 46,294,916
                                                                      ==============  ==============  =============

Supplemental disclosures of cash flow information:
    Cash paid during the period for:
       Income taxes                                                       $ 270,142       $ 874,446    $ 2,755,907
                                                                      ==============  ==============  =============

Supplemental disclosures related to acquisitions:
    The Company acquired certain assets and technology
       of other companies as described in Note 2.
       These acquisitions are summarized as follows:
       In-process research and development                                                            $ 16,270,000
       Purchased technology                                                                              3,304,270
       Fair value of assets acquired                                                                     3,369,697
       Goodwill                                                                                          1,330,205
       Common stock issued                                                                              (3,910,000)
       Cash paid for acquisitions                                                                      (12,734,439)
       Obligations related to acquisitions                                                              (6,800,000)
                                                                                                      -------------
       Liabilities assumed                                                                              $ (829,733)
                                                                                                      =============
</TABLE>


          See accompanying notes to consolidated financial statements.


                                      F-6


<PAGE>   41

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

    General and Nature of Operations - Simulation Sciences Inc. is engaged
primarily in the development and marketing of commercial application software
and related services to the petroleum, petrochemical, industrial chemical and
other process industries all over the world. The Company performs ongoing credit
evaluations of its customers and generally does not require collateral. The
Company maintains reserves for potential credit losses and losses have
approximated management's expectations. The accompanying consolidated financial
statements include the accounts of Simulation Sciences Inc. and its wholly owned
subsidiaries in Barbados, Brazil, Germany, Japan, Singapore, the United Kingdom,
the United States and Venezuela (collectively, the Company). All significant
intercompany transactions and balances have been eliminated.

    Cash and Cash Equivalents - Cash equivalents represent highly liquid
investments purchased with an original maturity date of three months or less.

    Fair Value of Financial Instruments - The recorded amounts of cash and cash
equivalents, investment securities, accounts receivable and accounts payable at
December 31, 1996 and 1997 approximate fair value in accordance with Statement
of Financial Accounting Standards No. 107, Disclosures About Fair Value of
Financial Instruments (SFAS No. 107), due to the relatively short period of time
between origination of the instruments and their expected realization.

    Long-Term Installments Receivable - Long-term installments receivable
represent the present value of future payments under noncancelable license
agreements which provide for payments in installments typically over a one- to
five-year period. A portion of the revenue from each installment payment is
recognized as interest income in the accompanying consolidated statements of
operations. The present value interest rate in effect during 1996 and 1997 was
8%.

    Property and Equipment - Property and equipment are stated at cost and
depreciated using the straight-line method over the estimated useful lives of
the related assets, generally three to five years.

    Goodwill - Goodwill represents the excess of the purchase price over the
fair value of net assets acquired and is amortized using the straight line
method over ten years. The Company periodically evaluates the recoverability of
goodwill and, based on its most recent analysis, believes that no impairment
exists at December 31, 1997.

    Other Assets, net - Purchased technology, which is included in other assets,
net, represents an allocation of the purchase price with respect to certain
technology acquired by the Company in its recent acquisitions (Note 2) and is
amortized using the straight line method over 3 years. Also included in other
assets, net at December 31, 1997 is $1.1 million paid related to a purchase
option with respect to certain advanced multivariable control technology from
Shell Oil and $1.0 million related to the rights to use other technology. The
Company periodically evaluates the recoverability of purchased technology and
has written off $1.3 million related to purchased technology acquired in a
previous year. Such amount is included in in-process research and development
and other costs in the accompanying consolidated statements of operations. Based
on its most recent analysis, the Company believes that no impairment exists at
December 31, 1997.

    Long-Lived Assets - The Company accounts for the impairment and disposition
of long-lived assets in accordance with Statement of Financial Accounting
Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of (SFAS No. 121). In accordance with SFAS No.
121, long-lived assets to be held are reviewed for events or changes in
circumstances which indicate that their carrying value may not be recoverable.
The Company periodically reviews the carrying value of long-lived assets to
determine whether or not an impairment to such value has occurred. Based on its
most recent analysis, the Company believes that no impairment exists at December
31, 1997.


                                      F-7

<PAGE>   42

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)


    Software Development Costs - Development costs related to new software
products and enhancements to existing software products are expensed as incurred
until technological feasibility has been established. After technological
feasibility is established, any additional costs would be capitalized in
accordance with Statement of Financial Accounting Standards No. 86, Accounting
for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed
(SFAS No. 86). Because the Company believes its current process for developing
software is essentially completed concurrently with the establishment of
technological feasibility, no costs have been capitalized as of December 31,
1996 or 1997.

    Revenue Recognition - The Company recognizes revenue from product licensing
agreements in accordance with the American Institute of Certified Public
Accountants Statement of Position No. 91-1, Software Revenue Recognition ("SOP
91-1"). SOP 91-1 generally requires recognition of license revenue upon shipment
or renewal and recognition of revenue for maintenance and support ratably over
the life of the contract. However, if license fees and maintenance and support
charges are not separately identified, then all revenue from the contract must
be recognized ratably over its life. More than 95% of the Company's license
contracts entered into before 1996 did not separately identify software license
fees and charges for maintenance and support obligations. As a result, the
Company recognized revenue from these contracts ratably over the terms of such
contracts in accordance with SOP 91-1 ("Ratable Revenue"). The remaining
contracts identified the cost of the license fee and maintenance and support
separately and, under SOP 91-1, the Company recognized revenue from the license
portion of the contracts upon shipment or renewal ("License Revenue") and from
the maintenance and support portion of such contracts as Ratable Revenue.
Accordingly, the revenue recognized under a contract resulting in License
Revenue recognition will be higher in the quarter of shipment or renewal, and
lower in later quarters, than that recognized under a contract resulting only in
Ratable Revenue recognition. In order to more closely conform to
industry-standard practices regarding licenses and maintenance agreements, the
Company began entering into contracts for new and renewing customers that
separately identify software license fees and maintenance and support charges,
resulting in recognition of License Revenue on an increased portion of
contracts. The substantial majority of the Company's new and renewal contracts
now contain terms that result in License Revenue. For this reason, the Company
does not believe that revenue and results of operations for periods ended on or
prior to June 30, 1996 will be directly comparable to results for future
periods. Furthermore, because the Company had only begun to recognize License
Revenue during the quarter ending March 31, 1996, the Company does not believe
that revenue and results of operations for the year ended December 31, 1997 are
directly comparable to the results for the year earlier period. Revenue
recognition on certain service offerings is based on percentage of completion
and on attainment of project milestones.

    Revenues from software product sales are recognized upon shipment of the
products to customers, and revenues from related customer software support
programs are recognized ratably over terms specified in the sale agreement. The
Company accounts for insignificant vendor obligations by deferring a portion of
the revenue and recognizing it either ratably as the obligations are fulfilled
or when the related services are performed.

    Service revenues from fixed-price contracts are recognized on the
percentage-of-completion method, measured by the percentage of costs (primarily
labor) incurred to date as compared to the estimated total costs (primarily
labor) for each contract. When a loss is anticipated on a contract, the full
amount thereof is provided currently. Service revenues from time and expense
contracts and consulting and training revenue are recognized as the related
services are performed. Billings that have been recorded before the services
have been performed, and services that have been performed but for which
billings have not been made, are recorded net, as unearned revenue in the
accompanying consolidated balance sheets.

    The American Institute of Certified Public Accountants recently issued
Statement of Position No. 97-2, Software Revenue Recognition ("SOP 97-2") which
supersedes SOP 91-1. SOP 97-2 is effective for transactions entered into in
fiscal years beginning after December 15, 1997. Retroactive application is
prohibited. Accordingly,

                                      F-8


<PAGE>   43
                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

the Company will recognize revenue in accordance with SOP 97-2 for its years
beginning January 1, 1998. The Company is reviewing the impact of SOP 97-2
on its consolidated financial statements.

    Income Taxes - The Company accounts for income taxes under the provisions of
Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes
(SFAS No. 109). This statement requires the recognition of deferred tax assets
and liabilities for the future consequences of events that have been recognized
in the Company's financial statements or tax returns. Measurement of the
deferred items is based on enacted tax laws.

    Foreign Currency Translation - In accordance with Statement of Financial
Accounting Standards No. 52, Foreign Currency Translation (SFAS No. 52), the
United States dollar is considered to be the functional currency for the
Company's foreign subsidiaries, and translation adjustments are included in
other income in the Company's consolidated statements of operations.

    Pro Forma and Net Income (Loss) per Share - In accordance with the recently
issued Statement of Financial Accounting Standards No. 128, Earnings per Share
(SFAS No. 128), pro forma and net income (loss) per share, on a basic and
diluted basis, are presented for all periods. Basic pro forma net income (loss)
per share is computed by dividing net income (loss) by the weighted average
number of common shares outstanding. Diluted pro forma net income (loss) per
share is computed by dividing net income (loss) by the weighted average number
of common and dilutive common equivalent shares outstanding. Weighted average
common shares include common shares and the pro forma conversion of all
outstanding shares of preferred stock into shares of common stock. Weighted
average common equivalent shares include warrants to purchase shares of common
stock and stock options using the treasury stock method. Net income (loss) per
share is computed as described above and includes the actual conversion of the
preferred shares into the same number of common shares upon the completion of
the Company's initial public offering in October 1996 (Note 3).

    Use of Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.

    Stock-based Compensation - The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB
No. 25).

    Concentration of Revenue in the Petroleum Industry - The Company derives a
substantial majority of its total revenue from software licenses and services to
companies in the petroleum industry, which is highly cyclical. Accordingly, the
Company's future success is dependent upon the continued demand for process
engineering software by companies in the petroleum industry.

    Other Recent Accounting Pronouncements - The Company will adopt SFAS No.
130, Reporting Comprehensive Income, and SFAS No. 131, Disclosures About
Segments of an Enterprise and Related Information for its years beginning
January 1, 1998. The Company is reviewing the impact of such statements on its
consolidated financial statements.


                                      F-9

<PAGE>   44

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

2.  ACQUISITIONS

    In March 1997, the Company acquired substantially all of the assets of
Visual Solutions, Inc. for $5.7 million, including acquisition costs, consisting
of $1.8 million in cash and $3.9 million in common stock of the Company. Visual
Solutions, Inc. was a privately held Texas corporation providing commercial
simulation software and related services to the process industries. The
acquisition was accounted for under the purchase method of accounting and the
purchase price was allocated primarily to in-process research and development
($5.2 million), goodwill ($0.3 million), purchased technology ($0.1 million) and
accounts receivable ($0.1 million). The amount allocated to in-process research
and development was based upon management's assumptions.

    In March 1997, the Company acquired substantially all of the assets of
Salumunek & Assoc., Inc., for approximately $950,000 in cash, including
acquisition costs. Salumunek & Assoc., Inc. was a privately held Texas
corporation providing plant performance monitoring software and related services
to the process industries. The acquisition was accounted for under the purchase
method of accounting and the purchase price was allocated primarily to goodwill.

    In May 1997, the Company entered into an agreement and acquired certain
technology from Bayer AG for $1.0 million in cash, to be paid in equal
installments over a five year period. The acquisition was accounted for under
Statement of Financial Accounting Standards No. 68, Research and Development
Arrangements (SFAS No. 68). In accordance with SFAS No. 68, an asset and
liability have been recorded for an amount equal to the purchase price.

    In June 1997, the Company acquired certain technology and assets from
Raytheon Engineers & Constructors, Inc. for $1.1 million in cash, including
transaction costs, plus assumed liabilities of $30,000. The acquisition was
accounted for under the purchase method of accounting and the purchase price was
allocated primarily to in-process research and development. The amount allocated
to in-process research and development was based upon management's assumptions.

    In September 1997, the Company acquired certain business planning products
from Shell Oil Products Company for $1.6 million, including transaction costs.
The acquisition was accounted for under the purchase method of accounting and
the purchase price was allocated to intangible assets.

    In September 1997, the Company acquired certain royalty rights and a
purchase option with respect to certain advanced multivariable process control
technology from Shell Oil Products Company for $1.1 million, including
transaction costs. The acquisition was accounted for under the purchase method
of accounting and the purchase price was allocated to intangible assets.

    In September 1997, the Company acquired an irrevocable, perpetual, exclusive
royalty-free license with respect to certain solver and modeling technology from
Shell Oil Products Company for a total of $6.2 million, including transaction
costs. The purchase price is to be paid in 1998 as follows: $1.5 million in cash
and $4.5 million in common stock. The acquisition was accounted for under the
purchase method of accounting and the purchase price was allocated to in-process
research and development ($6.0 million) and goodwill ($0.2 million). The amount
allocated to in-process research and development was based upon management's
assumptions.

    On September 30, 1997, the Company acquired substantially all of the assets
of W.R. Biles & Associates, Inc. for $5.6 million, including acquisition costs.
The purchase price consisted of $2.5 million in cash and $2.7 million of assumed
net liabilities (net of $0.8 million in assets), plus transaction costs. W.R.
Biles & Associates, Inc. was a privately held Texas based corporation providing
process information solutions to companies in the chemical, pharmaceutical, food
and beverage and other industries. The acquisition was accounted for under the
purchase method of accounting and the net purchase price was allocated to
in-process research and development


                                      F-10


<PAGE>   45
                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

($4.0 million), purchased technology ($1.6 million), accounts receivable ($0.7
million), fixed assets ($0.1 million), and accrued liabilities ($3.7 million).
The amount allocated to in-process research and development was based upon
management's assumptions.

    The following unaudited pro forma information presents results of operations
of the Company for the year ended December 31, 1997, as if the W.R. Biles and
Associates, Inc. acquisition had been consummated as of the beginning of 1997.
The pro forma information is presented for information purposes only. It is
based on historical information and does not necessarily reflect the actual
results that would have occurred nor is it necessarily indicative of future
results of operations of the combined enterprise.

<TABLE>
<CAPTION>
                                                   Year Ended
                                               December 31, 1997
                                               -----------------
<S>                                            <C>
Total revenues                                    $65,303,962
Net loss                                           (8,441,173)
Basic loss per share                                    (0.77)
Diluted loss per share                                  (0.77)
</TABLE>


3.  REVOLVING LINE OF CREDIT

    At December 31, 1997, the Company had a revolving line of credit with a
commercial bank which provides for an unsecured line of credit up to $3.0
million at the bank's prime rate, contains certain restrictive financial and
other covenants (including but not limited to, profitability, tangible net
worth, liquidity and capital expenditures), and expires March 31, 1999. At
December 31, 1997, there were no borrowings outstanding under the agreement.

4.  STOCKHOLDERS' EQUITY

    Stock Transactions - On December 17, 1993, in a private placement offering,
the Company sold 1,666,668 shares of Series A Convertible Preferred Stock ($.001
par value) at a price of $3.00 per share, raising proceeds of $4,802,120, net of
offering costs of $197,884. In connection with this offering, the Company also
issued warrants to the holders of Series A Convertible Preferred Stock to
purchase 438,598 shares of the Company's common stock for $2.85 per share. Such
warrants were exercised on a net basis in 1997.

    On December 17, 1993, the Company repurchased from its stockholders
1,827,940 shares of common stock for $5,000,000. Upon repurchase by the Company,
the shares were canceled.

    In the fourth quarter of 1996, the Company sold 3,248,866 shares, including
overallotment, of its Common Stock in its initial public offering and raised net
proceeds of $25,943,009. The 1,666,668 shares of Series A Convertible Preferred
Stock were converted into the same number of shares of Common Stock at the
initial public offering. No dividends were declared on the Convertible Preferred
Stock.

    In the fourth quarter of 1997, the Company sold 2,991,818 shares, including
overallotment, of its Common Stock in its secondary public offering and raised
net proceeds of $50,400,661.

    Stock Split - On May 2, 1996, the Company's Board of Directors approved a
1-for-3 reverse stock split of the Company's common stock, which was effected in
October 1996. All share, per share and conversion amounts relating to common
stock, preferred stock, warrants and stock options included in the accompanying
consolidated financial statements and footnotes have been restated to reflect
the stock split for all periods presented.


                                      F-11


<PAGE>   46

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

    Reincorporation - The Company reincorporated in the State of Delaware in
September 1996.

    401(k) - In 1993, the Company had a profit sharing plan and a defined
contribution money purchase pension plan covering substantially all employees.
Both plans were combined in an employee stock ownership plan (ESOP). On January
1, 1994, the ESOP was amended and restated to provide for the combination of the
plans into a 401(k) plan. The Company matches 50% of participating employee
(participant) contributions of up to 5% of compensation. During the years ended
December 31, 1995, 1996 and 1997, matching contributions totaled $111,092,
$163,472 and $238,018 respectively.

    Stock Option Plans - The Company currently has three fixed price stock
option plans which reserve shares of common stock for issuance to key employees
and directors: the 1994 Stock Option Plan (1994 Plan), the 1996 Stock Option
Plan (1996 Plan) and the 1996 Director Option Plan (1996 Director Plan).

    The 1994 Plan provides for the granting of up to 1,666,667 options to
purchase common stock of the Company at a price at least equal to the market
price as of the date of grant. The nonstatutory options are to be issued to key
employees and directors as determined by the Company's Board of Directors. Such
options vest ratably over five years and expire ten years from date of grant. At
December 31, 1997 there were 383,991 shares available for grant under the 1994
Plan.

    The 1996 Plan provides for the granting to employees of incentive stock
options and for the granting to employees and consultants of nonstatutory stock
options and stock purchase rights (SPRs). The 1996 Plan may be administered by
the Board of Directors or a committee of the Board. A total of 2,000,000 shares
of Common Stock is currently reserved for issuance under the 1996 Plan. The
exercise price of the options must be at least equal to the market price at the
date of grant. Such options vest ratably over four years and expire ten years
from date of grant. Unless terminated sooner, the 1996 Plan will terminate
automatically in May 2006. At December 31, 1997, there were 829,608 shares
available for grant under the 1996 Plan.

    The 1996 Director Plan provides for the automatic granting of an option for
20,000 shares of Common Stock (First Option) to each non-employee director on
the earlier of: (i) the effective date of the Director Plan, or (ii) the date on
which the person first becomes a non-employee director, unless immediately prior
to becoming a non-employee director, such person was a director of the Company.
After the First Option is granted to the non-employee director, he or she shall
automatically be granted an option to purchase 5,000 shares (Subsequent Option)
each year on the date of the annual stockholders' meeting of the Company at
which such non-employee director is re-elected as a director, if on such date he
or she shall have served on the Board for at least six months. The Company has
reserved 125,000 shares of Common Stock for issuance under the 1996 Director
Plan. The exercise price of the options must be at least equal to the market
price at the date of grant. Such options vest ratably over four years and expire
ten years from date of grant. As of December 31, 1997, there were 115,000 shares
available for grant under the 1996 Director Plan.


                                      F-12

<PAGE>   47

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

    The following table summarizes activity under the Company's 1994 Plan, 1996
Plan and the 1996 Director Plan:

<TABLE>
<CAPTION>
                                                                 NUMBER OF
                                NUMBER OF          PRICE          OPTIONS
                                  SHARES         PER SHARE      EXERCISABLE
                               ----------------------------------------------
<S>                            <C>              <C>          <C>       <C>
Balance, January 1, 1995            500,667     $2.73 - $  2.73         -
    Granted                         585,000      2.67 -    2.67
    Canceled                       (171,667)     2.73 -    2.73
                               -------------
Balance, December 31, 1995          914,000      2.67  -   2.73    65,800
    Granted                         724,333      5.37  -  10.38
    Exercised                       (71,805)     2.67  -   2.73
    Canceled                       (101,716)     2.67  -   6.30
                               -------------
Balance, December 31, 1996        1,464,812      2.67  -  10.38   193,137
    Granted                       1,168,392      9.88  -  18.13
    Exercised                      (303,818)     2.67  -   7.50
    Canceled                       (241,936)     2.67  -  16.25
                               -------------
Balance, December 31, 1997        2,087,450     $2.67  - $18.13   192,515
                               =============
</TABLE>


    The following table summarizes other information regarding stock options
outstanding at December 31, 1997:

<TABLE>
<CAPTION>
                             OPTIONS OUTSTANDING                OPTIONS EXERCISABLE
                    ---------------------------------------  --------------------------
                                   WEIGHTED
                                   AVERAGE      WEIGHTED                    WEIGHTED
     RANGE OF          NUMBER     REMAINING     AVERAGE         NUMBER      AVERAGE
     EXERCISE       OUTSTANDING  CONTRACTUAL    EXERCISE     EXERCISABLE    EXERCISE
      PRICES        AT 12/31/97      LIFE        PRICES      AT 12/31/97     PRICES
------------------- ---------------------------------------  --------------------------
<S>                  <C>           <C>          <C>          <C>             <C>
$ 2.67 to $ 2.73      471,698        7          $ 2.69         116,156       $ 2.70
$ 5.37 to $ 7.50      436,610        8            6.40          60,609         6.37
$ 9.75 to $14.38      514,417        9           12.33          15,750        10.38
$16.25 to $22.88      664,725       10           20.62
                    ---------                                  -------
                    2,087,450                                  192,515
                    =========                                  =======

</TABLE>


    1996 Employee Stock Purchase Plans (1996 ESPP) - The U.S. 1996 ESPP permits
eligible employees to acquire shares of the Company's common stock at 85% of the
lower of the fair market value of the Common Stock at the beginning or at the
end of each offering period through payroll deductions of up to 10% of an
employee's compensation (excluding bonuses and incentive compensation), up to a
maximum of $20,000 per year. The plan has two six-month offering periods each
year beginning on the first trading day on or after January 1 and July 1,
respectively, and terminates in 2006. The Foreign 1996 ESPP contains terms
similar to those of the U.S. 1996 ESPP. A total of 200,000 shares have been
approved for grant under the 1996 ESPP. During 1997, 118,006 shares of common
stock were purchased under the plan. At December 31, 1997, the Company had a
liability of $8,376 recorded in connection with the plan.

    APB Opinion No. 25 - As discussed in Note 1, the Company continues to
account for its stock-based awards using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB No. 25) and its related interpretations. No
compensation expense has been recognized in the financial statements for
employee stock arrangements.

                                      F-13

<PAGE>   48

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

     SFAS No. 123 - Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation, (SFAS No. 123) requires the disclosure
of pro forma net income (loss) and earnings (loss) per share had the Company
adopted the fair value method as of the beginning of 1995. Under SFAS No. 123,
the fair value of stock-based awards to employees is calculated through the use
of option pricing models, even though such models were developed to estimate the
fair value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
These models also require subjective assumptions, including future stock
volatility and expected time to exercise, which greatly affect the calculated
values. The Company's calculations were made using the Black-Scholes option
pricing model with the following weighted-average assumptions for the years
1995, 1996 and 1997, respectively: no dividend yield, expected volatility of
0.0%, 3.0% and 59.5%, risk free interest rate of 6.4%, 6.1% and 5.8%, and
expected lives of 5, 4.8 and 4 years. The Company's calculations are based on a
multiple option valuation approach and forfeitures are recognized as they occur.
If the computed fair values of the 1995, 1996 and 1997 awards had been amortized
to expense over the vesting period of the awards, pro forma net income (loss)
would have been as follows:

<TABLE>
<CAPTION>
                                            YEAR ENDED DECEMBER 31,
                                    ----------------------------------------
                                       1995          1996          1997
                                    ------------  ------------  ------------
<S>                                 <C>           <C>           <C>
Net income (loss) as reported       $1,354,684    $2,692,163    $(11,120,785)
Pro forma net income (loss)          1,329,515     2,550,205     (11,819,467)
Pro forma basic net income (loss)
   per share                              0.20          0.35           (1.07)
Pro forma diluted net income
  (loss) per share                        0.20          0.32           (1.07)

</TABLE>

5.  INCOME TAXES

    The provision for income taxes consists of the following:

<TABLE>
<CAPTION>
                                                YEAR ENDED DECEMBER 31,
                                       -----------------------------------------
                                           1995          1996           1997
                                       ------------   -----------   ------------
<S>                                     <C>            <C>          <C>
Current:
    Federal                              $ 224,311     $ 641,190    $ 2,937,855
    State                                  228,876       343,926        623,495
    Foreign                                850,658     1,365,181      1,270,622
                                       ------------   -----------   ------------
                                         1,303,845     2,350,297      4,831,972
Deferred federal and state, net
    of valuation allowance                (351,973)     (400,797)    (2,369,191)
                                       ------------   -----------   ------------
                                         $ 951,872    $ 1,949,500   $ 2,462,781
                                       ============   ===========   ============
</TABLE>

    The following summary reconciles the U.S. Federal statutory income tax
(benefit) rate to the Company's effective tax rate:

<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31,
                                           ---------------------------------------
                                               1995          1996           1997
                                           ------------   -----------   ----------
<S>                                         <C>           <C>            <C>
Income tax (benefit) at U.S.
  Federal statutory rate                       35.0%         35.0%         (35.0%)

Increases (decreases) resulting from:
    State taxes (benefit), net                  3.9           3.9           (3.7)
    Foreign tax rate differential               2.2           5.2            3.5
    Change in valuation allowance                                           59.0
    Other                                       0.2          (2.1)           4.6
                                           ---------------------------------------
       Effective tax rate                      41.3%         42.0%          28.4%
                                           ============   ===========   ==========
</TABLE>


                                      F-14


<PAGE>   49

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

    The Company provides deferred income taxes for temporary differences between
assets and liabilities recognized for financial reporting purposes and income
tax purposes. The income tax effects of these temporary differences representing
significant portions of the deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
                                                           YEAR ENDED DECEMBER 31,
                                                          --------------------------
                                                             1996           1997
                                                          -----------   ------------
<S>                                                       <C>           <C>
Deferred tax assets:
    Deferred revenues                                     $ 1,953,241    $ 2,324,128
    Depreciable assets                                        106,415
    Accrued expenses and reserves                           1,028,985      1,736,176
    Intangibles                                                            6,825,014
    Tax credit carryforwards                                   68,240        166,884
                                                          -----------    -----------
       Total deferred tax assets                            3,156,881     11,052,202
                                                          -----------    -----------

Deferred Tax Liabilities:
    Depreciable assets                                                       (30,897)
    Deferred state taxes                                      (52,152)      (429,941)
                                                          -----------    -----------
       Total deferred tax liabilities                         (52,152)      (460,838)
                                                          -----------    -----------
          Net deferred tax assets before
              valuation allowance                           3,104,729     10,591,364
          Valuation allowance                                             (5,110,000)
                                                          -----------    -----------
          Net deferred tax assets                         $ 3,104,729    $ 5,481,364
                                                          ===========    ===========
</TABLE>

    At December 31, 1997, the Company has recognized a deferred tax asset, net
of deferred tax liabilities, of $5.5 million, after a valuation allowance of
$5.1 million primarily related to temporary differences between the book and tax
basis of assets and liabilities. The Company's management believes that it is
more likely than not that this deferred tax asset will be realized against
future taxable income.


6.  COMMITMENTS AND CONTIGENCIES

    As of December 31, 1997, the Company has various operating lease commitments
expiring through 2008 for office space and rental equipment, as follows:


<TABLE>

<S>                                 <C>
Year ending December 31:
    1998                            $ 3,674,553
    1999                              3,453,818
    2000                              2,956,978
    2001                              2,391,065
    2002                              2,276,041
    Thereafter                       10,121,865
                                  --------------
                                   $ 24,874,320
                                  ==============
</TABLE>

    Rent expense was $1,828,365, $2,012,297 and $2,447,960 for the years ended
December 31, 1995, 1996 and 1997, respectively. Certain stockholders of the
Company, in connection with their involvement in a partnership, held a 44%
interest in the Company's main office facility from October 1992 through
September 30, 1997. Total rent expense incurred by the Company to such
partnership amounted to $482,973, $602,830 and $452,122 for the years ended
December 31, 1995, 1996 and 1997, respectively.


                                      F-15

<PAGE>   50

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

    During the fourth quarter of 1997, a dispute arose over invoices received by
the Company in connection with a development project. The Company's management
believes that such billings, which approximate $750,000, were outside the scope
of the development project and has advised the service provider of the Company's
position. The Company and the service provider are presently discussing this
issue; however, it is not presently determinable what amounts, if any, will be
due related to this matter.

    The Company is not currently subject to any legal actions that are expected
to have a material adverse effect on the Company's business, operating results
or financial condition.


7.  GEOGRAPHICAL INFORMATION

    Revenue, income (loss) before income taxes and identifiable assets are as
follows:

<TABLE>
<CAPTION>
                                              YEAR ENDED DECEMBER 31,
                                    --------------------------------------------
                                        1995            1996           1997
                                    -------------  --------------  -------------
<S>                                 <C>             <C>            <C>
Revenue:
  North America                     $ 11,095,791    $ 14,991,650   $ 23,095,060
  Europe/Middle East/Africa           11,416,180      16,396,830     19,389,970
  Japan                                5,109,689       7,860,232      6,890,284
  Pacific Rim                          3,483,784       4,294,605      4,361,890
  Other *                              2,013,867       3,360,066      6,838,370
                                    -------------  --------------  -------------
                                    $ 33,119,311    $ 46,903,383   $ 60,575,574
                                    =============  ==============  =============

Income (loss) before income taxes:
  United States                      $ 1,474,826     $ 3,101,383   $ (9,441,007)
  Japan                                  282,149       1,176,915        287,453
  Other                                  549,581         363,365        495,550
                                    -------------  --------------  -------------
                                     $ 2,306,556     $ 4,641,663   $ (8,658,004)
                                    =============  ==============  =============

Assets:
  United States                     $ 20,419,549    $ 51,861,721   $106,002,209
  Japan                                2,049,995       1,472,848      5,919,819
  Other                                  858,925       1,906,522      3,507,833
  Eliminations                        (1,774,087)     (2,043,314)    (8,677,232)
                                    -------------  --------------  -------------
                                    $ 21,554,382    $ 53,197,777   $106,752,629
                                    =============  ==============  =============
</TABLE>

*  Consists primarily of sales into Latin American countries.


                                      F-16

<PAGE>   51

                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

8.  PRO FORMA AND NET INCOME (LOSS) PER SHARE

    The following table is a reconciliation of net income, and pro forma and
weighted average common shares used in the calculation of pro forma and net
income per share, and pro forma and net income per share assuming dilution:

<TABLE>
<CAPTION>
                                                          PRO FORMA AND
                                                         WEIGHTED AVERAGE   PER SHARE
                                            NET INCOME     COMMON SHARES      AMOUNT
                                            -----------  ----------------   ---------
<S>                                        <C>            <C>                <C>
Year ended December 31, 1996:
Basic pro forma and net income per share    $ 2,692,163       7,249,817       $0.37
Effect of dilutive stock options                                727,948       (0.03)
                                            -----------      ----------       -----
Diluted pro forma and net income per share  $ 2,692,163       7,977,765       $0.34
                                            ===========      ==========       =====
</TABLE>

    The pro forma and weighted average number of shares outstanding for 1995 and
1997 were 6,666,669 and 11,003,571, respectively. Options to purchase shares of
common stock were outstanding in 1995 and 1997, but were not included in the
computation of diluted pro forma and net income (loss) per share, as their
effect was antidilutive.


                                      F-17



<PAGE>   52


                    SIMULATION SCIENCES INC. AND SUBSIDIARIES

                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>

                                          BALANCE AT   CHARGED TO                 BALANCE AT
                                           BEGINNING    COSTS AND                     END
               DESCRIPTION                 OF PERIOD    EXPENSES     DEDUCTIONS    OF PERIOD
----------------------------------------------------------------------------------------------
<S>                                        <C>          <C>           <C>          <C>
Allowance for Doubtful Accounts:

December 31, 1995                          $ 427,944      28,443            -      $  456,387

December 31, 1996                          $ 456,387     478,169      (212,520)    $  722,036

December 31, 1997                          $ 722,036     749,666          (624)    $1,471,078
</TABLE>



                                      S-1


<PAGE>   53
                                 EXHIBIT INDEX

<TABLE>
<CAPTION>

Exhibit No.    Description of Exhibit
----------     ----------------------
<S>            <C>
 3.1(1)        Amended and Restated Certificate of Incorporation of the
               Registrant, as currently in effect

 3.2(2)        Amended and Restated Bylaws of the Registrant

 4.1(3)        Form of specimen certificate for the Registrant's Common Stock

 4.2(9)        Certificate of Designations of Rights, Preferences and Privileges
               of Series A Participating Preferred Stock

10.1(2)        Form of Indemnification Agreement entered into by the Registrant
               with each of its directors and executive officers

10.2(1)        1994 Stock Option Plan and related agreements

10.3(8)        1996 Stock Option Plan and related agreements as amended

10.4(1)        1996 Employee Stock Purchase Plan for U.S. Employees and related
               agreements

10.5(1)        1996 Employee Stock Purchase Plan for Non-U.S. Employees and
               related agreements

10.6(3)        1996 Director Option Plan and related agreements

10.7(1)        Registration Rights Agreement dated December 17, 1993

10.8(1)        Standard Office Lease dated September 1, 1992 between the
               Registrant and Brea Partners, as amended

10.9(1)        Stock Purchase and Investment Agreement dated December 17, 1993
               by and among the Registrant, certain shareholders and Northern
               Trust Bank of California, N.A. as Trustee of the Registrant's
               Employee Stock Ownership Plan and Money Purchase Pension Plan

10.10(2)*      Software License Agreement dated September 1, 1995 between
               Mobil Oil Corporation and the Registrant

10.11(3)       Form of Separation Agreement between the Registrant and each of
               Katherine S. Abrams, Robert E. Grice, Charles R. Harris, Daniel
               T. Nichols, and Dirk Pfeiffer
</TABLE>



<PAGE>   54
<TABLE>
<CAPTION>

Exhibit No.    Description of Exhibit
----------     ----------------------
<S>            <C>
10.12(4)       Asset Purchase Agreement dated March 24, 1997 among the
               Registrant, Visual Solutions, Inc. and John L. Dial, II, Mark G.
               Brosius, Donald L. Miller and Christopher E. Glass

10.13(4)       Registration Rights Agreement dated March 26, 1997 among the
               Registrant, Visual Solutions, Inc. and John L. Dial, II, Mark G.
               Brosius, Donald L. Miller and Christopher E. Glass

10.14(5)*      Software License Agreement dated September 15, 1997 between Shell
               Oil Products Company, acting for itself and as Agent for Shell
               Oil Company, and the Registrant

10.15(5)*      Asset Purchase Agreement dated September 15, 1997 between Shell
               Oil Products Company, acting for itself and as Agent for Shell
               Oil Company, and the Registrant

10.16(5)*      Software Marketing Agreement dated September 15, 1997 between
               Shell Oil Products Company, acting for itself and as Agent for
               Shell Oil Company, and the Registrant

10.17(6)       Asset Purchase Agreement dated as of September 30, 1997 by and
               among Registrant, W.R. Biles & Associates, Inc., a Delaware
               corporation, and William R. Biles , an individual

10.18(7)       Lease Agreement dated September 2, 1997 between Registrant and
               The Prudential Insurance Company of America

21.1           List of Subsidiaries

23.1           Consent of Deloitte & Touche LLP, independent auditors

24.1           Power of Attorney (included on page 34)

27.1           Financial Data Schedule

27.2           Financial Data Schedule as amended

27.3           Financial Data Schedule as amended

</TABLE>

------------------------

 *             Confidential treatment has been granted with respect to portions
               of this agreement

(1)            Incorporated by reference to the Company's Form S-1 filed on
               August 29, 1996, File Number 333-11017

(2)            Incorporated by reference to the Company's Amendment No. 1 to
               Form S-1 filed on September 17, 1996, File Number 333-11017

(3)            Incorporated by reference to the Company's Amendment No. 3 to
               Form S-1 filed on October 17, 1996, File Number 333-11017

(4)            Incorporated by reference to the Company's report on Form 8-K
               dated March 26, 1997, filed on April 10, 1997, File Number
               000-21283

(5)            Incorporated by reference to the Company's report on Form 8-K
               dated September 15, 1997, filed on September 30, 1997, File
               Number 000-21283

(6)            Incorporated by reference to the Company's report on Form 8-K
               dated September 30, 1997, filed on October 14, 1997, File Number
               000-21283

(7)            Incorporated by reference to the Company's report on Form 10-Q
               filed on October 29, 1997

(8)            Incorporated by reference to the Company's report on Form S-8
               filed on December 19, 1997, Registration Number 333-42697

(9)            Incorporated by reference to the Company's Registration Statement
               on Form 8-A, filed on August 14, 1997, File Number 000-21283