MACNEAL SCHWENDLER CORP, 10-K405, 1998-04-30

MACNEAL SCHWENDLER CORP
10-K405, 1998-04-30
PREPACKAGED SOFTWARE

Previous: LORD ABBETT MID CAP VALUE FUND INC, 485BPOS, 1998-04-30

Next: MACNEAL SCHWENDLER CORP, DEF 14A, 1998-04-30

<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED JANUARY 31, 1998
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 Identification No.)
incorporation or organization)

815 COLORADO BOULEVARD, 90041
LOS ANGELES, CALIFORNIA (Zip Code)
(Address of principal executive offices)

Registrant's telephone number including area code: (213) 258-9111
------------------------

Securities registered pursuant to Section 12(b) of the Act:

NAME OF EACH EXCHANGE ON WHICH
TITLE OF EACH CLASS REGISTERED
---------------------------------------- ----------------------------

Common Stock par value $.01 per share New York Stock Exchange
7 7/8% Convertible Subordinated
Debentures due August 18, 2004 New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: NONE

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 / /

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

As of April 16, 1998 the approximate aggregate market value of The
MacNeal-Schwendler Corporation's voting stock held by nonaffiliates was
$150,351,000.

As of April 16, 1998 there were outstanding 13,668,256 shares of Common
Stock of The MacNeal-Schwendler Corporation.

Documents incorporated by reference: The Annual Proxy Statement of The
MacNeal-Schwendler Corporation for the Annual Meeting of Shareholders to be held
on June 10, 1998 is incorporated by reference into Part III.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
FORM 10K
TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Business.............................................................. 2

Properties............................................................ 10

Legal Proceedings..................................................... 10

Submission of Matters to a Vote of Security Holders................... 10

Market for Registrant's Common Equity and Related Shareholder
Matters............................................................. 11

Selected Financial Data............................................... 11

Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................... 12

Financial Statements and Supplementary Data........................... 18

Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure................................................ 38

Exhibits, Financial Statement Schedules and Reports on Form 8-K....... 38
</TABLE>
<PAGE>
PART I

ITEM 1. BUSINESS.

The MacNeal-Schwendler Corporation ("MSC" or the "Company") was incorporated
in Delaware in 1994. Since its inception in 1963, the Company has been engaged
in computer-aided engineering ("CAE"), including the development and marketing
of software for use principally by engineers and designers in industry, research
laboratories and universities. In the last two years, the Company has expanded
its scope to focus on providing engineering solutions through strategic
consulting, software integration, and customization services in addition to
engineering software sales. The Company's principal software products are
MSC/NASTRAN and MSC/PATRAN. Each product has been adapted over the years so that
it is compatible with most of the computer hardware platforms currently used by
engineers.

In the current computer-aided manufacturing ("CAM") environment, designs are
subjected to engineering analysis before manufacturing has begun. MSC/NASTRAN is
a basic CAE analytical tool. MSC/PATRAN is an interactive CAE environment that
facilitates the use of geometric data from popular computer-aided design ("CAD")
systems such as CATIA, Pro/ENGINEER, and EDS/Unigraphics in a variety of
commercial analysis programs including MSC/NASTRAN. The use of CAE analysis
helps to get products to market faster, reduce product cost, and increase
reliability. CAE analysis can be used to simulate the performance of a design
prior to its physical manufacture, replacing time-consuming and costly manual
analyses and physical testing and permits a substantial increase in the number
of design trade-offs and design cycles. The Company's CAE tools are used by
engineers worldwide in several industries, including aerospace, automotive,
shipbuilding, consumer products and electronic packaging.

MSC/NASTRAN, is a descendant of NASTRAN-Registered Trademark-, a computer
program owned by the United States Government and leased to others. Since
NASTRAN was first released in 1970, its contents and MSC/NASTRAN have rapidly
diverged, and the current capabilities and scope of MSC/NASTRAN are
substantially greater than those of NASTRAN. MSC commenced offering its
proprietary version as a commercial product in 1971. Pursuant to a 1982
agreement with the National Aeronautics and Space Administration, MSC acquired
the perpetual rights to commercially use those elements of NASTRAN which are
embodied in MSC/NASTRAN. See "Intellectual Property Rights" below.

MSC offers the following CAE products in addition to MSC/NASTRAN and
MSC/PATRAN:

MSC/DYTRAN--a tool used to solve highly nonlinear, transient dynamic
problems, including those involving high speed impact, and
fluid-structure interaction problems.

MSC/SuperForge--a tool for the simulation of complex forging operations.

MSC/SuperModel--provides automatic assembly of airframe and launch
vehicle models.

MSC/MVISION--a materials data management system for test, design and
analysis engineers.

MSC/NASTRAN for Windows--an integrated finite element modeling and
analysis system for Windows NT, Windows 95, and Windows 3.1.

MSC/InCheck--a series of software tools to be used in conjunction with
"mid-range" CAD tools such as Autodesk Mechanical Desktop, Solidworks
and Solid Edge. It is a Wizard-driven product.

As an extension of its software business, the Company develops educational
tools designed to train users of MSC/NASTRAN, MSC/PATRAN and its other products.
Training seminars are conducted in local languages on a frequent basis at the
MSC Institute of Technology in Costa Mesa, California, at the Company's Los
Angeles headquarters, at MSC's offices worldwide, and at actual client sites. In
addition,

2
<PAGE>
the Company now provides a broad range of engineering software consulting
services. A typical assignment might include all or some of the following
activities:

- design/analysis process audits, wherein we will contract to examine the
current practice in a customer's operation and, based on our worldwide
experience in similar operations, benchmark that process against the
industry

- process reengineering planning, wherein we will contract to define an
improved process state and provide a roadmap of changes to be made to
achieve that improved state

- reengineering implementation, wherein we will contract to make the
recommended changes, often introducing new software tools and analysis
techniques. The tools may be our own or those of other third parties.
Often process change includes integration with the customer's Product Data
Management (PDM) system and possibly the Enterprise Resource Management
(ERM) system

- software customization, wherein we will contract to modify our software
products to capture particular features of the client's process or
methodology

- proprietary software commercialization, wherein we will contract to
commercialize proprietary software programs to reduce the client's support
costs, increase the sources of input for technological advance and/or
increase access to the software for the client's supply chain

The following is a detailed discussion of each of the Company's major CAE
products:

MSC/NASTRAN

MSC/NASTRAN is based upon the "finite element method" (FEM) of analysis.
With FEM, complex structures are divided into small elements which form a finite
element model. The model is then subjected to computer analysis. MSC/NASTRAN is
used to analyze structures in order to determine, among other things, their
strength, safety and performance characteristics. For example, in the aerospace
industry, MSC/NASTRAN is employed to determine the stress distribution in the
major parts of an aircraft, such as engines, wings, fuselage and tail. The
computer analysis could be applied, for example, to improve the design of
aircraft by suggesting the removal of material where stresses are low and the
addition of material where stresses are high, while creating a reduced usage of
prototypes and other testing. With this knowledge, aircraft can be made both
stronger and lighter. The same principles have been applied to improve the
design of jets, rockets, engines, automobiles, trucks, tires, ships, farm
equipment, heavy industrial equipment, nuclear containment vessels, helicopters,
spacecraft and other products and structures.

Additional types of structural analysis are also provided by MSC/NASTRAN,
including analyses of vibration characteristics, dynamic response, transient
heat transfer, elastic stability and aeroelastic response, including flutter.
The sequence of calculations required for each such analysis is prearranged. The
user need only provide a physical description of the problem and the desired
output.

Because MSC/NASTRAN has been designed in a modular way, new features can be
added and obsolete features replaced without disrupting the other modules of the
system. As a result, major changes in computer hardware have been systematically
accommodated. For example, the program has been adapted to be used on
minicomputers and microcomputers, including Windows based personal computers.
The Company believes that the continued development and maintenance of
MSC/NASTRAN, together with the modular design features of the program, have
prevented, and will continue to prevent, its obsolescence, although no assurance
can be given that future changes in hardware or breakthroughs in software design
will not result in the obsolescence of the program.

MSC/NASTRAN is currently operational on a wide variety of computer operating
system/hardware platform combinations, including those manufactured and
distributed by International Business Machines Corporation ("IBM"), Digital
Equipment Corporation ("DEC"), Hewlett-Packard Corporation ("HP"),

3
<PAGE>
Hitachi Data Systems, Nippon Electric Corporation ("NEC"), Silicon Graphics Inc.
("SGI"), Fujitsu Ltd., Siemens GmbH, and Sun Microsystems Inc. ("SUN").

MSC/PATRAN

MSC/PATRAN provides finite element modeling, analysis data integration,
analysis simulation, and results evaluation capabilities required for analysts
to simulate product performance early in the design-for-manufacture process.
With MSC/PATRAN, an engineer is able to visualize the design, interface with
other CAD programs, perform pre-processing to prepare the computer model for
engineering analysis, and perform post processing of the results of the analysis
to assist in interpretation and visualization of the results, as well as
integration of analysis data with testing software packages. All of the
functions of the software can be integrated, automated and tailored to the
user's specific requirements using a powerful programming command language.

The MSC/PATRAN system can be described as software that provides three
fundamental functions:

MSC/PATRAN CORE SOFTWARE--The core of the MSC/PATRAN software enables
the engineer to visualize the design, preprocess the design into a
computer model for engineering analysis, and postprocess the results of
the analysis into a graphical representation. The software interfaces
with many popular CAD programs and many analysis packages such as
MSC/NASTRAN.

APPLICATION MODULES--Through a series of modules that can be added to
the core software, engineers can perform analysis on stress, thermal
mechanisms and dynamics, fluid flow, solid modeling, and fatigue.
Certain of these application modules have been developed by third
parties and are marketed under joint development or marketing
agreements.

INTERFACES--MSC/PATRAN uses a series of interfaces that allow it to
interact with programs developed by other companies in the CAD/CAM/CAE
industry. These interfaces either involve direct links into other
software or translate data to and from other software so that it can be
processed within MSC/PATRAN.

Currently, the Company focuses its development activities with respect
to MSC/PATRAN on hardware platforms from HP, SUN, SGI, IBM, DEC, and
PC's based on Intel processors.

MSC/DYTRAN

MSC/DYTRAN is designed to analyze transient, dynamic events characterized by
large structural distortions or the interaction of fluids with structures. Using
MSC/DYTRAN, engineers can solve many practical problems, including automotive
crash simulations, vehicle occupant safety studies, aircraft crash-worthiness
studies, forging studies and drop-test simulations.

MSC/DYTRAN is also suitable for analyzing highly nonlinear and complex
processes such as the ingestion of objects into jet engines, hypervelocity
particle impacts upon spacecraft, the deployment of airbags in vehicle crashes,
accident containment during the transportation of hazardous cargo, and ballistic
armament penetration. With MSC/DYTRAN, engineers in a broad range of industries
can conduct "what if" studies involving the dynamic response and interaction of
fluids and structures subjected to high velocity impact. Events characterized by
rapid energy releases, such as explosions, can also be simulated. MSC/DYTRAN has
been used to successfully simulate phenomena as diverse as ship collisions, the
seismic response of structures to earthquakes, the performance of munitions and
armor, the safety tolerances of nuclear and chemical plant components, and
automobile crashes.

4
<PAGE>
MSC/MVISION

MSC/MVISION is a materials software system for visualization, selection and
data integration which helps companies take advantage of state-of-the-art
materials technology throughout the design-to-manufacture process. MSC/MVISION
electronically integrates data across engineering boundaries. It allows users to
build their own proprietary materials database and provides access to that data
across all engineering disciplines. It provides users with the ability to
search, query, compare and manipulate materials data as well as with direct
access to these databanks from within MSC/PATRAN. MSC/ MVISION is being adopted
to the client-server hardware environment and is the technical basis for the
Company's other engineering data management capabilities.

MSC/SUPERMODEL

MSC/SuperModel is an analysis process management and advanced aerospace
modeling solution that dramatically reduces the time required for design
simulation. Aerospace structures are designed, analyzed, and manufactured by
multiple companies, with each being responsible for a given component, such as a
wing or fuselage. These companies are also responsible for their component's
finite element model, which predicts stress and deflection. MSC/SuperModel
assembles a number of component models (submodels) into a complete model
(supermodel.) MSC/SuperModel automates the task of managing the component and
assembly processes, tasks to which aerospace companies previously devoted
significant time and effort.

RESEARCH AND DEVELOPMENT

The Company continually expends significant amounts on the development and
maintenance of its suite of CAE software products, as well as on new product
research and development. During the years ended January 31, 1998, 1997, and
1996, approximately $25,194,000, $30,425,000, and $30,752,000, respectively, was
expended for software research and development. Of the amounts expended,
$12,909,000 in 1998, $9,025,000 in 1997, and $10,447,000 in 1996 were included
in software costs capitalized.

The Company's development activities have historically involved adding new
capabilities to its family of CAE programs or converting those programs for use
on new computer platforms. Such activities are intended to prevent technological
obsolescence and assure the Company's clients the maximum flexibility in
selecting computer hardware. A decision to undertake development activity to
adapt MSC's software program for a particular computer is based upon the
Company's estimates regarding feasibility, cost and the size of the market for
the program in connection with the particular computer.

Maintenance of MSC software products includes system integration, quality
assurance testing, error correction, and modifications to accommodate changes to
computer system software. Given the maturity of the Company's software, most
maintenance efforts stem from continuing new developments. Maintenance costs are
expensed as incurred.

The Company has recently increased the portion of research and development
expenditure which is used for new product development and expects to continue
this trend. The Company now provides industry specific modules such as an
Automotive Modeling System and a Noise, Vibration and Harshness Manager for the
automobile industry.

MARKETING

The Company markets its products through advertising in trade publications,
participation in industry trade shows and exhibits, training seminars conducted
worldwide, its existing client base and through complementary marketing
agreements with computer hardware manufacturers.

5
<PAGE>
Foreign marketing is generally conducted in the same manner as U.S.
marketing. The basic licensing agreements are substantially the same. Prices for
agreements originating with MSC's German subsidiary are generally stated in
German Marks and agreements originating within Japan are generally stated in
Japanese Yen. Agreements with customers in Asia-Pacific outside of Japan are
denominated in US dollars. The agreements stated in foreign currencies are
subject to currency fluctuations.

REVENUE POLICY. The Company provides a variety of licensing alternatives
for the use of its software products. MSC's software products have been
primarily offered on an annual pre-paid license basis. An annual pre-paid
license is set at a fixed rate for the period and provides for payment in
advance of use. Under the pre-paid agreement, license revenue is recognized at
the time of sale, while maintenance revenue, representing approximately 15% of
the revenue from a pre-paid license, is recognized ratably over the term of the
maintenance period. In recent years, demand has also increased for paid up
licenses for engineering software products. A paid up license provides
significant revenue at the original time of sale of the product, with smaller
payments for maintenance following the time of sale. The growth of paid up
licenses creates higher earnings volatility since larger amounts of revenue are
recognized at one time instead of over a period of time. Service revenue was
less than 8% of revenue in fiscal 1998. See Note 1 of Notes to Consolidated
Financial Statements for additional information with respect to the Company's
revenue recognition policy.

SALES/SUPPORT OFFICES. The Company maintains U.S. sales and client support
offices in Los Angeles, CA; Costa Mesa, CA; Santa Clara, CA; Sacramento, CA;
Denver, CO; Dallas, TX; Atlanta, GA; Minneapolis, MN; Milwaukee, WI; Huntsville,
AL; Reston, VA; Dayton, OH; Sparta, NJ; Boca Raton, FL; Chicago, IL; Detroit,
MI; Philadelphia, PA; Boston, MA; New York, NY; Indianapolis, IN; Rochester, NY;
Phoenix, AZ; and Seattle, WA areas. The Los Angeles office also serves as the
Company's headquarters. The other offices are staffed by sales and/or technical
support representatives who have engineering backgrounds and experience using
MSC products. These representatives market the Company's products, provide
training in their use, respond to user support calls and provide solutions for
CAE analysis throughout North America.

The Company's products are marketed, distributed and supported outside of
North America through a network of foreign subsidiary offices.

The Company's wholly-owned European subsidiary headquartered in Munich,
Germany, manages its own network of wholly-owned subsidiaries in the United
Kingdom, Italy, Spain, France, Norway, and The Netherlands. Other sales offices
are located in Moscow, Russia, Fribourg, Switzerland and Brno, Czech Republic.
In Asia Pacific, sales and service are handled through the Company's
wholly-owned subsidiary in Tokyo, Japan, with a branch office in Osaka, Japan,
as well as other sales offices in Taipei, Taiwan and Beijing, People's Republic
of China.

Representative arrangements are also utilized in several European and Asia
Pacific countries as well as in India, Australia, and parts of Latin America.

POST CONTRACT SUPPORT. Client service is an integral aspect of the
Company's marketing program. The Company maintains toll-free numbers and a "hot
line" service for its clients. The Company has invested in advanced "call
center" technology to improve its capabilities.

User manuals, training and quality assurance are also essential to the
Company's marketing program. The Company's user manuals are comprehensive and
updated on a regular basis. A staff of writers and editors manage the design,
writing, editing and preparation of user manuals as well as of training
materials and promotional literature. A periodic newsletter provides clients
with new information on the Company's products and services.

6
<PAGE>
Formal training for clients is conducted by the Company, ranging from
three-day introductory courses to intensive courses on specialized subjects for
experienced users. On site courses for clients are provided for larger user
organizations.

The Company also hosts annual users' conferences in the United States,
Europe, Asia Pacific, Australia, and Latin America to gather data on client
needs, new engineering applications, and new trends in computing technology.

CUSTOMERS

The Company's products are marketed internationally to clients from
aerospace, automotive, industrial, computer and electronics manufacturers, and
universities. These categories of clients accounted for 39%, 26%, 28%, 4%, and
3%, respectively, of the Company's revenues for the fiscal year ended January
31, 1998.

For the year ended January 31, 1998, foreign export sales accounted for
approximately 56% of gross revenues, most of which were attributable to Europe
(28%) and Asia-Pacific (26%). The balance was attributable to Canada and South
America. The operating margins derived from the Company's foreign export sales
do not materially differ from its domestic operations. See Notes 8 and 10 of
Notes to Consolidated Financial Statements for additional information with
respect to the Company's foreign operations.

No customer of the Company accounts for more than 10% of the Company's
consolidated revenues.

BACKLOG

The Company does not maintain backlog statistics for its products because
software is generally available for delivery upon execution of a licensing
agreement or contract. Backlog for consulting services work is currently not
material.

INTELLECTUAL PROPERTY RIGHTS

MSC, MSC/, MSC/ARIES, MSC/PATRAN, MSC/MVISION, MSC/DYTRAN are registered
trademarks of the Company. NASTRAN is a registered trademark of NASA.
MSC/NASTRAN is an enhanced proprietary version of NASTRAN.

MSC/NASTRAN, MSC/NASTRAN for Windows, MSC/SuperModel, MSC/InCheck, MSC/
SuperForge, MSC/NVH Manager, MSC/DropTest, MSC/FEA, MSC/FATIGUE, MSC/CONSTRUCT,
and MSC/AMS are trademarks of the Company. Registration on certain of these
trademarks is pending. Most of the Company's trademarks have also been
registered in foreign countries. MSC believes that it could successfully defend
the use of its trademarks, whether registered or pending registration, under
federal or common law existing in the State of California.

In addition, the Company maintains federal statutory copyright protection
with respect to its software programs and products and has registered copyrights
on all documentation and manuals related to these programs and maintains trade
secret protection on its software products.

COMPETITION

The Company competes in highly competitive markets including the development
and marketing of software for use principally by engineers and designers in
industry, research laboratories, and universities. The Company believes it is a
leading supplier of software and services to the CAE market in which it competes
with its MSC/NASTRAN and MSC/PATRAN product offerings.

The Company believes that MSC/NASTRAN is the leading program for engineering
analysis worldwide based upon capability, functionality, international
acceptance, and sales volume and that MSC/

7
<PAGE>
PATRAN is the standard CAE environment for manufacturers worldwide, based upon
its enhanced usability, direct CAD access, intelligent use of geometry,
automated finite element modeling, and completeness of analysis integration.

The Company must continue to offer attractive prices and performance
capabilities in order to retain existing clients and further extend its markets.
See "Research and Development" and "Marketing" above. The Company competes
primarily based upon product quality, service, price, and technological
innovation.

EMPLOYEES

At January 31, 1998, the Company and its subsidiaries employed approximately
700 persons, of whom 290 were involved in technical activities, 237 in sales and
marketing and 173 in administration. Of these employees, 267 hold advanced
degrees. The Company's business is dependent in part upon its ability to attract
and retain highly skilled personnel who are in great demand. The Company has no
contracts with labor organizations and believes its relations with its employees
are good.

8
<PAGE>
EXECUTIVE OFFICERS OF THE REGISTRANT

The table below sets forth certain information with regard to executive
officers who are not also directors of the Company. The Company is not aware of
any arrangement or understanding between such persons and any other persons
pursuant to which the executive officers were selected as such. The Company is
not aware of any family relationships between these executive officers and any
other executive officers.

<TABLE>
<S> <C> <C>
Kenneth D. Blakely...... 43 Senior Vice President of International Operations and General
Manager of Aerospace Business Unit for the Company
(February 1998-present); Vice President and General Manager
of Aerospace Business Unit for the Company (March
1996-January 1998); Vice President of Marketing for the
Company (January 1995-February 1996); Department Director
of Production and Support for the Company (March
1993-December 1994); Section Manager of Technical Product
Planning and Support for the Company (January 1992-February
1993); Department Director of Product Management and
Support for the Company (June 1991-December 1991);
MSC/NASTRAN Program Manager of the Company (October
1989-May 1991).

Louis A. Greco.......... 50 Chief Financial Officer of the Company (March 1983-present)
and Corporate Secretary of the Company (December
1985-present).

Thomas C. Tecco......... 48 Vice President of Automotive Business Unit for the Company
(August 1996-present).

James B. Archer......... 49 Senior Vice President of Product Development for the Company
(February 1998-present); Vice President of Product
Development for the Company (August 1997-January 1998).

Richard C. Murphy....... 34 Vice President and General Manager of Growth Industries
Business Unit for the Company (February 1997-present); Vice
President and General Manager of General Manufacturing Unit
for the Company (September 1996-January 1997); Department
Director of North American Sales and Support for the
Company (March 1996-August 1996); Regional Office Manager
of North American Sales and Sales Support for the Company
(February 1994-February 1996); Sales Representative of
North American Sales and Sales Support for the Company
(April 1991-January 1994).

Masaru Tateishi......... 52 Vice President of Asia-Pacific Operations for the Company
(February 1995-present); General Manager of MSC Japan for
the Company (March 1993-January 1995); General Manager of
MSC Hong Kong for the Company (August 1986-February 1993).

Christopher St. John.... 51 Vice President of European Operations for the Company (April
1997-present); Director of European Engineering Services
for the Company (January 1995-March 1997).
</TABLE>

Certain information in Item 1, "Business," and Item 7, "Management's
Discussion and Analysis of Results of Operations and Financial Condition"
contained in this Form 10-K includes information that is forward looking. Such
forward-looking statements include, among others, statements concerning the

9
<PAGE>
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 this Annual Report on Form 10K.

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-K.

ITEM 2. PROPERTIES.

The Company's offices are leased under agreements expiring at various times
over the next one to ten years. The company's principal offices are in Los
Angeles, California and Costa Mesa, California, and include 56,690 square feet
and 81,178 square feet, respectively, under leases expiring in 2005 and 2002,
respectively. Management of the Company believes current properties and
facilities to be adequate and suitable for the Company's current and future
needs. The Company also leases its other offices throughout the United States
and internationally. See Note 13 of Notes to Consolidated Financial Statements
of this report for additional information regarding the Company's lease
obligations.

ITEM 3. LEGAL PROCEEDINGS.

None.

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

No matters were submitted to a vote of shareholders during the last quarter
of the Company's fiscal year ended January 31, 1998.

10
<PAGE>
PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.

The Company's common stock is listed for trading on the New York Stock
Exchange under symbol MNS. The following table sets forth through January 31,
1998, the high and low prices as reported on the applicable exchanges for the
period shown:

<TABLE>
<CAPTION>
SALES PRICES
--------------------
HIGH LOW
--------- ---------
<S> <C> <C>
Fiscal 1998
Fourth quarter............................................ $ 12.13 $ 8.94
Third quarter............................................. 13.25 10.00
Second quarter............................................ 11.63 9.25
First quarter............................................. 10.00 8.13

Fiscal 1997
Fourth quarter............................................ $ 10.13 7.25
Third quarter............................................. 9.13 6.38
Second quarter............................................ 14.75 6.25
First quarter............................................. 15.00 13.00
</TABLE>

As of April 16, 1998 there were 363 record holders of the Company's Common
Stock. The Company eliminated its dividend in September of 1996 and does not
anticipate paying a dividend in the foreseeable future. The price of the Common
Stock on April 16, 1998 was $11.

ITEM 6. SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
FOR THE YEARS ENDED JANUARY 31,
-----------------------------------------------------
1998 1997 1996 1995** 1994
--------- --------- --------- --------- ---------
IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
<S> <C> <C> <C> <C> <C>
Revenue.................................... $ 134,850 $ 133,321 $ 130,483 $ 100,686 $ 79,574
Operating income (loss).................... 21,247 19,043 24,739 (27,732) 16,785
Net income (loss).......................... 11,492 9,621 14,407 (30,382) 11,440
Basic earnings (loss) per share*........... .85 .71 1.07 (2.27) .86
Diluted earnings (loss) per share*......... .83 .70 .99 (2.27) .86
Cash dividends declared per share.......... -- .22 .64 .64 .64
Total assets............................... 140,283 127,822 119,660 118,751 78,504
Convertible long-term debt................. 56,574 56,574 56,576 56,576 --
</TABLE>

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

* The earnings per share prior to 1998 have been restated as required to
comply with SFAS No. 128. For further discussion of earnings per share and
the impact of SFAS No. 128, see the related Notes to the Financial
Statements.

** Reflects an in-process research and development charge of $35,000,000 and a
restructuring charge of $8,962,000. Revenues in Fiscal 1996 and 1995 were
positively affected by the acquisition of PDA Engineering.

The selected financial data for the five years ended January 31, 1998, are
derived from the Company's audited Financial Statements. The selected financial
data should be read in conjunction with Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations, the Consolidated
Financial Statements of the Company and the related Notes to Financial
Statements.

11
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

1998 VS. 1997

The Company reported revenue of $134,850,000 for the year ended January 31,
1998 compared to revenue of $133,321,000 for the year ended January 31, 1997, a
1% increase. Revenue growth in the current year would have been approximately
$8,000,000, or 7% if valued using prior year foreign currency translation rates.
Software license revenue and maintenance fees account for 93% of total reported
revenue in fiscal 1998 and 94% in fiscal 1997, 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
upgrade privileges. In accordance with The American Institute of Certified
Public Accountant's ("AICPA") Statement of Position ("SOP") 91-1, "Software
Revenue Recognition" issued in 1991, revenue associated with support and upgrade
privileges has been consistently deferred and recognized over the term of the
license agreement.

Fiscal 1998 revenue growth was adversely affected by the strength of the
U.S. Dollar compared to foreign currencies in which the Company operates. The
Company's revenue growth in fiscal 1998, measured in local currencies, was
approximately 8% compared to the 1% reported in U.S. Dollars. The Asia Pacific
region, which accounts for 26% of the Company's total revenue, grew by 10% in
local currency compared to fiscal 1997. Europe, which accounts for 28% of the
Company's total revenue, grew by 7% in local currency compared to fiscal 1997,
and the Americas, which accounts for 46% of the Company's total revenue reported
a 8% growth rate in fiscal 1998. In light of the economic turmoil in the
Asia-Pacific region, the Company remains cautious about its Asia-Pacific
prospects. Approximately 16% of the Company's total revenue comes from Japan as
part of the Asia-Pacific region.

In addition to the currency impact, fiscal 1998 revenue growth was also
adversely affected by the sale of the electromagnetic product line in July 1996,
which contributed revenues of $2,459,000 in fiscal 1997.

Operating expense of $113,603,000 in fiscal 1998 decreased by approximately
1% from the $114,278,000 reported in fiscal 1997.

In accordance with the AICPA Statement of Financial Accounting Standards No.
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.

In fiscal 1998, total reported cost of revenue was $25,655,000 compared to
$20,686,000 in fiscal 1997, an increase of $4,969,000 or 24%. Ninety percent or
$4,484,000 of the fiscal 1998 increase is due to the amortization of capitalized
software, which is a significant component of cost of revenue. Capitalized
software amortization increased to $12,358,000 in fiscal 1998 from $7,874,000 in
fiscal 1997. 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 services, and expenses associated with other
services were not deemed to be material in fiscal 1998 or 1997.

Net research and development expense in fiscal 1998 of $12,285,000 was
$9,115,000 less than that reported in fiscal 1997. The decrease is the result of
a decrease of $5,231,000 in the total gross research and development investment
and an increase of $3,884,000 in the amount of research and development
investment required to be capitalized in fiscal 1998 compared to fiscal 1997,
which reduces the amount reported as expense.

As noted above, research and development expense is reported net of
capitalized software costs. The total gross investment in research and
development activities in fiscal 1998 amounted to $25,194,000, or 19% of current
year revenue, compared to $30,425,000, or 23% of revenue in fiscal 1997. The
total decrease in research and development investment in fiscal 1998 of
$5,231,000 resulted primarily from

12
<PAGE>
changes in staffing mix and staff makeup related to strategic revisions in
product development emphasis. The changes are in line with the Company's revised
goals and objectives for research and development.

Capitalized software, which is a significant component of reported research
and development expense, was $12,909,000 in fiscal 1998 compared to $9,025,000
in fiscal 1997, an increase of $3,884,000. 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 fiscal 1998 was $73,395,000
compared to $69,923,000 in fiscal 1997, an increase of $3,472,000, or 5%. The
increase relates primarily to expanded worldwide staffing requirements in the
sales and distribution area and was part of the change in customer focus
implemented during fiscal 1997.

Operating income is affected by the amount of software capitalized and the
amortization thereof. Operating income, including software capitalization and
amortization, was $21,247,000 in fiscal 1998 compared to $19,043,000 in fiscal
1997, an increase of 12%. The net effect of the amortization and capitalization
of software costs was a $551,000 reduction of operating expenses in fiscal 1998
compared to a $1,151,000 reduction of operating expenses in fiscal 1997. Thus,
the operating income benefit from the amortization and capitalization of
software costs was $600,000 less in fiscal 1998 than fiscal 1997.

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 (expense) was income of $620,000 in fiscal 1998 compared to an
expense of $333,000 in fiscal 1997. The fluctuation is primarily attributable to
increased interest and investment income from $642,000 in fiscal 1997 to
$852,000 in fiscal 1998 and a reduction of foreign exchange losses from a loss
of $562,000 in fiscal 1997 to a loss of $25,000 in fiscal 1998. Other income
(expense) also includes gains and losses on sales of assets and other
non-operating income.

The effective tax rate for the year was 34% compared to 32.5% in fiscal
1997. This change reflects an increase of $261,000 in income tax expense on a
year to year basis.

Net income was $11,492,000 in fiscal 1998 compared to $9,621,000 in fiscal
1997, an increase of 20%. Net income in fiscal 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 in fiscal 1999 and future years. The
effect of foreign currency translation on net income was an unfavorable variance
of approximately $2,000,000 if valued using prior year foreign currency
translation rates.

1997 VS. 1996

The Company reported revenue of $133,321,000 for the year ended January 31,
1997, an increase of 2% from $130,483,000 for the year ended January 31, 1996.
Revenue growth in fiscal 1997 would have been approximately $5,600,000, or 4%
greater, if valued using prior year foreign currency translation rates. A total
of 94% of total revenue in fiscal 1997 and 93% of revenue in 1996 was derived
from the licensing of the Company's software products and from software
maintenance fees with service revenue making up the difference.

13
<PAGE>
SOP 91-1, "Software Revenue Recognition" issued in 1991, revenue associated with
support and upgrade privileges has been consistently deferred and recognized
over the term of the license agreement.

Fiscal 1997 revenue growth was adversely affected by the strength of the
U.S. Dollar compared to foreign currencies in which the Company operates. The
Company's revenue growth in fiscal 1997, measured in local currencies, was
approximately 8% compared to the 2% reported in U.S. Dollars. The Asia-Pacific
region, which accounts for 26% of the Company's total revenue, grew by 18% in
local currency compared to the prior year. In U.S. dollar terms, the growth in
the Asia-Pacific region was 7%. Europe, which accounts for 30% of the Company's
total revenue, grew by 9% in local currency compared to the prior year and 3% in
U.S. dollar terms. The Americas, which accounts for 44% of the Company's total
revenue, reported a 2% decline in fiscal 1997.

In addition to the currency impact, fiscal 1997 real growth was also
affected by the sale of the Electromagnetic Analysis product line (MSC/EMAS) in
July of 1996, which contributed revenue of $2,459,000 in fiscal 1997 and
$3,780,000 in fiscal 1996.

Operating expenses of $114,278,000 in fiscal 1997 increased by approximately
8% from the $105,744,000 reported in fiscal 1996, an increase of $8,534,000.
This increase is attributable to many factors.

In fiscal 1997 total reported cost of revenue was $20,686,000 compared to
$19,856,000 in fiscal 1996, an increase of $830,000, or 4%. Amortization of
capitalized software cost, which is a significant component of cost of revenue,
was $7,874,000 in fiscal 1997 compared to $8,739,000 in fiscal 1996, a decrease
of $865,000. The increase in the cost of revenue expense is primarily due to
higher third-party royalty expenses brought about by increased revenues from
software products that carry a royalty obligation. Royalty expense is 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 services and
expenses associated with other services were not deemed to be material in fiscal
1997 or fiscal 1996.

Net research and development expense in fiscal 1997 was $21,400,000 compared
to $20,305,000 in fiscal 1996, a $1,095,000 increase. The increase is the result
of a decrease of $1,422,000 in the amount of research and development investment
required to be capitalized in fiscal 1997 compared to fiscal 1996 and a decrease
of $327,000 in gross research and development expense.

As noted above, research and development expense is reported net of
capitalized software costs. The total gross investment in research and
development activities in fiscal 1997 amounted to $30,425,000, or 23% of fiscal
1997 revenue, compared to $30,752,000, or 24% of revenue in fiscal 1996.

Capitalized software, which is a significant component of research and
development expense, was $9,025,000 in fiscal 1997 compared to $10,447,000 in
fiscal 1996, a decrease of $1,422,000. 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 improvements 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.

14
<PAGE>
Selling, general, and administrative expenses in fiscal 1997 were
$69,923,000 compared to $63,163,000 in fiscal 1996, an increase of $6,760,000,
or 11%. The increase in sales and marketing expense is primarily related to the
expansion of the infrastructure in our international operations. The increases
in general and administrative expenses relate to the expansion of the Company's
worldwide information systems network, and, to a lesser extent, to an increase
in the Company's bad debt expense.

Operating income is affected by the amount of software capitalized and the
amortization thereof. Operating income, including software capitalization and
amortization, was $19,043,000 in fiscal 1997 compared to $24,739,000 in fiscal
1996, a decrease of 23%. The net effect of the amortization and capitalization
of software costs was a $1,151,000 reduction of operating expenses in fiscal
1997 compared to a $1,708,000 reduction of operating expenses in fiscal 1996.
Thus, the operating income benefit from the amortization and capitalization of
software costs was $557,000 less in fiscal 1997 than fiscal 1996.

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 (expense) was an expense of $333,000 in fiscal 1997 compared to
income of $823,000 in fiscal 1996. The fluctuation is primarily attributable to
the increased loss on exchange rates due to the significant strengthening of the
U.S. dollar versus the German mark and Japanese yen during fiscal 1997. The
exchange rate losses were partially offset by investment income, and gains and
losses on sales of assets.

The effective tax rate for the year was 32.5% compared to 31.7% in fiscal
1996. This change reflects an increase of $114,000 in income tax expense on a
year to year basis.

Net income was $9,621,000 in fiscal 1997 compared to $14,407,000 in fiscal
1996, a decrease of 33%. Net income in fiscal 1997 was unfavorably affected by
fluctuations in functional currencies used in the Company's international
operations. The effect of foreign currency translation on net income was an
unfavorable variance of approximately $1,800,000 if valued using prior year
foreign currency translation rates.

COMPANY TRENDS

During fiscal 1998, the Company released the following products: MSC/AMS,
MSC/DropTest, MSC/ SuperForge, MSC/InCheck (for Mechanical Desktop, Solid Work,
and Solid Edge software), MSC/ CONSTRUCT, MSC/SuperModel, and MSC/NVH Manager.

During fiscal 1997, the Company created market-oriented units to increase
focus on its customers. The Company believes that by organizing itself around
three core customer groups--Aerospace, Automotive, and Growth Industries--it can
provide customers with complete mechanical computer-aided engineering solutions
instead of simply selling software.

Also during fiscal 1997, the Company acquired Automotive Analytics, Inc.,
which included an analysis tool specifically for automotive engineers, as well
as a group of consultants experienced at applying CAE techniques to support the
automotive engineering design process.

OPERATING PATTERN

Of the 93%, 94% and 93% of the Company's revenues in fiscal 1998, 1997 and
1996, respectively, that consisted of software license and maintenance revenue,
approximately 71% in fiscal 1998, 73% in fiscal 1997, and 70% in fiscal 1996 of
the software license and maintenance revenue is derived from annual renewable
leases and recurring maintenance fees with the remaining 22% in fiscal 1998, 21%
in fiscal 1997, and 23% in fiscal 1996 related to paid-up licenses.

15
<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
working capital needs in the foreseeable future. Net cash from operating
activities was $18,756,000, $28,439,000, and $25,977,000 in fiscal 1998, 1997,
and 1996, respectively. Fiscal 1998 net cash from operating activities was
affected by the increase in accounts receivable at year end. The Company's
working capital at January 31, 1998 was $47,753,000, compared to $33,029,000 at
January 31, 1997. The Company has an agreement with its principal bank for a
$15,000,000 unsecured line of credit at the prevailing prime rate. No amounts
were outstanding under this line of credit as of January 31, 1998 or January 31,
1997.

The Company issued convertible subordinated debentures in August 1994, in
connection with the 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. Each semi-annual interest payment was
approximately $2,200,000 in fiscal 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 $25,194,000, $30,425,000, and $30,752,000 in fiscal 1998, 1997, and 1996,
respectively, on research and development efforts of which $12,909,000,
$9,025,000, and $10,447,000 were capitalized in fiscal 1998, 1997, and 1996,
respectively. 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 years ended January 31, 1998, 1997 and 1996, the Company acquired
$4,436,000, $4,591,000, and $7,885,000, respectively, of new property and
equipment. Capital expenditures during fiscal 1998 included significant upgrades
in computer equipment in order to keep current with technological advances and
expansion 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.

The Company sold its Electromagnetics Business Unit ("EBU") to Ansoft
Corporation for $5,600,000 in July 1996, which did not result in a material
effect on earnings. The sale of the unit did not materially affect fiscal 1997
net income compared to prior years because of the relatively small size compared
to the Company's overall operations. However, the sale did significantly improve
both the Company's cash position and its cash used in investing activities,
compared to prior years. The Company is not contemplating other similar sales in
the foreseeable future.

During the middle of fiscal 1997, the Company eliminated its quarterly
dividend in order to reinvest more of its earnings into its operations. Dividend
payments were made on the Company's common stock in the aggregate amounts of
$5,111,000 and $8,571,000 in the years ended January 31, 1997 and 1996,
respectively. The Company does not plan to reinstate the payment of dividends in
the foreseeable future.

IMPACT OF YEAR 2000

The Company has initiated formal communications with all of 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

16
<PAGE>
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 has completed a study on the software that is sold to customers.
The study determined that all software sold by the Company was Year 2000
compliant. The cost of this study was immaterial.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In December 1997, the Financial Accounting Standards Board ("FASB") issued
Statement 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. All earnings per share amounts for all periods have been
presented, and where appropriate, restated to conform to the FASB No. 128
requirements.

In June 1997, the FASB issued Statement 130, "Reporting Comprehensive
Income". SFAS No. 130 establishes new rules for the reporting and display of
comprehensive income and its components; however, adoption in fiscal 1999 will
have no impact on the Company's net income or shareholders' equity. SFAS No. 130
requires unrealized gains or losses on the Company's available-for-sale
securities and the foreign currency translation adjustments, which currently are
reported in shareholders' equity, to be included in other comprehensive income
and the disclosure of total comprehensive income. The Company will adopt SFAS
No. 130 in the first quarter of fiscal 1999.

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 will adopt SFAS No. 131 in fiscal
1999.

In October 1997, the Accounting Standards Executive Committee ("AcSEC") of
the AICPA issued SOP 97-2, "Software Revenue Recognition," which supercedes
Statement of Position 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. The
Company will adopt SOP 97-2 in the first quarter of fiscal 1999. The Company is
currently analyzing the requirements of SOP 97-2. The ultimate impact on the
Company's fiscal 1999 financial statements is uncertain until this analysis is
complete.

INFLATION

Inflation in recent years has not had a significant effect on the Company's
business.

17
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

THE MACNEAL-SCHWENDLER CORPORATION
CONSOLIDATED BALANCE SHEETS
JANUARY 31, 1998 AND 1997
ASSETS

<TABLE>
<CAPTION>
1998 1997
-------------- --------------
<S> <C> <C>
Current assets:
Cash and cash equivalents...................................................... $ 10,086,000 $ 24,016,000
Securities available for sale.................................................. 16,073,000 1,052,000
Accounts receivable, net....................................................... 49,091,000 36,328,000
Deferred tax charges........................................................... 3,446,000 3,111,000
Other current assets........................................................... 7,219,000 5,773,000
-------------- --------------
Total current assets....................................................... 85,915,000 70,280,000

Property and equipment, net...................................................... 8,926,000 10,242,000
Capitalized software costs, net.................................................. 28,780,000 28,173,000
Goodwill and other intangible assets, net........................................ 13,958,000 16,265,000
Other assets..................................................................... 2,704,000 2,862,000
-------------- --------------
$ 140,283,000 $ 127,822,000
-------------- --------------
-------------- --------------

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................... $ 3,131,000 $ 2,248,000
Accrued liabilities:
Compensation and related expenses............................................ 6,516,000 6,845,000
Contribution to profit sharing plan.......................................... 2,784,000 3,107,000
Other........................................................................ 14,422,000 15,233,000
Deferred income................................................................ 10,561,000 9,035,000
Income taxes payable........................................................... 748,000 783,000
-------------- --------------
Total current liabilities.................................................. 38,162,000 37,251,000
Deferred income taxes............................................................ 10,983,000 10,465,000
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 in 1998 and 1997................................................. -- --
Common Stock, $0.01 par value, 100,000,000 shares authorized; 13,621,900 and
13,455,800 issued and outstanding in 1998 and 1997, respectively............. 31,482,000 30,250,000
Retained earnings(deficit)..................................................... 7,399,000 (4,093,000)
Accumulated translation adjustment............................................. (4,317,000) (2,625,000)
-------------- --------------
Total shareholders' equity................................................. 34,564,000 23,532,000
-------------- --------------
$ 140,283,000 $ 127,822,000
-------------- --------------
-------------- --------------
</TABLE>

See accompanying notes.

18
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED JANUARY 31, 1998, 1997 AND 1996

<TABLE>
<CAPTION>
1998 1997 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Revenues:
Software licenses............................................. $ 104,253,000 $ 107,594,000 $ 108,719,000
Software maintenance and services............................. 30,597,000 25,727,000 21,764,000
-------------- -------------- --------------
Total revenues............................................ 134,850,000 133,321,000 130,483,000
Operating expenses:
Cost of revenue............................................... 25,655,000 20,686,000 19,856,000
Amortization of goodwill and other intangibles................ 2,268,000 2,269,000 2,420,000
Research and development...................................... 12,285,000 21,400,000 20,305,000
Selling, general, and administrative.......................... 73,395,000 69,923,000 63,163,000
-------------- -------------- --------------
Total operating expenses.................................. 113,603,000 114,278,000 105,744,000
Operating income................................................ 21,247,000 19,043,000 24,739,000
Debenture interest.............................................. (4,456,000) (4,456,000) (4,465,000)
Other income (expense), net..................................... 620,000 (333,000) 823,000
-------------- -------------- --------------
Income before income taxes...................................... 17,411,000 14,254,000 21,097,000
Provision for income taxes...................................... 5,919,000 4,633,000 6,690,000
-------------- -------------- --------------
Net income...................................................... $ 11,492,000 $ 9,621,000 $ 14,407,000
-------------- -------------- --------------
-------------- -------------- --------------
Basic earnings per share........................................ $ 0.85 $ 0.71 $ 1.07
-------------- -------------- --------------
-------------- -------------- --------------
Diluted earnings per share...................................... $ 0.83 $ 0.70 $ 0.99
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>

See accompanying notes.

19
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

FOR THE YEARS ENDED JANUARY 31, 1998, 1997 AND 1996

<TABLE>
<CAPTION>
SHARES OF ACCUMULATED TOTAL
COMMON COMMON RETAINED TRANSLATION SHAREHOLDERS'
STOCK STOCK EARNINGS ADJUSTMENT EQUITY
------------ ------------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at January 31, 1995.................. 13,380,000 $ 29,366,000 $ (16,580,000) $ (411,000) $ 12,375,000
Shares issued under Stock Option Plans..... 68,100 716,000 716,000
Cash dividends declared--$.64 per share.... (8,581,000) (8,581,000)
Net income................................. 14,407,000 14,407,000
Translation adjustment..................... (1,772,000) (1,772,000)
------------ ------------- -------------- ------------- -------------

Balance at January 31, 1996.................. 13,448,100 30,082,000 (10,754,000) (2,183,000) 17,145,000
Shares issued under Stock Option Plans..... 7,700 168,000 168,000
Cash dividends declared--$.22 per share.... (2,960,000) (2,960,000)
Net income................................. 9,621,000 9,621,000
Translation adjustment..................... (442,000) (442,000)
------------ ------------- -------------- ------------- -------------

Balance at January 31, 1997.................. 13,455,800 30,250,000 (4,093,000) (2,625,000) 23,532,000
Shares issued under Stock Option Plans..... 166,100 1,232,000 1,232,000
Net income................................. 11,492,000 11,492,000
Translation adjustment..................... (1,692,000) (1,692,000)
------------ ------------- -------------- ------------- -------------

Balance at January 31, 1998.................. 13,621,900 $ 31,482,000 $ 7,399,000 $ (4,317,000) $ 34,564,000
------------ ------------- -------------- ------------- -------------
------------ ------------- -------------- ------------- -------------
</TABLE>

See accompanying notes.

20
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED JANUARY 31, 1998, 1997 AND 1996

<TABLE>
<CAPTION>
1998 1997 1996
-------------- ------------- --------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income...................................................... $ 11,492,000 $ 9,621,000 $ 14,407,000
Adjustments to reconcile net income to net cash provided by
operating activities
Depreciation and amortization of property and equipment....... 5,700,000 6,346,000 5,880,000
Amortization of goodwill and other intangibles................ 2,268,000 2,269,000 2,420,000
Amortization of capitalized software costs.................... 12,358,000 7,874,000 8,739,000
Deferred income taxes......................................... 183,000 -- 2,669,000
Loss (gain) on disposal of property and equipment............. 52,000 93,000 (4,000)
Changes in assets and liabilities:
Accounts receivable, net...................................... (12,763,000) (19,000) (2,633,000)
Other current assets.......................................... (1,445,000) (584,000) (769,000)
Income tax refund receivable.................................. -- 1,243,000 2,902,000
Accounts payable.............................................. 883,000 (246,000) (243,000)
Accrued liabilities........................................... (1,463,000) 1,977,000 686,000
Deferred income............................................... 1,526,000 1,094,000 (4,250,000)
Restructuring reserve......................................... -- (1,379,000) (4,428,000)
Income taxes payable.......................................... (35,000) 150,000 601,000
-------------- ------------- --------------
Net cash provided by operating activities....................... 18,756,000 28,439,000 25,977,000
Cash flows from investing activities:
Purchase of securities available-for-sale..................... (16,073,000) (1,052,000) --
Sale of securities available-for-sale......................... 1,052,000 3,340,000 3,735,000
Proceeds from sale of Electromagnetics Business Unit.......... -- 5,600,000 --
Acquisition of property and equipment......................... (4,436,000) (4,591,000) (7,885,000)
Purchase of subsidiaries, net of cash acquired................ -- (115,000) --
Capitalized software costs.................................... (12,909,000) (9,025,000) (10,447,000)
Other......................................................... 140,000 (428,000) (1,462,000)
-------------- ------------- --------------
Net cash used in investing activities........................... (32,226,000) (6,271,000) (16,059,000)
Cash flows from financing activities:
Issuance of common stock...................................... 1,232,000 166,000 716,000
Cash dividends paid........................................... -- (5,111,000) (8,571,000)
-------------- ------------- --------------
Net cash provided by (used in) financing activities............. 1,232,000 (4,945,000) (7,855,000)
Translation adjustment.......................................... (1,692,000) (442,000) (1,772,000)
-------------- ------------- --------------
Net increase (decrease) in cash and cash equivalents............ (13,930,000) 16,781,000 291,000
Cash and cash equivalents at beginning of year.................. 24,016,000 7,235,000 6,944,000
-------------- ------------- --------------
Cash and cash equivalents at end of year........................ $ 10,086,000 $ 24,016,000 $ 7,235,000
-------------- ------------- --------------
-------------- ------------- --------------
Supplemental cash flow information:
Income taxes paid............................................. $ 4,171,000 $ 3,208,000 $ 2,857,000
-------------- ------------- --------------
-------------- ------------- --------------
Debenture interest paid....................................... $ 4,456,000 $ 4,454,000 $ 4,737,000
-------------- ------------- --------------
-------------- ------------- --------------
Reconciliation of assets acquired and liabilities assumed:
Fair value of assets acquired................................. $ -- $ 309,000 $ --
Liabilities assumed........................................... -- 194,000 --
-------------- ------------- --------------
$ -- $ 115,000 $ --
-------------- ------------- --------------
-------------- ------------- --------------
</TABLE>

See accompanying notes.

21
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS INFORMATION

BUSINESS The Company designs, produces, and markets proprietary computer
software products and provides related services for use in computer-aided
engineering. The Company's products are marketed internationally to aerospace,
automotive, and other industrial concerns, computer and electronics
manufacturers, and universities.

PRINCIPLES OF CONSOLIDATION The consolidated financial statements include
the accounts of the Company and its subsidiaries. All significant intercompany
accounts and transactions have been eliminated.

USE OF ESTIMATES The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

REVENUE RECOGNITION Revenue is recognized in accordance with AICPA's issued
Statement of Position 91-1 "Software Revenue Recognition". Software revenue
consists of licensing fees, which are fees charged for the right to use the
software, and maintenance fees, which consist of support and upgrade privileges.
Revenue from monthly leases of the Company's computer software products is
recognized monthly as earned. Revenue from prepaid and paid-up licenses is
recognized in full upon the delivery of the software, with postcontract customer
support ("PCS") on such licenses deferred and recognized over the term of the
PCS agreement, generally one year. There are no material incremental costs
associated with PCS or upgrade privileges. Revenue from the sale of products
provided by other suppliers and for which a royalty is due the suppliers is
reported as gross revenues earned from the product sale. Royalty due to the
supplier represents an operating expense and is recorded as royalty expense in
cost of revenue. Service and other revenues are recognized when the service is
provided and the revenue has been earned. Long term contracts are recognized
using the percentage of completion method. Services revenue and costs associated
with services revenue are not material. Discounts on the sale of computer
software products and PCS are proportionately allocated to each element of a
sale based on the list price of each element.

STOCK-BASED COMPENSATION The Company grants stock options for a fixed
number of shares to employees with an exercise price equal to the fair value of
the shares at the date of grant. The Company accounts for stock option grants in
accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees,
and, accordingly, recognizes no compensation expense for the stock option
grants. The Company has also made available an Employee Stock Purchase Plan for
eligible employees. Such eligible employees are entitled semi-annually to
purchase common stock, by means of limited payroll deductions at a 10% discount
from the fair market value of the common stock as of specific dates. In 1997,
the Company adopted the disclosure only provisions of SFAS No. 123, "Accounting
For Stock-Based Compensation". Refer to Note 12: Stock Option Plans.

RECLASSIFICATIONS The consolidated financial statements for 1997 and 1996
contain certain reclassifications to conform to the 1998 presentation.

CASH, CASH EQUIVALENTS AND AVAILABLE FOR SALE SECURITIES For purposes of
the consolidated statements of cash flows, the Company considers investments in
money market instruments to be cash equivalents. Marketable equity securities
and debt securities are classified as held-to-maturity or as available-for-sale.
Management determines the appropriate classification of debt securities at the
time of purchase and reevaluates such designation as of each balance sheet date.
At January 31, 1998 and 1997, all securities

22
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS INFORMATION
(CONTINUED)
were designated as available-for-sale. Available-for-sale securities are carried
at fair value, with the unrealized gains and losses, net of tax, reported in a
separate component of shareholders' equity. Available-for-sale securities held
by the Company are principally municipal debt securities. Unrealized gains and
losses did not have a material effect on equity at January 31, 1998 or January
31, 1997. Refer to Note 3: Available for Sale Securities.

ACCOUNTS RECEIVABLE Accounts receivable are reported net of allowances for
doubtful accounts. The Company's revenue is generated from customers in
diversified industries, primarily in North America, Europe and Asia-Pacific. The
Company performs ongoing credit evaluations of its customers and generally does
not require collateral. The Company maintains reserves for potential credit
losses and such losses have been within management's expectations.

PROPERTY AND EQUIPMENT Depreciation and amortization are computed on the
straight-line method over the estimated useful lives of assets, ranging from two
to five years.

CAPITALIZED SOFTWARE COSTS Capitalized software costs are comprised of
purchased software and internal software development costs. Software costs
incurred subsequent to the determination of the software product's technological
feasibility are capitalized. Capitalization ceases and amortization of
capitalized costs begins when the software product is available for general
release to clients. Capitalized software amortization expense is included in
cost of revenue. The amortization period for the software costs capitalized is
the economic life of the related products, typically three to four years.

GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill amounting to approximately
$9,950,000 and $11,456,000 net of accumulated amortization of $5,238,000 and
$3,732,000 as of January 31, 1998 and 1997, respectively, arising from
acquisitions is amortized on the straight-line basis over a period of 10 years.
Other intangibles amounted to approximately $4,008,000 and $4,809,000, net of
accumulated amortization as of January 31, 1998 and 1997, respectively, and are
amortized on a straight-line basis over five to 10 years. Accumulated
amortization of other intangibles as of January 31, 1998 and 1997, amounted to
$2,731,000 and $1,968,000, respectively. The carrying value of intangibles is
evaluated periodically in relation to the operating performance and future
undiscounted cash flows of the underlying business. Adjustments are made if the
sum of expected future net cash flows is less than book value. No adjustments
have been made in the periods presented.

ADVERTISING EXPENSE The cost of advertising is expensed as incurred. The
Company incurred $1,282,000, $1,431,000, and $1,229,000 in advertising costs
during fiscal 1998, 1997, and 1996, respectively.

ROYALTIES TO THIRD PARTIES The Company has several agreements with third
parties requiring the payment of royalties for sales of third party products, or
inclusion of such products as a component of the Company's products. The Company
does not consider any royalty expense related to individual agreements to be
material.

INCOME TAXES The Company utilizes the asset and liability method of
accounting for income taxes. Provision is made in the Company's financial
statements for current income taxes payable and deferred income taxes arising
primarily from temporary differences in accounting for capitalized software
costs, undistributed earnings of international subsidiaries, depreciation
expense, deferred income and state income taxes.

23
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS INFORMATION
(CONTINUED)
EFFECT OF FOREIGN CURRENCY The Company translates the assets and
liabilities of its foreign subsidiaries at the rate of exchange in effect at the
period end. Revenues and expenses are translated using an average of exchange
rates in effect during the period. Translation adjustments are recorded as a
separate component of shareholders' equity in the consolidated balance sheet.

DERIVATIVE INSTRUMENT The Company enters into forward exchange contracts to
hedge certain anticipated repayments of its intercompany debt with its foreign
subsidiaries. The forward exchange contracts do not qualify as a hedge for
financial reporting purposes and, accordingly, unrealized gains or losses based
on the current forward foreign exchange rates are reflected directly in income.
Refer to Note 13: Commitments.

EARNINGS PER SHARE In December 1997, the FASB issued Statement 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 1998 and 1997 assumes 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. All earnings per share amounts for all periods have been restated
to conform to the FASB No. 128 requirements.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In June 1997, the Financial Accounting Standards Board issued Statement 130,
"Reporting Comprehensive Income". SFAS No. 130 establishes new rules for the
reporting and display of comprehensive income and its components; however,
adoption in fiscal 1999 will have no impact on the Company's net income or
shareholders' equity. SFAS No. 130 requires unrealized gains or losses on the
Company's available-for-sale securities and the foreign currency translation
adjustments, which currently are reported in shareholders' equity, to be
included in other comprehensive income and the disclosure of total comprehensive
income. The Company will adopt SFAS No. 130 in the first quarter of fiscal 1999.

In October 1997, the AcSEC of the AICPA issued Statement of Position ("SOP")
97-2, "Software Revenue Recognition," which supercedes Statement of Position
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. The Company will
adopt SOP 97-2 in the first quarter of fiscal 1999. The Company is currently
analyzing the requirements of SOP 97-2. The ultimate impact on the Company's
fiscal 1999 financial statements is uncertain until this analysis is complete.

NOTE 2: DIVESTITURES

In July 1996, the Company sold its Electromagnetics Business Unit to Ansoft
Corporation for $5,600,000, which did not result in a material effect on
earnings. The sale of the unit did not materially

24
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 2: DIVESTITURES (CONTINUED)
affect fiscal 1997 net income compared to prior years because of the relatively
small size compared to the Company's overall operations.

NOTE 3: AVAILABLE FOR SALE SECURITIES

The carrying value (i.e., amortized cost) of available-for-sale securities
approximates the fair market value at January 31, 1998 and January 31, 1997.

The following is a summary of available-for-sale securities:

<TABLE>
<CAPTION>
FAIR MARKET VALUE
----------------------------------
JANUARY 31,
1998 JANUARY 31, 1997
--------------- -----------------
DOLLARS IN THOUSANDS
<S> <C> <C>
Municipal securities....................................... $ 15,742 $ 1,001
Other debt securities...................................... 331 51
------- ------
$ 16,073 $ 1,052
------- ------
------- ------
</TABLE>

The fair market value of municipal and debt securities at January 31, 1998
and 1997, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because the issuers of the securities may
have the right to prepay obligations without prepayment penalties.

<TABLE>
<CAPTION>
FAIR MARKET VALUE
----------------------------------
JANUARY 31,
1998 JANUARY 31, 1997
--------------- -----------------
DOLLARS IN THOUSANDS
<S> <C> <C>
Due in one year or less.................................... $ 3,925 $ 51
Due after one year through three years..................... 7,487 --
Due after three years...................................... 4,661 1,001
------- ------
$ 16,073 $ 1,052
------- ------
------- ------
</TABLE>

NOTE 4: ACCOUNTS RECEIVABLE

The components of the Company's allowance for doubtful accounts receivable,
consist of the following:

<TABLE>
<CAPTION>
YEARS ENDED JANUARY
31
--------------------
1998 1997
--------- ---------
DOLLARS IN THOUSANDS
<S> <C> <C>
Beginning balance..................................................... $ 1,806 $ 2,562
Amounts charged to expense............................................ 973 616
Write-downs against the reserve....................................... (1,170) (1,372)
--------- ---------
Ending balance........................................................ $ 1,609 $ 1,806
--------- ---------
--------- ---------
</TABLE>

25
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 5: PROPERTY AND EQUIPMENT

Property and equipment, at cost, consists of the following:

<TABLE>
<CAPTION>
JANUARY 31,
----------------------
1998 1997
---------- ----------
DOLLARS IN THOUSANDS
<S> <C> <C>
Computers and other equipment......................................... $ 33,257 $ 30,026
Furniture and fixtures................................................ 1,186 1,862
Leasehold improvements................................................ 2,398 1,666
---------- ----------
36,841 33,554
Less accumulated depreciation and amortization........................ (27,915) (23,312)
---------- ----------
$ 8,926 $ 10,242
---------- ----------
---------- ----------
</TABLE>

NOTE 6: CAPITALIZED SOFTWARE COSTS

Amortization of capitalized software costs of $12,358,000 in 1998,
$7,874,000 in 1997, and $8,739,000 in 1996 is included in cost of revenues.
Software costs capitalized amounted to $12,909,000 in 1998, $9,025,000 in 1997,
and $10,447,000 in 1996. In addition, the Company purchased certain software
that was capitalized in fiscal 1998 and fiscal 1997 amounting to $56,000 and
$150,000, respectively.

<TABLE>
<CAPTION>
JANUARY 31,
--------------------
1998 1997
--------- ---------
DOLLARS IN THOUSANDS
<S> <C> <C>
Capitalized software costs................................ $ 67,687 $ 54,617
Less accumulated amortization............................. (38,907) (26,444)
--------- ---------
Capitalized software costs, net........................... $ 28,780 $ 28,173
--------- ---------
--------- ---------
</TABLE>

NOTE 7: OTHER ACCRUED LIABILITIES

The components of the Company's other accrued liabilities, consist of the
following:

<TABLE>
<CAPTION>
JANUARY 31,
--------------------
1998 1997
--------- ---------
DOLLARS IN THOUSANDS
<S> <C> <C>
Debenture interest payable................................ $ 1,688 $ 1,687
Royalties payable......................................... 929 911
Commissions payable....................................... 2,752 3,958
Consumption taxes payable................................. 3,057 3,552
Post retirement benefits.................................. 1,271 1,551
Incentive compensation payable............................ 1,089 224
Other..................................................... 3,636 3,350
--------- ---------
Total..................................................... $ 14,422 $ 15,233
--------- ---------
--------- ---------
</TABLE>

26
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 8: TAXES BASED ON INCOME

The provision for taxes based on income consists of the following:

<TABLE>
<CAPTION>
YEARS ENDED JANUARY 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
DOLLARS IN THOUSANDS
<S> <C> <C> <C>
Current:
Federal........................................... $ 827 $ 560 $ 464
State............................................. 452 404 675
Foreign........................................... 4,457 3,669 2,882
--------- --------- ---------
5,736 4,633 4,021
Deferred............................................ 183 -- 2,669
--------- --------- ---------
$ 5,919 $ 4,633 $ 6,690
--------- --------- ---------
--------- --------- ---------
</TABLE>

The foreign tax provision for fiscal 1998, 1997, and 1996 includes
withholding taxes of $2,546,000, $1,780,000, and $1,811,000, respectively,
assessed to the Company by foreign authorities on foreign revenues remitted to
the U.S. The Company's foreign operations realized combined income, including
intercompany charges and before taxes of $2,889,000 in 1998, $2,025,000 in 1997,
and $1,841,000 in 1996.

27
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 8: TAXES BASED ON INCOME (CONTINUED)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets as of January 31, 1998 and
1997 are as follows:

<TABLE>
<CAPTION>
JANUARY 31,
--------------------
1998 1997
--------- ---------
DOLLARS IN THOUSANDS
<S> <C> <C>
Deferred tax liabilities
Capitalized software.................................... $ 12,441 $ 12,274
Intangible assets....................................... 1,205 1,391
Organization Costs...................................... 462 591
Prepaid expenses........................................ 63 126
Tax in excess of book depreciation...................... -- 36
Other................................................... 10 --
--------- ---------
Total deferred tax liabilities.......................... 14,181 14,418
Deferred tax assets
State taxes............................................. 584 622
Accrued liabilities..................................... 236 306
Net operating losses.................................... 4,945 5,664
Deferred revenue........................................ 1,324 910
Undistributed earnings of foreign subsidiaries.......... 1,784 2,055
Business credits........................................ 1,684 1,918
Sale of business unit................................... 393 540
Restructuring charge.................................... -- --
Benefits and compensation............................... 972 883
Book in excess of tax depreciation...................... 164 --
Other................................................... -- (34)
--------- ---------
Total deferred tax assets............................. 12,086 12,864
Valuation allowance..................................... (5,442) (5,800)
--------- ---------
Net deferred tax assets............................... 6,644 7,064
--------- ---------
Net deferred tax liabilities............................ $ 7,537 $ 7,354
--------- ---------
--------- ---------
</TABLE>

The balance sheet presentation of the net deferred tax liabilities is as
follows:

<TABLE>
<CAPTION>
JANUARY 31,
--------------------
1998 1997
--------- ---------
DOLLARS IN THOUSANDS
<S> <C> <C>
Net long-term deferred tax liability...................... $ 10,983 $ 10,465
Current deferred charges.................................. (3,446) (3,111)
--------- ---------
Net deferred tax liabilities.............................. $ 7,537 $ 7,354
--------- ---------
--------- ---------
</TABLE>

At January 31, 1998, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $14,129,000. The federal net
operating loss carryforwards expire at various

28
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 8: TAXES BASED ON INCOME (CONTINUED)
dates through the year 2010. An acquisition by the Company in 1993 constituted
an ownership change for federal income tax purposes and as a result, the amount
of net operating loss carryforward that may be utilized in any given year may be
limited. For financial reporting purposes, a valuation allowance of $5,442,000
at January 31, 1998, $5,800,000 at January 31, 1997, and $5,904,000 at January
31, 1996 has been recognized to offset the deferred tax assets relating to
recent acquisitions. The decrease in the valuation allowance was $358,000 in
1998 and $104,000 in 1997.

The following table reconciles the provision for taxes based on income
before taxes to the statutory federal income tax rate of 35% for the years ended
January 31, 1998, 1997 and 1996.

<TABLE>
<CAPTION>
YEARS ENDED JANUARY 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
DOLLARS IN THOUSANDS
<S> <C> <C> <C>
Tax expense at statutory rate..................... $ 6,094 $ 4,989 $ 7,384
Increase (decrease) related to:
State income taxes, net of federal benefits....... 656 504 926
Amortization of goodwill.......................... 527 527 580
Income of Foreign Sales........................... (1,056) (1,201) (1,632)
Excludable portion of investment income........... (66) (24) (91)
Federal and state research and development tax
credits......................................... (526) -- --
Benefit from net operating loss................... -- (104) (5)
Other, net........................................ 290 (58) (472)
--------- --------- ---------
$ 5,919 $ 4,633 $ 6,690
--------- --------- ---------
--------- --------- ---------
</TABLE>

NOTE 9: CONVERTIBLE SUBORDINATED DEBENTURES

The Company issued $56,608,000 of convertible subordinated debentures in
connection with the acquisition of PDA Engineering, Inc. in 1994. The debentures
bear interest at 7 7/8% with interest payments due semi-annually on March 15th
and September 15th. They have a conversion feature which permits the holder to
convert the debentures into shares of the Company's Common Stock at a conversion
price of $15.15 per share. The debentures mature August 18, 2004, but are
redeemable at the Company's option at any time after August 18, 1997 upon
payment of a premium. At January 31, 1998 the fair market value of the
debentures outstanding based on their quoted trading price was approximately
$56,715,000.

NOTE 10: INTERNATIONAL OPERATIONS

The following tables summarize consolidated financial information of the
Company's operations by geographic location:

<TABLE>
<CAPTION>
YEARS ENDED JANUARY 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
DOLLARS IN THOUSANDS
<S> <C> <C> <C>
Revenues:
The Americas................................ $ 62,371 $ 57,443 $ 58,324
Europe...................................... 37,515 40,635 39,361
Asia-Pacific................................ 34,964 35,243 32,798
--------- --------- ---------
Consolidated................................ $ 134,850 $ 133,321 $ 130,483
--------- --------- ---------
--------- --------- ---------
</TABLE>

29
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 10: INTERNATIONAL OPERATIONS (CONTINUED)
Financial data included in the consolidated financial statements of the
Company's European and Asia-Pacific subsidiaries is based on years ending
December 31.

<TABLE>
<CAPTION>
JANUARY 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
DOLLARS IN THOUSANDS
<S> <C> <C> <C>
Identifiable assets:
The Americas.................................... $ 108,967 $ 95,335 $ 94,795
Europe.......................................... 19,798 21,151 17,686
Asia-Pacific.................................... 11,518 11,336 7,179
--------- --------- ---------
Consolidated.................................... $ 140,283 $ 127,822 $ 119,660
--------- --------- ---------
--------- --------- ---------
</TABLE>

The net assets of the Company's foreign subsidiaries totaled $17,309,000,
$17,638,000, and $11,137,000 in 1998, 1997 and 1996, respectively, excluding
intercompany items. The income of the Company's foreign subsidiaries is reported
in Note 8.

NOTE 11: EMPLOYEE BENEFITS

The Company contributes an amount, integrated with Social Security, to a
defined contribution plan, covering substantially all North American full-time
employees who have completed a specified term of service with the Company.
Contributions charged to expense in connection with this plan were approximately
$2,694,000 in 1998, $2,960,000 in 1997, and $3,019,000 in 1996. The plan has a
401(k) feature to permit voluntary employee contributions, which does not affect
the Company's expenses.

The Company adopted a non-qualified supplemental retirement plan during the
year ended January 31, 1995. The Company contributes an amount, integrated with
Social Security and the Company's defined contribution plan, covering certain
key employees who have completed a specified term of service with the Company.
Contributions charged to expense in connection with this plan were approximately
$134,000 in 1998, $148,000 in 1997, and $135,000 in 1996.

The Company also has a post retirement health care plan for employees
completing minimum age and years of service requirements. The plan provides for
a benefit offsetting premiums for health care coverage. The amount of the
benefit is based on a combination of the age of the participant and the number
of years of service at retirement. The gross accumulated post-retirement
obligation was approximately $1,271,000 and $1,551,000 at January 31, 1998 and
1997, respectively. The Company is recognizing past service cost over 20 years.
Total expense for the years ended January 31, 1998, 1997 and 1996 was $347,000,
$306,000, and $196,000, respectively.

30
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 12: STOCK OPTION PLANS

1983 PLAN

The 1983 MacNeal-Schwendler Incentive Stock Option Plan for Key Employees
provided for the granting of options for the purchase of up to 900,000
authorized but unissued shares of the Company's Common Stock, at option prices
of not less than the fair market value of the common shares at the date of
grant. The options become fully exercisable one year from the date of grant and
expire five years after the date of grant. The 1983 Plan expired during fiscal
1995, therefore no additional shares are available for grant.

A summary of stock option activity is as follows:

<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTION PRICE EXERCISE
OPTIONS PER SHARE PRICE
--------- --------------- -------------
<S> <C> <C> <C>
Outstanding at January 31, 1995................... 258,700 $ 8.00-$16.13 $ 13.35
Exercised......................................... (43,600) $ 8.00-$14.25 $ 12.05
Canceled.......................................... (15,800) $11.00-$13.38 $ 13.31
---------
Outstanding at January 31, 1996................... 199,300 $ 8.00-$16.13 $ 13.64
Canceled.......................................... (55,500) $ 8.00-$16.13 $ 12.70
---------
Outstanding at January 31, 1997................... 143,800 $13.38-$14.25 $ 14.00
Canceled.......................................... (77,700) $13.38-$14.25 $ 13.68
---------
Outstanding at January 31, 1998................... 66,100 $14.25-$14.25 $ 14.25
---------
---------
</TABLE>

All options outstanding were exercisable at January 31, 1998, 1997, and
1996.

1991 PLAN

The MacNeal-Schwendler 1991 Stock Option Plan, as amended, consists of two
parts--a "Key Employee Program" that allows discretionary awards of
nontransferable incentive stock options and nonqualified stock options to
officers and other key employees, and a "Non-Employee Director Program" that
provides for automatic annual grants of nontransferable, nonqualified stock
options to non-employee directors.

The "Key Employee Program" section of the 1991 Plan provides for the
granting of both incentive stock options and nonqualified options for the
purchase of up to 2,500,000 authorized but unissued shares of the Company's
common stock at the fair market value of such shares on the date the option is
granted, or for non-qualified options at such price as the Compensation
Committee may determine.

The "Non-Employee Director Program" section of the 1991 Plan provides for
automatic grants to members of the Board of Directors who are not officers or
employees of the Company or its subsidiaries. A maximum of 500,000 shares of
Company authorized but unissued common stock may be issued upon the exercise of
options under the "Non-Employee Director Program." All eligible directors will
receive annual non-discretionary grants of non-qualified stock options for the
purchase of 3,000 shares of the Company's common stock.

Options under the 1991 Plan are exercisable up to ten years from the date of
grant, subject to vesting provisions outlined at the grant date.

31
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 12: STOCK OPTION PLANS (CONTINUED)
A summary of stock option activity is as follows:

<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTION PRICE EXERCISE
OPTIONS PER SHARE PRICE
---------- --------------- -------------
<S> <C> <C> <C>
Outstanding at January 31, 1995................. 990,000 $ 8.00-$15.38 $ 12.03
Granted......................................... 785,500 12.50-19.38 15.15
Exercised....................................... (24,500) 11.00-14.25 11.66
Canceled........................................ (45,000) 11.00-15.38 12.37
----------
Outstanding at January 31, 1996................. 1,706,000 8.00-19.38 13.46
Granted......................................... 629,550 6.50-15.38 8.82
Exercised....................................... (7,700) 8.00-11.00 10.20
Canceled........................................ (120,000) 8.00-19.38 14.17
----------
Outstanding at January 31, 1997................. 2,207,850 6.50-15.88 12.03
Granted......................................... 722,350 9.75-13.06 9.99
Exercised....................................... (27,600) 6.50-11.00 7.18
Canceled........................................ (568,450) 8.00-15.38 13.37
----------
Outstanding at January 31, 1998................. 2,334,150 $ 6.50-$15.88 11.21
----------
----------
</TABLE>

The number of options exercisable under the 1991 Plan at January 31, 1998,
1997, and 1996 were 1,389,800, 1,584,500, and 941,000, respectively.

At January 31, 1998 and 1997, the per share weighted-average exercise prices
of the stock options exercisable under the 1991 Plan were $11.73 and $13.40, and
under the 1983 Plan were $14.25 and $14.00, respectively. Options for the
purchase of 588,250 and 699,500 shares were available for future grant as of
January 31, 1998 and 1997, respectively. At January 31, 1998 the
weighted-average remaining contractual life for stock options granted under the
1991 Plan and 1983 Plan was 6 years and 1 year, respectively.

EMPLOYEE STOCK PURCHASE PLAN

In September 1996, the Company's Board of Directors adopted The
MacNeal-Schwendler Corporation 1996 Employee Stock Purchase Plan. This Plan was
approved by the shareholders at the 1997 annual meeting of shareholders. Under
the Plan, a maximum of 750,000 shares of the Company's common stock have been
made available for purchase by eligible employees electing to participate in the
Plan. The Plan is intended to provide an additional incentive to participating
eligible employees, through ownership of common stock, to advance the best
interests of the Company. At January 31, 1998, a total of 176 eligible employees
elected to participate in the Plan with total payroll deductions at that date of
$407,000. Purchases totaling 90,000 shares for $627,700 and 48,500 shares for
$406,500 were exercised at July 31, 1997 and January 31, 1998 respectively.
There are 611,500 remaining shares eligible for purchase under the Plan.

STOCK-BASED COMPENSATION

The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." Accordingly, no compensation cost has
been recognized in the results of operations

32
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 12: STOCK OPTION PLANS (CONTINUED)
for the stock option grants. Had compensation cost for the Company's stock
option plans been determined based on the fair value at the grant date for
awards in fiscal 1998, 1997, and 1996 consistent with the provisions of SFAS No.
123, the Company's net income and basic earnings per share would have been
reduced to the pro forma amounts as follows:

<TABLE>
<CAPTION>
FISCAL YEAR ENDED JANUARY 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
DOLLARS IN THOUSANDS
<S> <C> <C> <C>
Net income--as reported........................... $ 11,492 $ 9,621 $ 14,407
Net income--pro forma............................. 10,179 7,803 14,070
Basic earnings per share--as reported............. 0.85 0.71 1.07
Basic earnings per share--pro forma............... 0.73 0.58 1.05
Diluted earnings per share--as reported........... 0.83 0.70 0.99
Diluted earnings per share--pro forma............. 0.73 0.58 0.98
</TABLE>

Note: Diluted earnings per share is presented as equal to or less than basic
earnings per share.

Using the Black-Scholes valuation model, the per share weighted-average fair
value of stock options granted during the fiscal years ended January 31, 1998,
1997, and 1996 was $4.62, $4.71, and $3.88, respectively.

The pro forma effect on the Company's net income and basic earnings per
share for fiscal 1998, 1997, and 1996 is not representative of the pro forma
effect in future years. The pro forma effect does not take into consideration
compensation expense related to grants made prior to fiscal 1996 or additional
grants in future years which are anticipated. The fair value of each option is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions used for grants made in fiscal 1998:
dividend yield of 0%; expected volatility of 41.9%; risk-free interest rate of
7.0%. The following weighted-average assumptions were used for grants made in
fiscal 1997: dividend yield of 0%; expected volatility of 42.0%; risk-free
interest rate of 7.5%. The following weighted average assumptions were used for
grants made in fiscal 1996: dividend yield of 4.5%; expected volatility of
28.0%; risk-free interest rate of 7.5%.

The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options. The Company's employee stock options have
characteristics significantly different from those of traded options, such as
vesting restrictions and extremely limited transferability. In addition, the
assumptions used in option valuation models (see above) are highly subjective,
particularly the expected stock price volatility of the underlying stock.
Because changes in these subjective input assumptions can materially affect the
fair value estimate, in management's opinion the existing models do not provide
a reliable single measure of the fair value of its employee stock options.

33
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 13: COMMITMENTS

The Company leases facilities and equipment under various lease agreements,
which range from one to ten years, which require the following minimum annual
rental commitments:

<TABLE>
<CAPTION>
OPERATING LEASES DOLLARS IN
YEARS ENDED JANUARY 31 THOUSANDS
- ------------------------------------------------------------------------- -------------------
<S> <C>
1999..................................................................... $ 6,178
2000..................................................................... 5,624
2001..................................................................... 3,881
2002..................................................................... 3,193
2003..................................................................... 1,873
Thereafter............................................................... 4,304
-------
$ 25,053
-------
-------
</TABLE>

The combined annual rental cost for facilities and various equipment under
operating leases approximated $5,645,000 in fiscal 1998, $5,340,000 in fiscal
1997, and $5,310,000 in fiscal 1996. In most cases management expects that in
the normal course of business, leases will be renewed or replaced by others.

The Company has an agreement with its principal bank for a $15,000,000
unsecured line of credit at the prevailing prime rate. Borrowings under the line
are subject to certain restrictive covenants. This line of credit agreement
expires August 31, 2000. The line was unused at January 31, 1998 and January 31,
1997.

At January 31, 1998, the Company had a forward exchange contract maturing in
less than one month, to exchange deutsche marks for U.S. dollars in the amount
of $1,172,000. The unrealized gain at January 31, 1998 was immaterial.

NOTE 14: SHAREHOLDERS' EQUITY

In September 1988, the Company distributed to common shareholders one right
for each outstanding share of Common Stock. Each right entitles the holder to
purchase one-half share of Common Stock at an exercise price of $50 subject to
adjustment. The rights were attached to all Common Stock certificates and no
separate right certificate will be distributed.

The rights, which do not have any shareholder rights, including voting or
dividend rights, will expire on September 19, 1998 unless earlier redeemed by
the Company prior to expiration at a price of $.01 per right. The rights
automatically transfer with a transfer of Common Stock until the time they
become exercisable, which happens when certain specified events occur. If the
rights become exercisable, they entitle the holders thereof to purchase stock or
other property of the Company at a reduced price, subject to certain other
provisions of the plan. At January 31, 1998, approximately 6,811,000 shares of
Common Stock were reserved for issuance in connection with these rights.

The debentures issued by the Company have a feature that allows the holder
to convert the debentures to Common Stock of the Company at a conversion price
of $15.15 per share. At January 31, 1998, approximately 3,734,000 shares were
reserved for issuance upon conversion of debentures.

34
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 15: EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings
per share:

Numerator:

Numerator for basic earnings per share........ $ 11,492,000 $ 9,621,000 $ 14,407,000

Effect of dilutive securities:

Interest on 7 7/8% convertible debentures,
net of tax................................ 2,941,000 2,540,000 2,838,000
------------- ------------- -------------

Numerator for diluted earnings per share...... $ 14,433,000 $ 12,161,000 $ 17,245,000
------------- ------------- -------------
------------- ------------- -------------

Denominator:

Denominator for basic earnings per
share--weighted average shares.............. 13,528,000 13,456,000 13,401,000

Effect of dilutive securities:

Employee stock options...................... 148,000 157,000 201,000

7 7/8% convertible debentures............... 3,734,000 3,734,000 3,734,000
------------- ------------- -------------

Dilutive potential common shares.............. 3,882,000 3,891,000 3,935,000
------------- ------------- -------------

Denominator for diluted earnings per
share--adjusted weighted average shares and
assumed conversions......................... 17,410,000 17,347,000 17,336,000
------------- ------------- -------------
------------- ------------- -------------

Basic earnings per share........................ $ 0.85 $ 0.71 $ 1.07
------------- ------------- -------------
------------- ------------- -------------

Diluted earnings per share...................... $ 0.83 $ 0.70 $ 0.99
------------- ------------- -------------
------------- ------------- -------------
</TABLE>

For additional disclosures regarding the convertible debentures and employee
stock options, see Notes 9 and 12.

Options to purchase 1,200,600 shares of common stock at $10.50 to $15.88 per
share were outstanding during 1998 but were not included in the computation of
diluted earnings per share because the options' exercise price was greater than
the average market price of the common shares and, therefore, the effect would
be anitdilutive.

35
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 16: QUARTERLY FINANCIAL DATA (UNAUDITED)

The following is selected quarterly financial data for the years ended
January 31, 1998 and 1997.

<TABLE>
<CAPTION>
1998
------------------------------------------
1ST 2ND 3RD 4TH
--------- --------- --------- ---------
DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER
SHARE AMOUNTS
<S> <C> <C> <C> <C>
Revenues...................................... $ 31,936 $ 32,292 $ 31,561 $ 39,061
Operating expenses, net....................... 27,832 27,529 27,161 31,081
--------- --------- --------- ---------
Operating income.............................. 4,104 4,763 4,400 7,980
Other expense, net............................ (1,186) (1,039) (588) (1,023)
--------- --------- --------- ---------
Income before income taxes.................... 2,918 3,724 3,812 6,957
Provision for income taxes.................... 992 1,266 1,296 2,365
--------- --------- --------- ---------
Net income.................................... $ 1,926 $ 2,458 $ 2,516 $ 4,592
Basic earnings per share...................... $ 0.14 $ 0.18 $ 0.19 $ 0.34
Diluted earnings per share.................... $ 0.14 $ 0.18 $ 0.19 $ 0.31
Basic weighted average shares outstanding..... 13,462,000 13,496,000 13,565,000 13,587,000
Diluted weighted average shares outstanding... 17,280,000 17,375,000 17,509,000 17,409,000
</TABLE>

<TABLE>
<CAPTION>
1997
------------------------------------------
1ST 2ND 3RD 4TH
--------- --------- --------- ---------
DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER
SHARE AMOUNTS
<S> <C> <C> <C> <C>
Revenues...................................... $ 32,192 $ 32,759 $ 31,590 $ 36,780
Operating expenses, net....................... 28,349 28,658 26,929 30,342
--------- --------- --------- ---------
Operating income.............................. 3,843 4,101 4,661 6,438
Other expense, net............................ (1,359) (1,360) (1,188) (882)
--------- --------- --------- ---------
Income before income taxes.................... 2,484 2,741 3,473 5,556
Provision for income taxes.................... 807 891 1,129 1,806
--------- --------- --------- ---------
Net income.................................... $ 1,677 $ 1,850 $ 2,344 $ 3,750
Basic earnings per share...................... $ 0.12 $ 0.14 $ 0.17 $ 0.28
Diluted earnings per share.................... $ 0.12 $ 0.14 $ 0.17 $ 0.25
Basic weighted average shares outstanding..... 13,450,000 13,454,000 13,454,000 13,457,000
Diluted weighted average shares outstanding... 17,349,000 17,211,000 17,214,000 17,234,000
</TABLE>

Note: The 1997 and the first three quarters of 1998 earnings per share
amounts have been restated to comply with SFAS No. 128, "Earnings per Share."
Diluted earnings per share is presented as equal to or less than basic earnings
per share.

36
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

To the Board of Directors and Stockholders of
The MacNeal-Schwendler Corporation

We have audited the accompanying consolidated balance sheets of The
MacNeal-Schwendler Corporation as of January 31, 1998 and 1997, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended January 31, 1998. Our audits also
included the financial statement schedule listed in the Index at Item 14 (a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of The
MacNeal-Schwendler Corporation at January 31, 1998 and 1997, and the
consolidated results of its operations and its cash flows for each of three
years in the period ended January 31, 1998, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

/s/ ERNST & YOUNG LLP

Los Angeles, California
March 12, 1998

37
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

None.

PART III

Pursuant to General Instruction G(3) to Form 10-K, the information required
by this part is incorporated by reference to such information contained in the
Company's definitive Proxy Statement for the Annual Meeting of Shareholders to
be held June 10, 1998, filed with the Securities and Exchange Commission
pursuant to Regulation 14A. In addition, the information set forth under Item 1
of this Form 10-K under the caption "Executive Officers of the Registrant" is
also incorporated herein by reference.

PART IV

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

ITEM 14(a)1. FINANCIAL STATEMENTS.

The following consolidated financial statements of The MacNeal-Schwendler
Corporation and subsidiaries as included in its annual report are included in
Item 8.

Consolidated Balance Sheets--January 31, 1998 and 1997

Consolidated Statements of Income for each of the three years in the period
ended January 31, 1998

Consolidated Statements of Cash Flows for each of the three years in the
period ended January 31, 1998

Consolidated Statements of Shareholders' Equity for each of the three years
in the period ended January 31, 1998

Notes to Consolidated Financial Statements

Report of Ernst & Young LLP, Independent Auditors

ITEM 14(a)2. FINANCIAL STATEMENT SCHEDULES.

The following financial statement schedule of The MacNeal-Schwendler
Corporation and subsidiaries is included in this Item 14:

Schedule II-Valuation and qualifying accounts

All other schedules have been omitted because the information either has
been shown in the consolidated financial statements or notes thereto, or is not
applicable or required under the instructions.

38
<PAGE>
SCHEDULE II
THE MACNEAL-SCHWENDLER CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JANUARY 31, 1998, 1997, AND 1996
(IN THOUSANDS)

<TABLE>
<CAPTION>
BALANCE AT
BEGINNING
OF CHARGES ENDING
PERIOD TO EXPENSE DEDUCTIONS BALANCE
----------- ------------- ------------- ---------
<S> <C> <C> <C> <C>
ACCOUNTS RECEIVABLE:

Year ended January 31, 1996....................................... $ 3,574 152 1,164 $ 2,562
Year ended January 31, 1997....................................... $ 2,562 616 1,372 $ 1,806
Year ended January 31, 1998....................................... $ 1,806 973 1,170 $ 1,609
</TABLE>

39
<PAGE>
ITEM 14(a)3. EXHIBITS.

The following exhibits are included in this Report:

<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ---------
<C> <S>
3.1 Certificate of Incorporation of The MacNeal-Schwendler Corporation (filed as Exhibit 3.1 to The
MacNeal-Schwendler Corporation's Registration of Securities on Form 8-B filed on September 23, 1994,
and incorporated herein by reference).

3.2 Restated Bylaws of The MacNeal-Schwendler Corporation (filed as Exhibit 3.2 to the The
MacNeal-Schwendler Corporation's Annual Report on Form 10-K filed for the fiscal year ended January
31, 1996, and incorporated herein by reference).

4.1 Rights Agreement, dated September 19, 1988, between The MacNeal-Schwendler Corporation and Bank of
America, NT&SA, as Rights Agent (filed as Exhibit 4.1 to a Current Report on Form 8-K filed October
4, 1988, and incorporated herein by reference).

4.2 Indenture, dated as of August 18, 1994, between The MacNeal-Schwendler Corporation and Chemical Trust
Company of California, as trustee (filed as part of The MacNeal-Schwendler Corporation's
Registration Statement on Form S-3 (No. 33-83174), and incorporated herein by reference).

4.3 First Supplemental Indenture, dated September 22, 1994, between The MacNeal-Schwendler Corporation and
Chemical Trust Company of California, as trustee (filed as Exhibit 4.2 of The MacNeal-Schwendler
Corporation's Quarterly Report on Form 10-Q for the quarterly period ended October 31, 1994, and
incorporated herein by reference).

4.4 Second Supplemental Indenture, dated December 14, 1994, between The MacNeal-Schwendler Corporation and
Chemical Trust Company of California, as trustee (filed as Exhibit 4.3 of The MacNeal-Schwendler
Corporation's Quarterly Report on Form 10-Q for the quarterly period ended October 31, 1994, and
incorporated herein by reference).

10.1 Form of Agreement for use of MSC/NASTRAN, as modified to September 1991 (filed as Exhibit 10.1 to The
MacNeal-Schwendler Corporation's Annual Report on Form 10-K filed for the fiscal year ended January
31, 1992, and incorporated herein by reference).

10.2 Agreement, dated October 22, 1982, between The MacNeal-Schwendler Corporation and NASA (filed as
Exhibit 10.2 to The MacNeal-Schwendler Corporation's Registration Statement on Form S-1, File No.
2-82719, and incorporated herein by reference).

10.3 Agreement of Lease, dated July 31, 1980, between The MacNeal-Schwendler Corporation and Frank De
Pietro (filed as Exhibit 10.3 to The MacNeal-Schwendler Corporation's Registration Statement on Form
S-1, File No. 2-82719, and incorporated herein by reference).

10.4* 1983 Incentive Stock Option Plan for Key Employees, as amended to January 31, 1989 (filed as Exhibit
10.4 to The MacNeal-Schwendler Corporation's Annual Report on Form 10-K filed for the year ended
January 31, 1989, and incorporated herein by reference).

10.5 Form of Indemnification Agreement between The MacNeal-Schwendler Corporation and directors, officers
and agents thereof (filed as Exhibit 10.5 to The MacNeal-Schwendler Corporation's Annual Report on
Form 10-K filed for the year ended January 31, 1989, and incorporated herein by reference).
</TABLE>

40
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ---------
<C> <S>
10.6(a) Form of Severance Agreement between The MacNeal-Schwendler Corporation and executive officers thereof
(filed as Exhibit 10.6(a) to The MacNeal-Schwendler Corporation's Annual Report on Form 10-K filed
for the year ended January 31, 1989, and incorporated herein by reference).

10.6(b) Form of Severance Agreement between The MacNeal-Schwendler Corporation and key employees (filed as
Exhibit 10.6(b) to The MacNeal-Schwendler Corporation's Annual Report on Form 10-K filed for the
year ended January 31, 1989, and incorporated herein by reference).

10.7* Amendment 1991-1 to 1983 Incentive Stock Option Plan for Key Employees (filed as Annex A to The
MacNeal-Schwendler Corporation's Annual Proxy Statement for the Annual Meeting of Shareholders held
on June 12, 1991, and incorporated herein by reference).

10.8* Amendment 1992-1 to 1983 Incentive Stock Option Plan for Key Employees (filed as part of the Annual
Proxy Statement for The MacNeal-Schwendler Corporation's Annual Meeting of Shareholders held on June
10, 1992, and incorporated herein by reference).

10.9* 1991 Stock Option Plan (filed as Annex A to The MacNeal-Schwendler Corporation's Annual Proxy
Statement for the Annual Meeting of Shareholders held on June 10, 1992, and incorporated herein by
reference).

10.10* 1991 Stock Option Plan Amendment (filed as part of the Company's definitive Proxy Statement for the
Annual Meeting of Shareholders on June 14, 1995, and incorporated herein by reference).

21 Material Subsidiaries of the Registrant (filed as Exhibit 21 to The MacNeal-Schwendler Coporation's
Annual Report on Form 10-K filed for the fiscal year ended January 31, 1996, and incorporated herein
by reference).

23 Consent of Ernst & Young LLP, Independent Auditors.

27.1 Financial Data Schedule for the year ended January 31, 1998.

27.2 Restated Financial Data Schedule for the quarter ended October 31, 1997.
</TABLE>

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

* Denotes compensatory plan.

ITEM 14(b). REPORTS ON FORM 8-K.

None.

41
<PAGE>
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

THE MACNEAL-SCHWENDLER CORPORATION

By /s/ THOMAS C. CURRY
-----------------------------------------
Thomas C. Curry
PRESIDENT, CHIEF EXECUTIVE
OFFICER AND DIRECTOR

Dated: April 22, 1998

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

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------

/s/ GEORGE N. RIORDAN
- ------------------------------ Chairman of the Board April 27, 1998
George N. Riordan

/s/ THOMAS C. CURRY
- ------------------------------ President, Chief Executive April 22, 1998
Thomas C. Curry Officer and Director

/s/ LOUIS A. GRECO Chief Financial Officer
- ------------------------------ (Principal Financial and April 22, 1998
Louis A. Greco Accounting Officer)

/s/ LARRY S. BARELS
- ------------------------------ Director April 27, 1998
Larry S. Barels

/s/ DONALD GLICKMAN
- ------------------------------ Director April 27, 1998
Donald Glickman

/s/ WILLIAM F. GRUN
- ------------------------------ Director April 27, 1998
William F. Grun

/s/ HAROLD HARRIGIAN
- ------------------------------ Director April 27, 1998
Harold Harrigian

/s/ PAUL B. MACCREADY
- ------------------------------ Director April 27, 1998
Paul B. Maccready
</TABLE>

42
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------

<C> <S> <C>
/s/ DALE D. MYERS
- ------------------------------ Director April 27, 1998
Dale D. Myers

/s/ FRANK PERNA
- ------------------------------ Director April 27, 1998
Frank Perna

/s/ ARTHUR H. REIDEL
- ------------------------------ Director April 27, 1998
Arthur H. Reidel
</TABLE>

<PAGE>
EXHIBIT 23

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 2-93416, 33-51744, 33-65239, and 333-12189) pertaining to the
1983 Incentive Stock Option Plan for Key Employees, the 1991 Stock Option Plan
of The MacNeal-Schwendler Corporation, and The MacNeal-Schwendler Corporation
1996 Employee Stock Purchase Plan and in the related Prospectuses of our report
dated March 12, 1998, with respect to the consolidated financial statements and
schedule of The MacNeal-Schwendler Corporation included in the Annual Report
(Form 10-K) for the year ended January 31, 1998.

/s/ Ernst & Young LLP

Los Angeles, California
April 27, 1998

<PAGE>
<ARTICLE> 5
<CIK> 0000717238
<NAME> MACNEAL SCHWENDLER CORPORATION
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JAN-31-1998
<PERIOD-START> FEB-01-1997
<PERIOD-END> JAN-31-1998
<EXCHANGE-RATE> 1
<CASH> 10,086
<SECURITIES> 16,073
<RECEIVABLES> 50,700
<ALLOWANCES> 1,609
<INVENTORY> 0
<CURRENT-ASSETS> 85,915
<PP&E> 36,841
<DEPRECIATION> 27,915
<TOTAL-ASSETS> 140,283
<CURRENT-LIABILITIES> 38,162
<BONDS> 56,574
0
0
<COMMON> 31,482
<OTHER-SE> 3,082
<TOTAL-LIABILITY-AND-EQUITY> 140,283
<SALES> 0
<TOTAL-REVENUES> 134,850
<CGS> 25,655
<TOTAL-COSTS> 113,603
<OTHER-EXPENSES> (620)
<LOSS-PROVISION> 594
<INTEREST-EXPENSE> 4,456
<INCOME-PRETAX> 17,411
<INCOME-TAX> 5,919
<INCOME-CONTINUING> 11,492
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 11,492
<EPS-PRIMARY> 0.85
<EPS-DILUTED> 0.83

</TABLE>

<PAGE>
<ARTICLE> 5
<RESTATED>
<CIK> 0000717238
<NAME> MACNEAL SCHWENDLER CORPORATION
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS

<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-31-1998
<PERIOD-START> AUG-01-1997
<PERIOD-END> OCT-31-1997
<EXCHANGE-RATE> 1
<CASH> 14,880
<SECURITIES> 10,546
<RECEIVABLES> 38,805
<ALLOWANCES> 1,573
<INVENTORY> 0
<CURRENT-ASSETS> 70,840
<PP&E> 35,756
<DEPRECIATION> 26,746
<TOTAL-ASSETS> 125,876
<CURRENT-LIABILITIES> 29,582
<BONDS> 56,574
0
0
<COMMON> 31,045
<OTHER-SE> (992)
<TOTAL-LIABILITY-AND-EQUITY> 125,876
<SALES> 0
<TOTAL-REVENUES> 31,561
<CGS> 6,474
<TOTAL-COSTS> 27,161
<OTHER-EXPENSES> (526)
<LOSS-PROVISION> 236
<INTEREST-EXPENSE> 1,114
<INCOME-PRETAX> 3,812
<INCOME-TAX> 1,296
<INCOME-CONTINUING> 2,516
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,516
<EPS-PRIMARY> 0.19
<EPS-DILUTED> 0.18

</TABLE>