<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 1998
/ / 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 1-8722
THE MACNEAL-SCHWENDLER CORPORATION
----------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 95-2239450
- --------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
815 Colorado Boulevard, Los Angeles, California 90041
-----------------------------------------------------
(Address of principal executive offices)
Registrant's telephone number (213) 258-9111
--------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
----- -----
The number of shares outstanding of Registrant's Common Stock, par value $.01
per share, was 13,538,375 shares at September 4, 1998.
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets - July 31, 1998 (Unaudited)
and January 31, 1998. . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Income (Unaudited)
Three and Six Months Ended July 31, 1998 and 1997 . . . . . 4
Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended July 31, 1998 and 1997 . . . . . . . . . . 5
Notes to Consolidated Financial Statements
(Unaudited) . . . . . . . . . . . . . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition . . . . . . . . . . . . . . . . . . 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk . . . 13
Part II. Other Information
Item 2. Changes in Securities and Use of Proceeds. . . . . . . . . . . . 14
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . 14
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . 15
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . 15
</TABLE>
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JULY 31, JANUARY 31,
1998 1998
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 15,258,000 $ 10,086,000
Securities available for sale 17,717,000 16,073,000
Trade accounts receivable, net 38,275,000 49,091,000
Deferred tax charges 3,446,000 3,446,000
Other current assets 7,267,000 7,219,000
------------- ------------
Total current assets 81,963,000 85,915,000
Property and equipment, net 8,786,000 8,926,000
Capitalized software costs, net 29,637,000 28,780,000
Goodwill and other intangible assets, net 12,810,000 13,958,000
Other assets 2,971,000 2,704,000
------------- ------------
$136,167,000 $140,283,000
------------- ------------
------------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,417,000 $ 3,131,000
Accrued liabilities 19,979,000 23,722,000
Deferred income 8,528,000 10,561,000
Income taxes payable - 748,000
------------- ------------
Total current liabilities 30,924,000 38,162,000
Deferred income taxes 10,983,000 10,983,000
Convertible subordinated debentures 56,574,000 56,574,000
Commitments
Shareholders' equity:
Preferred stock, $0.01 par value, 10,000,000
shares authorized; no shares outstanding
at July 31, 1998 or January 31, 1998 ----- -----
Common stock, $0.01 par value,
100,000,000 shares authorized;
13,538,400 and 13,621,900 issued and
outstanding at July 31, 1998 and
January 31, 1998, respectively, and
common stock warrants 30,834,000 31,482,000
Retained earnings 12,055,000 7,399,000
Accumulated unrealized investment gain 1,000 -----
Accumulated translation adjustment (5,204,000) (4,317,000)
------------- ------------
Total shareholders' equity 37,686,000 34,564,000
------------- ------------
$136,167,000 $140,283,000
------------- ------------
------------- ------------
</TABLE>
See accompanying notes.
3
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JULY 31, SIX MONTHS ENDED JULY 31,
1998 1997 1998 1997
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Revenues:
Software licenses $24,994,000 $24,661,000 $49,612,000 $50,086,000
Software maintenance and services 8,488,000 7,631,000 16,583,000 14,142,000
----------- ----------- ----------- -----------
Total revenues 33,482,000 32,292,000 66,195,000 64,228,000
Operating expenses:
Cost of revenue 7,740,000 7,593,000 15,862,000 15,194,000
Amortization of goodwill and other intangibles 567,000 567,000 1,134,000 1,134,000
Research and development 3,111,000 1,946,000 5,831,000 4,253,000
Selling, general and administrative 17,412,000 17,423,000 34,664,000 34,780,000
----------- ----------- ----------- -----------
Total operating expenses 28,830,000 27,529,000 57,491,000 55,361,000
Operating income 4,652,000 4,763,000 8,704,000 8,867,000
Debenture interest (1,114,000) (1,114,000) (2,228,000) (2,228,000)
Other income, net 335,000 75,000 579,000 3,000
----------- ----------- ----------- -----------
Income before income taxes 3,873,000 3,724,000 7,055,000 6,642,000
Provision for income taxes 1,317,000 1,266,000 2,399,000 2,258,000
----------- ----------- ----------- -----------
Net income $ 2,556,000 $ 2,458,000 $ 4,656,000 $ 4,384,000
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Basic earnings per share $ 0.19 $ 0.18 $ 0.34 $ 0.32
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Diluted earnings per share $ 0.19 $ 0.18 $ 0.34 $ 0.32
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Basic weighted average
shares outstanding 13,634,000 13,496,000 13,643,000 13,479,000
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Diluted weighted average
shares outstanding 17,511,000 17,375,000 17,557,000 17,325,000
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
4
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JULY 31
----------------------------
1998 1997
------------ -------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 4,656,000 $ 4,384,000
Adjustments to reconcile net income to net
Cash provided by operating activities:
Depreciation and amortization of property and equipment 2,745,000 2,885,000
Amortization of capitalized software costs 6,812,000 5,915,000
Amortization of goodwill and other intangibles 1,134,000 1,134,000
Amortization of premiums and discounts on securities
Available for sale 29,000 -
Deferred income taxes - (798,000)
(Gain) Loss on disposal of property and equipment (13,000) 13,000
Changes in assets and liabilities:
Trade accounts receivable, net 10,816,000 2,826,000
Other current assets (48,000) 843,000
Accounts payable (714,000) (627,000)
Accrued liabilities (3,743,000) (5,396,000)
Deferred income (2,033,000) (426,000)
Income taxes payable (748,000) 1,000
------------ ------------
Net cash provided by operating activities 18,893,000 10,754,000
Cash flows from investing activities:
Purchase of securities available for sale (1,672,000) (4,993,000)
Sale of securities available for sale - 3,000
Acquisition of property and equipment (2,592,000) (2,379,000)
Purchase of software (617,000) (51,000)
Capitalized software costs (7,052,000) (6,067,000)
Increase in other assets (253,000) (183,000)
------------ ------------
Net cash used in investing activities (12,186,000) (13,670,000)
Cash flows from financing activities:
Proceeds from common stock issued 957,000 703,000
Repurchase and retirement of common stock (1,877,000) -
Proceeds from common stock warrants issued 272,000 -
------------ ------------
Net cash provided by financing activities (648,000) 703,000
Effect of exchange rate changes on cash (887,000) (1,587,000)
------------ ------------
Net increase (decrease) in cash and cash equivalents 5,172,000 (3,800,000)
Cash and cash equivalents at beginning of period 10,086,000 24,016,000
------------ ------------
Cash and cash equivalents at end of period $ 15,258,000 $ 20,216,000
------------ ------------
------------ ------------
</TABLE>
See accompanying notes.
5
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1: BASIS OF PRESENTATION
The accompanying unaudited consolidated financial information is
condensed from that which would appear in the annual financial statements and
should be read in conjunction with the consolidated financial statements
included in The MacNeal-Schwendler Corporation's Annual Report on Form 10-K
for the year ended January 31, 1998.
All interim financial data is unaudited but, in the opinion of
management, reflects all adjustments necessary for a fair presentation
thereof. However, it should be understood that accounting measurements at
interim dates might be less precise than at year-end. Operating results for
the six months ended July 31, 1998 are not necessarily indicative of the
results that may be expected for the year ended January 31, 1999.
Supplemental cash flow information for taxes paid during the six months
ended July 31, 1998 and 1997 were $3,285,000 and $2,257,000, respectively.
Additionally, the company paid interest of $2,227,000 on its convertible
subordinated debentures due 2004 during both the six months ended July 31,
1998 and 1997.
As of February 1, 1998, the Company adopted Statement of Position
("SOP") 97-2, "Software Revenue Recognition," which supercedes SOP 91-1.
This method distinguishes between significant and insignificant vendor
obligations as a basis for recording revenue with a requirement that each
element of a software licensing arrangement be separately identified and
accounted for based on relative fair values of each element.
In December 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per
Share." SFAS No. 128 replaced the calculation of primary and fully diluted
earnings per share with basic and diluted earnings per share. Unlike primary
earnings per share, basic earnings excludes any dilutive effects of options,
warrants, and convertible securities. Diluted earnings per share is very
similar to the previously reported fully diluted earnings per share. Diluted
earnings per share for the three and six months ended July 31, 1998 and July
31, 1997 includes the dilutive effect of stock warrants and options
calculated under the treasury stock method. The assumption that the
convertible subordinated debentures were converted into common stock at the
beginning of the period and the related interest requirements, net of tax, is
added to net income in the calculation is anti-dilutive for the three and six
months ended July 31, 1998 and 1997. All earnings per share amounts for all
prior periods have been restated to conform to the FASB No. 128 requirements.
As of February 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes new rules for the reporting
and display of comprehensive income and its components; however, the adoption
of this Statement had no impact on the Company's reported net income or
shareholders' equity. SFAS No. 130 requires unrealized gains or losses on
the Company's available-for-sale securities and foreign currency translation
adjustments, which prior to adoption were reported separately in
shareholders' equity, to be included in other comprehensive income. Prior
year Consolidated Statement of Shareholders' Equity will be reclassified to
conform to the requirements of SFAS No. 130.
During the three and six months ended July 31,1998, total comprehensive
income amounted to $2,507,000 and $3,770,000, respectively, compared to
$1,195,000 and $2,797,000 for the three and six months ended July 31,1997,
respectively. The primary difference between net income and comprehensive
income was the change in accumulated translation adjustment.
6
<PAGE>
In December 1997, the FASB issued Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information," which requires the
Company to disclose certain information about reportable operating segments
in complete sets of financial statements of the enterprise and in condensed
financial statements of interim periods. The Company adopted SFAS No. 131 in
the first quarter of fiscal 1999.
Certain reclassifications have been made to the consolidated statements
of income for the three months and six months ended July 31, 1997 in order to
conform to the July 31, 1998 presentation.
NOTE 2: CAPITALIZED SOFTWARE
The components of net capitalized software costs were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JULY 31, SIX MONTHS ENDED JULY 31,
---------------------------- ----------------------------
1998 1997 1998 1997
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Software costs capitalized $(3,260,000) $(3,190,000) $(7,052,000) $(6,067,000)
Amortization of capitalized software 3,126,000 3,038,000 6,812,000 5,915,000
----------- ------------ ----------- -----------
Net capitalized software costs $ (134,000) $ (152,000) $ (240,000) $ (152,000)
----------- ------------ ----------- -----------
----------- ------------ ----------- -----------
</TABLE>
Amortization expense associated with capitalized software costs is reported
in cost of revenue, and capitalization of software costs is reported as a
reduction of research and development expense.
NOTE 3: ACCRUED LIABILITIES
The components of accrued liabilities are as follows:
<TABLE>
<CAPTION>
JULY 31, JANUARY 31,
1998 1998
----------- ------------
<S> <C> <C>
Compensation and related expenses $ 7,227,000 $ 6,516,000
Commissions payable 2,011,000 2,752,000
Debenture interest payable 1,689,000 1,688,000
Contribution to profit sharing plan 1,114,000 2,784,000
Post-retirement benefits 2,258,000 2,236,000
Royalties payable 698,000 929,000
Sales taxes payable 1,625,000 3,020,000
Incentive compensation 281,000 230,000
Stock purchase plan 27,000 438,000
Other 3,049,000 3,129,000
----------- ----------
$19,979,000 $23,722,000
----------- -----------
----------- -----------
</TABLE>
NOTE 4: WARRANTS
On May 15 and June 30, 1998, in connection with completing a marketing
arrangement with Kubota Solid Technology Corporation ("KSTC"), the Company
issued warrants to purchase 32,967 and 38,216 shares at $11.375 and $9.813
per share, respectively, for a total of $750,000, of the Company's common
stock. The exercise price was equal to the fair market value of the common
stock on the dates of purchase. The warrants are non-transferable, have a
five-year term and become exercisable two years after the date of issuance.
The warrants were valued using the Black Scholes valuation method. KSTC has
the right to purchase additional warrants to purchase common stock valued at
$2,250,000 through December 31, 1999.
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
THREE MONTHS ENDED JULY 31, 1998 VS. THREE MONTHS ENDED JULY 31, 1997
The Company reported revenue of $33,482,000 for the second quarter,
compared to revenue of $32,292,000 for the second quarter of the prior fiscal
year, a 4% increase. Revenue growth in the current year would have been
approximately $2,384,000, or 7%, if valued using prior year foreign currency
translation rates. Software license revenue and maintenance fees account for
91% of total reported revenue in the second quarter and 92% in the second
quarter of the prior fiscal year, with service revenue making up the
difference.
Software revenue consists of licensing fees, which are fees charged for
the right to use the software, and maintenance fees, which provide for
support and unspecified upgrade privileges on a when-and-if-available basis.
In accordance with The American Institute of Certified Public Accountant's
("AICPA") Statement of Position ("SOP") 97-2, "Software Revenue Recognition"
issued in 1997, which supercedes SOP 91-1, revenue associated with support
and upgrade privileges has been consistently deferred and recognized over the
term of the license agreement.
Second quarter revenue growth was adversely affected by the strength of
the U.S. Dollar compared to foreign currencies in which the Company operates.
Europe, which accounted for 32% of the Company's total revenue, grew by 23%
in functional currency compared to the second quarter of the prior fiscal
year. The Asia-Pacific region, which accounted for 27% of the Company's total
revenue, grew by 9% in functional currency compared to the second quarter of
the prior fiscal year. However, in light of the economic turmoil in the
Asia-Pacific region, the Company remains cautious about its Asia-Pacific
prospects. Approximately 5% of the Company's total revenue comes from outside
Japan in the Asia-Pacific region. The Americas, which accounted for 41% of
the Company's total revenue, reported a 3% decline in the second quarter from
the second quarter of the prior year. The decline in the Americas is mostly
attributable to a shift of annual license agreements to the third quarter of
fiscal 1999 in order to make certain agreements co-terminus for various
aerospace customers who have merged over the last year.
Operating expense of $28,830,000 in the second quarter increased by
approximately 5% from the $27,529,000 reported in the second quarter of the
prior fiscal year. The increase was attributable entirely to an increase in
the net cost of research and development. However, the Company's total
development cost before software capitalization was 19% of revenue for the
quarter which remains below management's target of 20% of total revenues.
In accordance with the AICPA Statement of Financial Accounting Standards
No. 86 (FAS 86), "Accounting for the Costs of Computer Software to be Sold,
Leased, or Otherwise Marketed," cost of revenue expense includes period
expenses directly related to revenue as well as the amortization of
capitalized software costs. Research and development expense is reported net
of the amount of software capitalized in the period.
In the second quarter, cost of revenue was $7,740,000 compared to
$7,593,000 in the second quarter of the prior fiscal year, an increase of
$147,000, or 2%. This increase included $88,000 of additional amortization of
capitalized software. Capitalized software amortization increased to
$3,126,000 in the second quarter from $3,038,000 in the second quarter of the
prior fiscal year. The assets' lives have remained consistent from year to
year. The increase in amortization of capitalized software has been
consistent with the increases in capitalization of software costs in prior
quarters. Royalty expense is also included in cost of revenue and paid to
third parties under various agreements. The Company does not consider any
royalty expense related to individual agreements to be material. The
incremental expense of providing maintenance and other services was not
deemed to be material in the second quarter of this fiscal year or the second
quarter of the prior fiscal year.
8
<PAGE>
Research and development expense is reported net of capitalized software
development costs. Research and development expense in the second quarter of
$3,111,000 was $1,165,000, or 60%, more than that reported in the second
quarter of the prior fiscal year. The increase is the result of an increase
of $1,235,000 in the total gross research and development investment offset
by an increase of $70,000 in the amount of research and development
expenditures capitalized under FAS 86.
The total gross investment in research and development activities in the
second quarter amounted to $6,371,000, or 19% of current quarter revenue,
compared to $5,136,000, or 16% of revenue in the second quarter of the prior
fiscal year. The total increase in the gross research and development
investment in the second quarter was 24%. This increase resulted primarily
from changes in staffing and staff mix related to a strategic revision in
product development activity. This shift in strategy de-emphasizes a features
upgrade for specific products and promotes the development of integrated
software solutions for targeted customers.
Capitalized software development costs were $3,260,000 in the second
quarter compared to $3,190,000 in the second quarter of the prior fiscal
year. The increase in the amount of research and development expenditures
capitalized was 2%. The amount of product development capitalized in any
given period is a function of many factors including the number of products
under development at any point in time as well as their stage of development.
The Company's product development process is continually under review to
improve efficiency, product quality, and reduce time to market. Due to the
continual change in the product development process there can be no assurance
that the level of development capitalized in future periods will be
comparable to current capitalized levels.
Selling, general, and administrative expense in the second quarter was
$17,412,000 compared to $17,423,000 in the second quarter of the prior fiscal
year, a decrease of less than 1%.
Operating income declined $111,000, including software capitalization
and amortization from $4,652,000 in the second quarter compared to $4,763,000
in the second quarter of the prior fiscal year, a decrease of 2%. This
decrease reflects the increase in research and development activities
described above.
Debenture interest reflects the interest on the convertible subordinated
debentures issued as part of the acquisition of PDA Engineering in 1994.
Interest payments are due on March 15 and September 15 of each year until the
debentures are converted or redeemed.
Other income increased $260,000 to $335,000 in the second quarter from
$75,000 in the second quarter of the prior fiscal year. The fluctuation is
primarily attributable to increased interest and investment income from
$244,000 in the second quarter of fiscal 1998 to $614,000 in the second
quarter of fiscal 1999. This was offset by an increase of foreign exchange
losses from a loss of $125,000 in the second quarter of fiscal 1998 to a loss
of $229,000 in the second quarter of fiscal 1999. Other income also includes
gains and losses on sales of assets and other non-operating income.
Net income was $2,556,000 in the second quarter compared to $2,458,000
in the second quarter of the prior fiscal year, an increase of 4%. Net
income in the second quarter of fiscal 1999 was unfavorably affected by
fluctuations in functional currencies used in the Company's international
operations. The fluctuation of the U.S. Dollar versus these currencies could
continue to have an unfavorable effect throughout fiscal 1999 and future
years. The effect of foreign currency translation on net income was an
unfavorable variance of approximately $361,000 if valued using prior year
foreign currency translation rates.
9
<PAGE>
SIX MONTHS ENDED JULY 31, 1998 VS. SIX MONTHS ENDED JULY 31, 1997
The Company reported revenue of $66,195,000 for the six months ended
July 31, 1998, compared to revenue of $64,228,000 for the same period of the
prior fiscal year, a 3% increase. Revenue growth in the current year would
have been approximately $4,430,000, or 7%, if valued using prior year foreign
currency translation rates. Software license revenue and maintenance fees
account for 92% of total reported revenue for the six months ended July 31,
1998 and 93% for the same period of the prior fiscal year, with service
revenue making up the difference.
Software revenue consists of licensing fees, which are fees charged for
the right to use the software, and maintenance fees, which provide for
support and unspecified upgrade privileges on a when-and-if-available basis.
In accordance with The American Institute of Certified Public Accountant's
("AICPA") Statement of Position ("SOP") 97-2, "Software Revenue Recognition"
issued in 1997, which supercedes SOP 91-1, revenue associated with support
and upgrade privileges has been consistently deferred and recognized over the
term of the license agreement.
Fiscal 1999 revenue growth was adversely affected by the strength of the
U.S. Dollar compared to foreign currencies in which the Company operates.
Europe, which accounted for 34% of the Company's total revenue, grew by 27%
in functional currency compared to the same period of the prior fiscal year.
The Asia-Pacific region, which accounted for 26% of the Company's total
revenue, grew by 1% in functional currency compared to the same period of the
prior fiscal year. In light of the economic turmoil in the Asia-Pacific
region, the Company remains cautious about its Asia-Pacific prospects.
Approximately 5% of the Company's total revenue comes from outside Japan in
the Asia-Pacific region. The Americas, which accounted for 40% of the
Company's total revenue, reported a 2% decline for the six months ended July
31, 1998. The decline in the Americas is mostly attributable to a shift of
annual license agreements to the third quarter of fiscal 1999 in order to
make certain agreements co-terminus for various aerospace customers who have
merged over the last year.
Operating expense of $57,491,000 in the six months increased by
approximately 4% from the $55,361,000 reported in the same period of the
prior fiscal year. The increase was attributable to an increase of $668,000
in cost of revenue and an increase of $1,578,000 in the net cost of research
and development. Cost of revenue as a percent of revenue remained constant at
24% for both six month periods. The Company's total development cost before
software capitalization was 19% of revenue for the six months ended July 31,
1998 which remains below management's target of 20% of total revenues on a
year to date basis.
In accordance with the AICPA Statement of Financial Accounting Standards
No. 86 (FAS 86), "Accounting for the Costs of Computer Software to be Sold,
Leased, or Otherwise Marketed," cost of revenue expense includes period expenses
directly related to revenue as well as the amortization of capitalized software
costs. Research and development expense is reported net of the amount
capitalized.
Cost of revenue was $15,862,000 for the six months ended July 31, 1998
compared to $15,194,000 for the same period of the prior fiscal year, an
increase of $668,000, or 4%. This increase included $897,000 of additional
amortization of capitalized software. Capitalized software amortization
increased to $6,812,000 in the six months ended July 31, 1998 from $5,915,000
in the same period of the prior fiscal year. The increase in the amount of
capitalized software costs is due to an increase in the number of products
offered by the Company. The assets' lives have remained consistent from year
to year. The increase in amortization of capitalized software has been
consistent with the increases in capitalization of software costs in prior
quarters. Royalty expense is also included in cost of revenue and paid to
third parties under various agreements. The Company does not consider any
royalty expense related to individual agreements to be material. The
incremental expense of providing maintenance and
10
<PAGE>
other services was not deemed to be material in the second quarter of this
fiscal year or the second quarter of the prior fiscal year.
Research and development expense for the six months ended July 31, 1998
was $5,831,000 or $1,578,000, or 37% more than that reported in the same
period of the prior fiscal year. The increase is the result of an increase
of $2,563,000 in the total gross investment in research and development
activities offset by an increase of $985,000 in the amount of research and
development expenditures capitalized under FAS 86.
The total gross investment in research and development activities for
the six months amounted to $12,883,000, or 19% of current quarter revenue,
compared to $10,320,000, or 16% of revenue in the same period of the prior
fiscal year. The total increase in the gross research and development
investment between the six month periods was $2,563,000, or 25%. This
increase resulted primarily from changes in staffing and staff mix related to
a strategic revision in product development activity. This shift in strategy
de-emphasizes a features upgrade for specific products and promotes the
development of integrated software solutions for targeted customers. The
increase was in line with the Company's goals and objectives for research and
development.
Capitalized software development costs were $7,052,000 in the six months
compared to $6,067,000 in the same period of the prior fiscal year, an
increase of $985,000, or 16%. The amount of product development capitalized
in any given period is a function of many factors including the number of
products under development at any point in time as well as their stage of
development. The Company's product development process is continually under
review to improve efficiency, product quality, and reduce time to market. Due
to the continual change in the product development process there can be no
assurance that the level of development capitalized in future periods will be
comparable to current capitalized levels.
Selling, general, and administrative expense in the six months was
$34,664,000 compared to $34,780,000 in the same period of the prior fiscal
year, a decrease of less than 1%.
Operating income, including software capitalization and amortization was
$8,704,000 in the six months compared to $8,867,000 in the same period of the
prior fiscal year, a decrease of 2%. The $163,000 decrease in operating
income is primarily attributable to the increase in research and development
expense of $1,578,000 offset by an increase in the Company's gross margin and
slight decrease in selling, general and administrative expense. Gross
margin, which is revenue less cost of revenue, increased $1,299,000 due to
the Company's increased revenue at a constant percentage of costs of revenue
to revenue.
Debenture interest reflects the interest on the convertible subordinated
debentures issued as part of the acquisition of PDA Engineering in 1994.
Interest payments are due on March 15 and September 15 of each year until the
debentures are converted or redeemed.
Other income was $579,000 in the six months ended July 31, 1998 compared
to income of $3,000 in the same period of the prior fiscal year. The
fluctuation is primarily attributable to an increase in interest and
investment income from $427,000 in the six months ended July 31, 1998 to
$977,000 in the same period of fiscal 1999 and a reduction of foreign
exchange losses from a loss of $244,000 in the six months ended July 31, 1998
to a loss of $18,000 in the same period of fiscal 1999. Other income also
includes gains and losses on sales of assets and other non-operating income.
11
<PAGE>
Net income was $4,656,000 in the six months compared to $4,384,000 in
the same period of the prior fiscal year, an increase of 6%. Net income in
the six months ended July 31, 1998 was unfavorably affected by fluctuations
in functional currencies used in the Company's international operations. The
fluctuation of the U.S. Dollar versus these currencies could continue to have
an unfavorable effect throughout fiscal 1999 and future years. The effect of
foreign currency translation on net income was an unfavorable variance of
approximately $807,000 if valued using prior year foreign currency
translation rates.
LIQUIDITY AND CAPITAL RESOURCES
Working capital needed to finance the Company's growth in the past has
been provided by cash on hand and cash flow from operations. Management
believes that cash generated from operations will continue to provide
sufficient capital for working capital needs in the foreseeable future. Net
cash from operating activities was $18,893,000 and $10,754,000 in second
quarter of fiscal 1999 and 1998, respectively. The Company's working capital
at July 31, 1998 was $51,039,000, compared to $36,998,000 at July 31, 1997.
The Company has an agreement with its principal bank for a $15,000,000
unsecured line of credit. No amounts were outstanding under this line of
credit as of July 31, 1998 or 1997.
The Company issued convertible subordinated debentures in August 1994,
in connection with its PDA acquisition, in the aggregate amount of
approximately $56,608,000. The debentures bear interest at 7 7/8% with
interest payments due semi-annually in March and September. A debenture
interest payment of $2,227,000 was made in March 1998. The amount of
interest will decrease if the debentures are converted into common stock. The
debentures mature in August 2004.
Management expects to continue to invest a substantial portion of the
Company's revenues in the research and development of new computer software
products and the enhancement of existing products. The Company expended a
total of $12,883,000 and $10,320,000 for the six months ended July 31,1999
and 1998, respectively, on research and development efforts, of which
$7,052,000 and $6,067,000, respectively, were capitalized. Product
development costs and the capitalization rate may vary depending, in part, on
the number of products and the stage of development of the products in
process.
During the six months ended July 31, 1998 and 1997, the Company acquired
$2,592,000 and $2,379,000, respectively, of new property and equipment.
Capital expenditures included upgrades in computer equipment in order to keep
current with technological advances and upgrades of facilities worldwide. The
Company's capital expenditures vary from year to year, as required by
business needs. The Company intends to continue to expand the capabilities
of its computer equipment used in the development and support of its
proprietary software products. Management expects expenditures for property
and equipment in fiscal years 1999 and 2000 to be consistent with those for
the fiscal year ended January 31, 1998.
During the quarter ended July 31, 1998, the Company repurchased 200,000
shares of common stock for $1,877,000. The Company's Board of Directors has
authorized the repurchase of common stock in the open market up to a total
aggregate amount of $3,000,000. Additionally during the quarter, the Company
issued warrants to purchase the Company's common stock in the amount of
$750,000.
12
<PAGE>
IMPACT OF YEAR 2000
The Company has initiated formal communications with all its significant
suppliers and large customers to determine the extent to which the Company's
internal applications and other interface systems are vulnerable to those
third parties' failure to remediate their own Year 2000 issues. The Company
has determined that the purchased software applications it uses and software
applications developed internally are Year 2000 compliant. However, there is
no guarantee that other systems of other companies on which the Company's
systems rely will be timely converted and would not have an adverse effect on
the Company's systems.
The Company is continuing to conduct extensive Year 2000 compliance
tests on the software that is sold to customers. All of the Company's
products licensed after January 1, 1998 are Year 2000 compliant or will have
new certified versions released on or before July 1, 1999. When this
requires an upgrade of an existing product to a later release, the supply of
that upgrade is covered under the terms of a standard Company maintenance
agreement. Certification letters for each product containing Year 2000
compliance details will be or is posted at the Company's web site at URL
Http://WWW.MACSCH.COM. The cost of this study has been immaterial.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain information in the Management's Discussion and Analysis of
Results of Operations and Financial Condition contained in this Form 10-Q
includes information that is forward looking. Such forward-looking
statements include, among others, statements concerning the Company's
international expansion, expected trends in revenue and operating expense,
capital expenditure plans, expectations regarding future liquidity, and other
statements of expectations, beliefs, future plans and strategies, anticipated
events or trends, and similar expressions concerning matters that are not
historical fact.
The forward-looking statements in this report are based on current
expectations and are subject to risks and uncertainties that could cause
actual results to differ materially from those expressed or implied by those
statements. The risks and uncertainties include but are not limited to: the
timely development and market acceptance of new versions of the Company's
software products; the impact of competitive products and pricing; the impact
of the economic issues in Asia-Pacific; successful involvement of
international and domestic business partners in creating mechanical
engineering solutions; the level of economic activity in the U.S. and abroad;
fluctuations of the U.S. dollar versus foreign currencies; timely development
of CAE technologies which, among other things, must accommodate industry
trends such as increasing computing power and increased usage of
workstations; the Company's ability to reduce costs without adversely
impacting revenues; the Company's ability to attract, motivate and retain
salespeople, programmers and other key personnel; continued demand for the
Company's products, including MSC/NASTRAN, MSC/PATRAN, MSC/ARIES,
MSC/MVISION, MSC/DYTRAN, MSC/FEA, MSC/SuperModel, MSC/FATIGUE, MSC/NVH
Manager, MSC/DropTest, MSC/CONSTRUCT, MSC/InCheck, MSC/SuperForge, MSC/AMS,
and MSC/NASTRAN FOR WINDOWS; and such other risks and uncertainties as are
described in the Company's other Securities and Exchange Commission reports
and filings.
Subsequent written and oral forward-looking statements attributable to
the Company or persons acting on its behalf are hereby expressly qualified in
their entirety by the cautionary statements in this section of this Form 10-Q.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
13
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
PART II: OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.
(c) On May 15 and June 30, 1998, in connection with completing a
marketing arrangement with Kubota Solid Technology Corporation
("KSTC"), the Company issued warrants to purchase 32,967 and 38,216
shares of the Company's common stock at $11.375 and $9.813 per share,
respectively, for a total exercise price of $750,000. The exercise
price was equal to the fair market value of the common stock on the
dates of purchase. The warrants are non-transferable, have a
five-year term and become exercisable two years after the date of
issuance. The warrants were valued using the Black Scholes valuation
method at $272,000. The transaction was a private placement involving
one offeree and one purchaser exempt from registration section 4(2)
of the Securities Act of 1933.
Item 4. Submission of Matters to a Vote of Security-Holders.
(a) On June 10, 1998, the annual meeting of the stockholders of the
Company was held for the purpose of voting on the election of
directors, class I, approval of the Company's 1998 stock option
plan and the ratification of Ernst & Young LLP as independent
auditors of the Company.
(b) The following matters were approved by the stockholders of the
Company. The following votes were cast with respect to each
proposal:
(i) Election of Directors(1):
<TABLE>
<CAPTION>
Director Votes Cast
-------- ------------------------------------
For Withheld Abstain
--- -------- -------
<S> <C> <C> <C>
Frank Perna 12,169,724 729,175 N/A
Thomas C. Curry 12,171,419 727,480 N/A
</TABLE>
(ii) Approval of the Company's 1998 Stock Option Plan:
<TABLE>
<CAPTION>
Votes Cast
-------------------------------------------------------
For Against Abstain Broken Non-Votes
--- -------- ------- ----------------
<S> <C> <C> <C>
8,303,896 1,670,644 712,674 2,211,685
</TABLE>
(iii) Ratification of Independent Auditors(1):
<TABLE>
<CAPTION>
Votes Cast
------------------------------------
For Against Abstain
--- -------- -------
<S> <C> <C>
12,732,213 145,506 21,180
</TABLE>
(1) There were no broker non-votes for these proposals.
14
<PAGE>
Item 5. Other Information
The Company hereby advises shareholders that until further notice March
16, 1999 is the date after which notice of a shareholder sponsored proposal
submitted outside the processes of Rule 14a-8 under the Securities Exchange
Act of 1934 (i.e., a proposal to be presented at the next annual meeting of
shareholders but not submitted for inclusion in the Company's proxy
statement) will be considered untimely under the SEC's proxy rules.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibit 27 - Financial Data Schedule
(b) The Company did not file any Current Reports on Form 8-K during the quarter
ended July 31, 1998.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE MACNEAL-SCHWENDLER CORPORATION
----------------------------------
(Registrant)
Date: SEPTEMBER 9, 1998
/s/ LOUIS A. GRECO
---------------------------------------
Louis A. Greco, Chief Financial Officer
(Mr. Greco is the Principal Financial
and Accounting Officer and has been
duly authorized to sign on behalf of
the registrant.)
15
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<PAGE>
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<NAME> MACNEAL SCHWENDLER CORP.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> JUL-31-1998
<CASH> 15,258
<SECURITIES> 17,717
<RECEIVABLES> 39,926
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<COMMON> 30,834
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