<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 October 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 13,710,713 shares at December 7, 1998.
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
INDEX
Page No.
--------
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets - October 31, 1998 (Unaudited)
and January 31, 1998..............................................3
Consolidated Statements of Income (Unaudited)
Three and Nine Months Ended October 31, 1998 and 1997 ............4
Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended October 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 5. Other Information..................................................14
Item 6. Exhibits and Reports on Form 8-K...................................14
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
October 31, January 31,
1998 1998
-------------------- --------------------
(Unaudited)
<S> <C> <C>
Assets
- ------
Current assets:
Cash and cash equivalents $ 14,434,000 $ 10,086,000
Securities available for sale 17,437,000 16,073,000
Trade accounts receivable, net 42,238,000 49,091,000
Deferred tax charges 3,446,000 3,446,000
Other current assets 7,929,000 7,219,000
-------------------- --------------------
Total current assets 85,484,000 85,915,000
Property and equipment, net 8,936,000 8,926,000
Capitalized software costs, net 29,344,000 28,780,000
Goodwill and other intangible assets, net 13,836,000 13,958,000
Other assets 3,040,000 2,704,000
-------------------- --------------------
$ 140,640,000 $ 140,283,000
-------------------- --------------------
-------------------- --------------------
Liabilities and Shareholders' Equity
- ------------------------------------
Current liabilities:
Accounts payable $ 1,941,000 $ 3,131,000
Accrued liabilities 22,193,000 24,470,000
Deferred income 8,282,000 10,561,000
-------------------- --------------------
Total current liabilities 32,416,000 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 October 31, 1998 or January 31, 1998 -- --
Common stock, $0.01 par value,
100,000,000 shares authorized;
13,711,000 and 13,622,000 issued and
outstanding at October 31, 1998 and
January 31, 1998, respectively, and
common stock warrants 32,166,000 31,482,000
Retained earnings 13,448,000 7,399,000
Accumulated unrealized investment gain 45,000 --
Accumulated translation adjustment (4,992,000) (4,317,000)
-------------------- --------------------
Total shareholders' equity 40,667,000 34,564,000
-------------------- --------------------
$ 140,640,000 $ 140,283,000
-------------------- --------------------
-------------------- --------------------
</TABLE>
See accompanying notes.
3
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended October 31, Nine Months Ended October 31,
------------------------------------ ----------------------------------
1998 1997 1998 1997
----------------- ---------------- ----------------- --------------
<S> <C> <C> <C> <C>
Revenues:
Software licenses $ 22,927,000 $ 24,438,000 $ 72,539,000 $ 74,524,000
Software maintenance and services 8,912,000 7,123,000 25,495,000 21,265,000
------------- ------------- ------------ -------------
Total revenues 31,839,000 31,561,000 98,034,000 95,789,000
Operating expenses:
Cost of revenue 8,204,000 7,428,000 24,064,000 22,622,000
Amortization of goodwill and other intangibles 567,000 567,000 1,701,000 1,701,000
Research and development 3,720,000 2,219,000 9,738,000 6,472,000
Selling, general and administrative 16,942,000 16,947,000 51,421,000 51,727,000
------------- ------------- ------------ -------------
Total operating expenses 29,433,000 27,161,000 86,924,000 82,522,000
Operating income 2,406,000 4,400,000 11,110,000 13,267,000
Debenture interest (1,114,000) (1,114,000) (3,342,000) (3,342,000)
Other income, net 819,000 526,000 1,398,000 529,000
------------- ------------- ------------ -------------
Income before income taxes 2,111,000 3,812,000 9,166,000 10,454,000
Provision for income taxes 718,000 1,296,000 3,117,000 3,554,000
------------- ------------- ------------ -------------
Net income $ 1,393,000 $ 2,516,000 $ 6,049,000 $ 6,900,000
------------- ------------- ------------ -------------
------------- ------------- ------------ -------------
Basic earnings per share $ 0.10 $ 0.19 $ 0.44 $ 0.51
------------- ------------- ------------ -------------
------------- ------------- ------------ -------------
Diluted earnings per share $ 0.10 $ 0.19 $ 0.44 $ 0.51
------------- ------------- ------------ -------------
------------- ------------- ------------ -------------
Basic weighted average
shares outstanding 13,653,000 13,565,000 13,646,000 13,508,000
------------- ------------- ------------ -------------
------------- ------------- ------------ -------------
Diluted weighted average
shares outstanding 17,448,000 17,509,000 17,456,000 17,367,000
------------- ------------- ------------ -------------
------------- ------------- ------------ -------------
</TABLE>
4
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
October 31
-----------------------------------------------
1998 1997
--------------------- ---------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 6,049,000 $ 6,900,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization of property and equipment 4,060,000 4,074,000
Amortization of capitalized software costs 9,698,000 9,120,000
Amortization of goodwill and other intangibles 1,701,000 1,701,000
Amortization of premiums and discounts on securities
available for sale 34,000 (74,000)
Deferred income taxes - (798,000)
(Gain) loss on disposal of property and equipment (16,000) 58,000
Changes in assets and liabilities:
Trade accounts receivable, net 6,853,000 (904,000)
Other current assets (710,000) 702,000
Accounts payable (1,190,000) (959,000)
Accrued liabilities (1,829,000) (4,704,000)
Deferred income (2,279,000) (1,233,000)
Income taxes payable (748,000) (773,000)
--------------------- ---------------------
Net cash provided by operating activities 21,623,000 13,110,000
Cash flows from investing activities:
Purchase of securities available for sale (1,903,000) (9,420,000)
Sale of securities available for sale 550,000 -
Acquisition of property and equipment (4,055,000) (2,929,000)
Purchase of software (507,000) -
Capitalized software costs (9,755,000) (9,422,000)
Increase in other assets (73,000) (96,000)
--------------------- ---------------------
Net cash used in investing activities (15,743,000) (21,867,000)
Cash flows from financing activities:
Proceeds from capital stock issued 957,000 795,000
Retirement of capital stock (2,226,000) -
Proceeds from common stock warrants issued 412,000 -
--------------------- ---------------------
Net cash provided by financing activities (857,000) 795,000
Effect of exchange rate changes on cash (675,000) (1,174,000)
--------------------- ---------------------
Net increase (decrease) in cash and cash equivalents 4,348,000 (9,136,000)
Cash and cash equivalents at beginning of period 10,086,000 24,016,000
--------------------- ---------------------
Cash and cash equivalents at end of period $ 14,434,000 $ 14,880,000
--------------------- ---------------------
--------------------- ---------------------
</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 nine months ended October 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 nine months
ended October 31, 1998 and 1997 were $4,021,000 and $4,327,000, respectively.
Additionally, the Company paid interest of $4,454,000 on its Convertible
Subordinated Debentures due 2004 during both the nine months ended October
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. On March 31,
1998, SOP 98-4, "Deferral of the Effective Date of a Provision of SOP 97-2,
Software Revenue Recognition," was issued. SOP 98-4 defers the requirement
related to SOP 97-2 associated with accounting for elements of software
license arrangements. Those provisions will be adopted by the Company upon
final ruling of this matter by the SEC.
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 nine months ended October 31, 1998 and
October 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
nine months ended October 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 nine months ended October 31,1998, total
comprehensive income amounted to $1,649,000 and $5,419,000, respectively,
compared to $2,103,000 and $5,726,000 for the three and nine months ended
October 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 nine months ended October 31, 1997 in
order to conform to the October 31, 1998 presentation.
NOTE 2: CAPITALIZED SOFTWARE
The components of net capitalized software costs were as follows:
<TABLE>
<CAPTION>
Three months Ended October 31, Nine months Ended October 31,
----------------------------- -----------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Software costs capitalized $(2,886,000) $(3,355,000) $(9,938,000) $(9,422,000)
Amortization of capitalized software 2,886,000 3,205,000 9,698,000 9,120,000
------------ ----------- ----------- ------------
Net capitalized software costs $ - $ (150,000) $ (240,000) $ (302,000)
------------ ----------- ----------- ------------
------------ ----------- ----------- ------------
</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>
October 31, January 31,
1998 1998
---- ----
<S> <C> <C>
Compensation and related expenses $6,432,000 $6,516,000
Commissions payable 2,797,000 2,752,000
Post-retirement benefits 2,700,000 2,236,000
Sales taxes payable 2,314,000 3,020,000
Contribution to profit sharing plan 1,425,000 2,784,000
Debenture interest payable 576,000 1,688,000
Royalties payable 1,011,000 929,000
Incentive compensation 329,000 230,000
Note Payable 300,000 -
Stock purchase plan 189,000 438,000
Income Taxes Payable - 748,000
Other 4,120,000 3,129,000
----------- ------------
$22,193,000 $ 24,470,000
----------- ------------
----------- ------------
</TABLE>
NOTE 4: WARRANTS
As of October 31, 1998, in connection with completing a marketing
arrangement with Kubota Solid Technology Corporation ("KSTC"), the Company
issued warrants to purchase 131,789 shares of the Company's common stock at
exercise prices which range between $6.188 per share and $11.375 per share,
for a total exercise price of $1,125,000, including 60,606 shares at an
exercise price of $6.188 per share for $375,000 during the third quarter of
fiscal 1999. In each case, the exercise price was equal to the fair market
value of the common stock on the date of issuance. 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 $1,875,000 through December 31, 1999. The
number of shares purchasable under these warrants and the exercise price will
be determined at purchase date based on the then fair value of the warrants
and underlying common stock, respectively.
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
THREE MONTHS ENDED OCTOBER 31, 1998 VS. THREE MONTHS ENDED OCTOBER 31, 1997
The Company reported revenue of $31,839,000 for the third quarter,
compared to revenue of $31,561,000 for the third quarter of the prior fiscal
year. Revenue growth in the current year would have been approximately
$594,000 higher, or 2%, if valued using prior year foreign currency
translation rates. Software license revenue and maintenance fees account for
90% of total reported revenue in the third quarter and 94% in the third
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. On March 31, 1998, SOP 98-4, "Deferral of the
Effective Date of a Provision of SOP 97-2, Software Revenue Recognition,"
was issued. SOP 98-4 defers the requirement related to SOP 97-2 associated
with accounting for elements of software license arrangements. Those
provisions will be adopted by the Company upon final ruling of this matter by
the SEC.
The Company operates in three world areas: Europe, Asia Pacific and The
Americas. Europe accounted for 29% of the Company's total revenue and grew
by 4% in functional currency compared to the third quarter of the prior
fiscal year. The Asia-Pacific region, which accounted for 17% of the
Company's total revenue, decreased by 21% in functional currency compared to
the third quarter 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 4% of the Company's total revenue comes
from outside Japan in the Asia-Pacific region. The Americas, which accounted
for 54% of the Company's total revenue, reported a 12% increase in revenue in
the third quarter compared to the third quarter of the prior year. The
increase 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 $29,433,000 in the third quarter increased by
approximately 8% from the $27,161,000 reported in the third quarter of the
prior fiscal year. The increase was primarily attributable to an increase of
$1,501,000 in the net cost of research and development and $776,000 in cost
of revenues. The Company's total development cost before software
capitalization was 21% of revenue for the quarter. Total development
expenditures were the same as the second quarter of fiscal 1999. At current
spending rates, total annual development cost are expected to be below
management's target of 20% of total annual 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 third quarter, cost of revenue was $8,204,000 or 26% of revenues
compared to $7,428,000 or 24% of revenues in the third quarter of the prior
fiscal year, an increase of $776,000, or 10%. This increase included $523,000
of increased consulting costs, $210,000 of increased training costs, $207,000
of increased royalty expense, and $143,000 of increased commissions to third
parties, offset by a decrease of $319,000 in the amortization of capitalized
software. Capitalized software amortization decreased to $2,886,000 in the
third quarter from $3,205,000 in the third quarter of the prior fiscal year.
The decrease in capitalized software amortization is predominantly due to the
fact that previously capitalized costs became fully amortized during the
current fiscal year but prior to the current quarter. Royalty expense
included in cost of revenue is 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 third
quarter of this fiscal year or the third 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 third quarter of
$3,720,000 was $1,501,000, or 68%, more than that reported in the third
quarter of the prior fiscal year. The increase is the result of an increase
of $1,032,000 in the total gross research and development investment and a
decrease of $469,000 in the amount of research and development expenditures
capitalized under FAS 86.
The total gross investment in research and development activities in the
third quarter amounted to $6,606,000, or 21% of current quarter revenue,
compared to $5,574,000, or 18% of revenue in the third quarter of the prior
fiscal year. The increase in the gross research and development investment
between the third quarter of the current and prior fiscal year is consistent
with prior year to current year quarterly increases in the first and second
quarters of fiscal 1999. These increases are primarily due to 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 industries.
Capitalized software development costs were $2,886,000 in the third
quarter compared to $3,355,000 in the third quarter of the prior fiscal year.
The decrease in the amount of research and development expenditures
capitalized of 14% is predominantly due to the spending curve of the current
version of MSC/PATRAN. This release was one of the most comprehensive
upgrades of that product and costs were incurred more ratably over the
development cycle. 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 third quarter was
$16,942,000 compared to $16,947,000 in the third quarter of the prior fiscal
year, a decrease of less than 1%.
Operating income declined $1,994,000, to $2,406,000 in the third quarter
compared to $4,400,000 in the third quarter of the prior fiscal year, a
decrease of 45%. This decrease reflects both an increase in cost of revenues
of 2% as a percentage of revenue and 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 $293,000 to $819,000 in the third quarter from
$526,000 in the third quarter of the prior fiscal year. The fluctuation is
primarily attributable to an increase in foreign exchange gains and
investment income. The foreign exchange gain rose from a gain of $360,000 in
the third quarter of fiscal 1998 to a gain of $542,000 in the third quarter
of fiscal 1999. Interest and investment income rose from $214,000 in the
third quarter of fiscal 1998 to $325,000 in the third quarter of fiscal 1999.
Other income also includes gains and losses on sales of assets and other
non-operating income.
Net income was $1,393,000 in the third quarter compared to $2,516,000 in
the third quarter of the prior fiscal year, a decrease of 45% which is equal
to the decline in operating income described above. Unlike the first and
second quarters of fiscal 1999, net income in the third quarter was not
affected by fluctuations in functional currencies used in the Company's
international operations.
On September 9, 1998, the Company acquired Silverado Software &
Consulting, Inc., ("SSC") for approximately $2,809,000 through the issuance
of the Company's common stock valued at $1,542,000, or $6.9375 per share, a
promissory note of $331,000 and cash of $936,000. SSC is a provider of
engineering services and custom software solutions for the design and
analysis of mechanical components, electronic packaging, and civil
structures. The acquisition has been accounted for as a purchase and,
accordingly, the operating results of SSC have been included in the Company's
consolidated financial statements since the date of acquisition. The excess
of the aggregate purchase price over the fair market value of net assets
acquired was approximately $1,572,000. Net assets acquired included cash and
securities available for sale of approximately
9
<PAGE>
$945,000. There was no net cash outlay for the SSC acquisition because the
cash and securities available for sale received in the purchase approximated
the cash paid.
NINE MONTHS ENDED OCTOBER 31, 1998 VS. NINE MONTHS ENDED OCTOBER 31, 1997
The Company reported revenue of $98,034,000 for the nine months ended
October 31, 1998, compared to revenue of $95,789,000 for the same period of
the prior fiscal year, a 2% increase. Revenue growth in the current year
would have been approximately $5,218,000, or 5%, if valued using prior year
foreign currency translation rates. Software license revenue and maintenance
fees account for 91% of total reported revenue for the nine months ended
October 31, 1998 and 94% 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 33% of the Company's total revenue, grew by 19%
in functional currency compared to the same period of the prior fiscal year.
The Asia-Pacific region, which accounted for 23% of the Company's total
revenue, decreased by 6% 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 4% of the Company's total revenue comes from
outside Japan in the Asia-Pacific region. The Americas, which accounted for
44% of the Company's total revenue, reported a 3% increase for the nine
months ended October 31, 1998. The increase 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 $86,924,000 in the nine months increased by
approximately 5% from the $82,522,000 reported in the same period of the
prior fiscal year. The increase was attributable to an increase of $3,266,000
in the net cost of research and development and an increase of $1,442,000 in
cost of revenue. Cost of revenue as a percent of revenue was 25% and 24% for
the nine-month periods ending October 31, 1998 and 1997, respectively. The
Company's total development cost before software capitalization was 20% of
revenue for the nine months ended October 31, 1998 which remains consistent
with management's target of 20% of total annual revenues. At current
spending rates, total annual development cost should be below management's
target of 20% of total annual 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 capitalized.
Cost of revenue was $24,064,000 for the nine months-ended October
31,1998 compared to $22,622,000 for the same period of the prior fiscal year,
an increase of $1,442,000, or 6%. This increase included $578,000 of
additional amortization of capitalized software and a $864,000 increase in
other costs of revenue. Capitalized software amortization increased to
$9,698,000 in the nine months ended October 31, 1998 from $9,120,000 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. 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 third quarter of this fiscal year or the third
quarter of the prior fiscal year.
10
<PAGE>
Research and development expense for the nine months ended October 31,
1998 was $9,738,000 or $3,266,000 more than that reported in the same period
of the prior fiscal year. The increase is the result of an increase of
$3,782,000 in the total gross investment in research and development
activities offset by an increase of $516,000 in the amount of research and
development expenditures capitalized under FAS 86.
The total gross investment in research and development activities for
the nine months amounted to $19,676,000, or 20% of current year revenue,
compared to $15,894,000, or 17% of revenue in the same period of the prior
fiscal year. The total increase in the gross research and development
investment between the nine-month periods was $3,782,000, or 24%. This
increase resulted primarily from changes within the Company's product
management 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. Additionally, the
Company increased its research costs related to the development and
enhancement of MSC/NASTRAN and MSC/PATRAN, the Company's two core products.
The increase was in line with the Company's goals and objectives for research
and development.
Capitalized software development costs were $9,938,000 in the nine
months compared to $9,422,000 in the same period of the prior fiscal year, an
increase of $516,000, or 5%. 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 nine months was
$51,421,000 compared to $51,727,000 in the same period of the prior fiscal
year, a decrease of less than 1%.
Operating income, including software capitalization and amortization was
$11,110,000 in the nine months compared to $13,267,000 in the same period of
the prior fiscal year, a decrease of 16%. The $2,157,000 decrease in
operating income is primarily attributable to the increase in research and
development expense of $3,266,000 offset by an increase in the Company's
gross margin and a slight decrease in selling, general and administrative
expense. Gross margin, which is revenue less cost of revenue, increased
$803,000 due to the Company's increased revenue with only a one-percent
increase in its costs of 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 $1,398,000 in the nine months ended October 31, 1998
compared to income of $529,000 in the same period of the prior fiscal year.
The fluctuation is primarily attributable to an increase in interest and
investment income from $649,000 in the nine months ended October 31, 1998 to
$1,367,000 in the same period of fiscal 1999 and an increase in foreign
exchange gains from a gain of $116,000 in the nine months ended October 31,
1997 to a gain of $271,000 in the same period of fiscal 1999. Other income
also includes gains and losses on sales of assets and other non-operating
income.
Net income was $6,049,000 in the nine months compared to $6,900,000 in
the same period of the prior fiscal year, a decrease of 12%. The decline in
net income was less than the operating income decline due to a doubling of
the Company's other income for the nine-month period. Net income in the nine
months ended October 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 $770,000 if valued using prior year foreign currency
translation rates.
11
<PAGE>
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 normal working capital needs in the foreseeable
future. Net cash provided by operating activities was $21,623,000 and
$13,110,000 for the nine months ended October 31,1998 and 1997, respectively.
The Company's working capital at October 31, 1998 was $53,068,000, compared
to $41,258,000 at October 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 October 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. Debenture
interest payments were made in both March 1998 and September 1998 totaling
$4,454,000. 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 $19,676,000 and $15,894,000 for the nine months ended October
31,1998 and 1997, respectively, on research and development efforts, of which
$9,938,000 and $9,422,000, 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 nine months ended October 31, 1998 and 1997, the Company
acquired $4,055,000 and $2,929,000, 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 October 31, 1998, the Company repurchased
49,884 shares of common stock for approximately $350,000. 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. The Company has
repurchased approximately $2,226,000 of common stock in the nine-month period
ended October 31, 1998. Through October 31, 1998, the Company issued
warrants for $1,125,000 to purchase the Company's common stock, including
$375,000 during the third quarter of fiscal 1999. There was no net cash
outlay for the SSC acquisition because the cash and securities available for
sale received in the purchase approximated the cash paid.
12
<PAGE>
FACTORS THAT MAY AFFECT FUTURE RESULTS:
The historical results of operations and financial position of the Company
are not necessarily indicative of future financial performance. The Company's
results and forward-looking statements are subject to certain risks and
uncertainties, including but not limited to those discussed below that could
cause future results to differ materially from those projected.
Revenue Growth:
The Company derives most of its revenue from selling
software products and services to the high end users of the product design
markets. Revenue growth and the Company's ability to match spending levels
with revenue growth rates will directly impact its future operating results.
Historically, a significant portion of the Company's revenue is generated
from shipments in the last month of a quarter. In addition, higher volumes
of orders have been experienced in the fourth quarter. The concentration of
orders makes projections of quarterly financial results difficult. In
addition, over 50% of the Company's revenues are derived from international
markets and are denominated in foreign currencies. As a result, the Company's
financial results could be impacted by weakened general economic conditions
in various parts of the world, differing technological advances or
preferences, volatile foreign exchange rates and government trade
restrictions in any country in which the Company does business.
New accounting rules regarding the recognition of software revenues
based on vendor specific objective evidence (VSOE) have not been finalized.
Therefore the Company is not able to estimate the impact to its operating
results from any changes that may be required to its current methodology
relating to the deferral of revenue for post-sales customer support (PCS).
Expense Management:
The Company's operating expense levels are planned, in part, on expected
revenue growth. The Company's expense levels are generally committed in
advance and, in the near term, relatively small portions of the Company's
expenses vary with revenue. Accordingly, future operating results will be
impacted by the Company's ability to convert operating outlays into expected
revenue growth at profitable margins. If future revenues are less than
expected, net income may be disproportionately affected since expenses are
relatively fixed.
Competition:
The software industry is highly competitive. The entire industry may
experience pricing and margin pressure which could adversely affect the
Company's operating results and financial position. The Company's success is
dependent on its ability to continue to develop, enhance and market new
products to meet its customers' sophisticated needs within competitive
pricing structures and in a timely manner. As product development cycles
become shorter, product quality, performance, reliability, ease of use,
functionality, breadth and integration may be impacted. The Company's
success also depends in part on its ability to attract and retain technical
and other key employees who are in great demand, to protect the intellectual
property rights of its products and to continue key relationships with
product development partners.
Year 2000:
The Year 2000 causes uncertainties about whether computer systems and
other equipment with date sensitive hardware or software will appropriately
recognize and process dates beyond 1999. The failure of software programs,
computer hardware and equipment in this regard could result in business
interruptions and adversely affect the Company's operating results. The
Company's major exposures to date-related failures include failure of
software used internally by the Company and product liability for the
software programs that it sells to customers. The Company has taken measures
to address its exposure to these potential date-related failures.
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 and internally
developed software applications that are used 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. With respect to
contingency plans, the Company has not developed contingency plans at this
time to handle significant failures. The Company will address contingency
planning in 1999 for the most reasonably likely worst case scenarios.
During the third quarter and continuing into the fourth quarter, the
Company has made significant progress in its' Year 2000 compliance testing on
the software that is sold to customers. The tests will certify that all our
currently supported products will operate and correctly process dates over a
supported date range which extends from before January 1, 2000 and
encompasses a time period reasonably suitable for the intended use of the
product. 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. The total cost of any modifications necessary to achieve
compliance is not expected to be material to operating results. When this
requires an upgrade of an existing product to a later release, the supply of
that upgrade is covered under the terms of the Company's standard maintenance
agreement. The Company's policy, in accordance with Generally Accepted
Accounting Procedures, is to expense as incurred the cost of maintenance and
modification to existing systems, and to capitalize the cost of any new
software or hardware and amortize that cost over the assets' estimated useful
lives. Compliance letters for each product containing Year 2000 compliance
details is posted at the Company's web site at URL HTTP://WWW.MACSCH.COM.
The cost of this study has been immaterial.
Euro Conversion:
On January 1, 1999, eleven of the fifteen member countries of the
European Union (the "participating countries") are scheduled to establish
fixed conversion rates between their existing sovereign currencies (the
"legacy currencies") and the Euro currency, adopting the Euro as their common
legal currency on that date. The legacy currencies are scheduled to remain
legal tender in the participating countries as denominations of the Euro
between January 1, 1999 and January 1, 2002. During this transition period,
public and private parties may pay for goods and services using either the
Euro or the participating country's legacy currency on a "no compulsion, no
prohibition" basis whereby recipients must accept Euros or the legacy
currency as offered by the payer. A currency translation process known as
triangulation will dictate how legacy currencies will be converted to the
Euro and other legacy currencies. Beginning January 1, 2002, the
participating countries will issue new Euro-denominated bills and coins and
replace the legacy currencies as legal tender in cash transactions by July 1,
2002.
Because the Company conducts a significant portion of its business in
Europe through its wholly owned German subsidiary, its business and
operations will be effected by the Euro conversion. Management is addressing
the Euro conversion, but its impact on future operating results is uncertain.
Management expects the conversion to decrease pressure for pricing in legacy
currencies in the participating countries. However, the Company also does
business in many non-participating countries including the United Kingdom.
This could lead to increased cross-border competition, which could effect its
allocation of resources within Europe, and eventually the Company's labor
cost.
The Company is implementing an upgrade to its management information
system which includes the ability to simultaneously record transactions in
Euros, perform the prescribed currency conversion computations and convert
legacy currency amounts to Euro. The impact of the conversion on the
Company's currency risk and taxable income is not expected to be significant.
In regard to contracts denominated in legacy currencies, management has not
identified any third party or customer contracts whose performance might be
considered unenforceable due to a currency substitution. Software lease and
maintenance contracts are typically renewed on an annual basis. Management
will continue to monitor for significant contracts, which may be void due to
the conversion.
Stock Market Volatility:
The trading price of the Company's stock, like other software and
technology stocks, is subject to significant volatility. If revenues or
earnings fail to meet securities analyst's expectations, there could be an
immediate and significant adverse impact on the trading price of the
Company's stock. In addition, the Company's stock price may be affected by
broader market factors that may be unrelated to the Company's performance.
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 September 30, 1998, in connection with completing a marketing
arrangement with Kubota Solid Technology Corporation ("KSTC"), the
Company issued warrants to purchase 60,606 shares of the Company's
common stock at $6.188 per share for an exercise price of $375,000. 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
$140,000. 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 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.
3.1 Certificate of Designations of Junior Participating Preferred Stock,
filed as Exhibit 2.2 to the Company's Registration Statement on Form 8-A
filed October 13, 1998 and incorporated herein by this reference.
4.1 Rights Agreement dated as of October 5, 1998 between The MacNeal-
Schwendler Corporation and ChaseMellon Shareholder Services, L.L.C., as
Rights Agent, including the Form of Right Certificate (Exhibit A), the
Summary of Rights to Purchase Junior Participating Preferred Stock
(Exhibit B) and the Form of Certificate of Designations of Junior
Participating Preferred Stock (Exhibit C), filed as Exhibit 2.1 to the
Company's Registration Statement on Form 8-A filed October 13, 1998 and
incorporated herein by this reference.
(a) Exhibit 27 - Financial Data Schedule
(b) Current Report on Form 8-K, event date October 5, 1998 (items 5 and 7).
14
<PAGE>
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: December 14, 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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