<PAGE>
===============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE PERIOD ENDED SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ___________ To ___________
COMMISSION FILE NUMBER 1-8722
MSC.SOFTWARE 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
LOS ANGELES, CALIFORNIA 90041
- ---------------------------------------- ------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(323) 258-9111
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
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 .
--- ---
As of November 1, 1999, the number of shares outstanding of the
Registrant's Common Stock, par value $0.01 per share, was 13,841,624.
================================================================================
<PAGE>
MSC.SOFTWARE CORPORATION
INDEX TO FORM 10-Q
SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
September 30, 1999 (Unaudited) and December 31, 1998 3
Consolidated Statements of Operations (Unaudited)
Three and Nine Month Periods Ended September 30, 1999 and 1998 4
Consolidated Statements of Cash Flows (Unaudited)
Nine Month Periods Ended September 30, 1999 and 1998 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 30
PART II. OTHER INFORMATION
Item 2. Changes In Securities and Use of Proceeds 31
Item 5. Other Information 31
Item 6. Exhibits and Reports on Form 8-K 31
</TABLE>
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(Unaudited)
ASSETS
<S> <C> <C>
Current Assets:
Cash and Cash Equivalents $ 19,488,000 $ 10,822,000
Securities Available for Sale 2,587,000 16,481,000
Trade Accounts Receivable, Net 27,721,000 39,674,000
Deferred Tax Charges 6,348,000 6,288,000
Other Current Assets 11,388,000 7,866,000
------------ ------------
Total Current Assets 67,532,000 81,131,000
Property and Equipment, Net 8,324,000 8,895,000
Capitalized Software Costs, Net 20,666,000 21,034,000
Goodwill, Net 28,676,000 11,146,000
Other Intangible Assets, Net 36,820,000 12,850,000
Other Assets 3,601,000 3,773,000
------------ ------------
TOTAL ASSETS $165,619,000 $138,829,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts Payable $ 2,111,000 $ 3,159,000
Obligation to MARC Shareholders 726,000 --
Line of Credit -- 10,800,000
Accrued and Other Liabilities 23,357,000 23,838,000
Restructuring Reserve 4,513,000 695,000
Deferred Revenue 31,247,000 20,903,000
------------ ------------
Total Current Liabilities 61,954,000 59,395,000
------------ ------------
Deferred Income Taxes 14,120,000 5,173,000
Convertible Subordinated Debentures 58,273,000 56,574,000
Subordinated Notes Payable 12,001,000 --
Commitments and Contingencies
Shareholders' Equity:
Preferred Stock, $0.01 Par Value, 10,000,000 Shares Authorized;
No Shares Outstanding -- --
Common Stock, $0.01 Par Value, 100,000,000 Shares Authorized;
13,842,000 and 13,711,000 Issued and Outstanding at
September 30, 1999 and December 31, 1998, Respectively 32,452,000 31,754,000
Common Stock Warrants 3,883,000 556,000
Accumulated Deficit (12,330,000) (11,404,000)
Accumulated Comprehensive Loss (4,734,000) (3,219,000)
------------ ------------
Total Shareholders' Equity 19,271,000 17,687,000
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $165,619,000 $138,829,000
============ ============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
3
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- -----------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Software Licenses $27,314,000 $19,658,000 $68,959,000 $69,937,000
Software Maintenance and Services 11,611,000 9,117,000 34,061,000 26,287,000
----------- ----------- ----------- -----------
Total Revenues 38,925,000 28,775,000 103,020,000 96,224,000
----------- ----------- ----------- -----------
Operating Expenses:
Cost of Revenue 8,649,000 9,049,000 27,279,000 27,635,000
Research and Development 5,472,000 3,382,000 14,927,000 8,973,000
Selling, General and Administrative 18,822,000 14,353,000 52,695,000 47,410,000
Amortization of Goodwill and Other Intangibles 2,450,000 567,000 4,815,000 1,701,000
Restructuring Charges -- -- 5,497,000 --
Write-Off of Acquired In-Process Technology -- -- 4,067,000 --
----------- ----------- ----------- -----------
Total Operating Expenses 35,393,000 27,351,000 109,280,000 85,719,000
----------- ----------- ----------- -----------
OPERATING INCOME (LOSS) 3,532,000 1,424,000 (6,260,000) 10,505,000
----------- ----------- ----------- -----------
Other Expense (Income):
Interest Expense 1,543,000 1,114,000 4,145,000 3,347,000
Gain on Sale of Investment -- -- (10,773,000) --
Other Expense (Income), Net 205,000 (719,000) (48,000) (1,376,000)
----------- ----------- ----------- -----------
Total Other Expense (Income), Net 1,748,000 395,000 (6,676,000) 1,971,000
----------- ----------- ----------- -----------
INCOME BEFORE PROVISION FOR
INCOME TAXES 1,784,000 1,029,000 416,000 8,534,000
Provision for Income Taxes 571,000 350,000 1,342,000 2,902,000
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ 1,213,000 $ 679,000 $ (926,000) $ 5,632,000
=========== =========== =========== ============
BASIC EARNINGS (LOSS) PER SHARE $ 0.09 $ 0.05 $ (0.07) $ 0.41
=========== =========== =========== ===========
DILUTED EARNINGS (LOSS) PER SHARE $ 0.09 $ 0.05 $ (0.07) $ 0.41
=========== =========== =========== ===========
BASIC WEIGHTED-AVERAGE SHARES OUTSTANDING 13,818,000 13,596,000 13,885,000 13,637,000
=========== =========== =========== ===========
DILUTED WEIGHTED-AVERAGE SHARES OUTSTANDING 13,885,000 13,619,000 13,885,000 13,770,000
=========== =========== =========== ===========
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
4
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1999 1998
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) $ (926,000) $ 5,632,000
Adjustments to Reconcile Net Income (Loss) to Net Cash Provided By
Operating Activities:
Depreciation and Amortization of Property and Equipment 3,647,000 3,954,000
Amortization of Capitalized Software Costs 6,341,000 9,314,000
Impairment of Capitalized Software Costs 1,500,000 --
Amortization of Goodwill and Other Intangibles 4,815,000 1,701,000
Write-Off of Acquired In-Process Technology 4,067,000 --
Amortization of Premiums and Discounts 286,000 54,000
Deferred Income Taxes 229,000 3,219,000
(Gain) Loss on Disposal of Property and Equipment 19,000 (12,000)
Gain on Sale of Investment (10,733,000) --
Changes in Assets and Liabilities:
Trade Accounts Receivable, Net 16,349,000 (278,000)
Other Current Assets (1,689,000) (3,354,000)
Accounts Payable (1,825,000) (1,150,000)
Accrued and Other Liabilities (3,314,000) (2,516,000)
Restructuring Reserve 3,818,000 --
Deferred Revenue 6,374,000 3,352,000
------------- ------------
Net Cash Provided By Operating Activities 28,958,000 19,916,000
------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Securities Available for Sale (6,650,000) (5,377,000)
Sale of Securities Available for Sale 20,544,000 3,650,000
Acquisition of Property and Equipment (1,912,000) (4,463,000)
Proceeds from Sale of Investment 12,000,000 --
Cash Paid for Businesses Acquired, Net of Cash Received (25,418,000) (13,000)
Purchase of Software (1,089,000) (643,000)
Capitalized Internal Software Development Costs (6,329,000) (9,638,000)
Other (120,000) (154,000)
------------- ------------
Net Cash Used In Investing Activities (8,974,000) (16,638,000)
------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment on Line of Credit (10,800,000) --
Issuance of Common Stock 698,000 1,386,000
Issuance of Common Stock Warrants 289,000 412,000
Retirement of Capital Stock -- (2,226,000)
Other (1,000) --
------------- ------------
Net Cash Used In Financing Activities (9,814,000) (428,000)
------------- ------------
Translation Adjustment (1,504,000) (269,000)
------------- ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 8,666,000 2,581,000
Cash and Cash Equivalents at Beginning of Period 10,822,000 10,846,000
------------- ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 19,488,000 $ 13,427,000
============= ============
RECONCILIATION OF CASH PAID FOR BUSINESSES ACQUIRED, NET OF CASH RECEIVED:
Fair Value of Assets Acquired $ 58,895,000 $ 1,986,000
Non-Cash Financing of Purchase Price and Liabilities Assumed:
Obligation to MARC Shareholders (726,000) --
Issuance of Convertible Subordinated Debentures (1,700,000) --
Issuance of Subordinated Notes Payable (11,715,000) --
Issuance of Common Stock -- (1,542,000)
Issuance of Common Stock Warrants (3,038,000) --
Issuance of Note Payable -- (300,000)
Liabilities Assumed (16,298,000) (131,000)
------------- ------------
Cash Paid for Businesses Acquired, Net of Cash Received $ 25,418,000 $ 13,000
============= ============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
5
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
NOTE 1 - BASIS OF PRESENTATION
As previously disclosed in a Form 8-K filed on July 1, 1999,
MSC.Software Corporation ("the Company") changed its name from The
MacNeal-Schwendler Corporation, as voted upon and approved by its
stockholders.
In January 1999, the Company changed its reporting period from a
January 31 fiscal year-end to a December 31 calendar year-end basis. As part
of this change, the Company elected to present restated financial results for
previous periods on a calendar year basis.
The accompanying unaudited consolidated financial statements of the
Company have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three and nine month periods ended September 30, 1999 are not
necessarily indicative of the results that may be expected for the year
ending December 31, 1999.
The balance sheet as of December 31, 1998 has been derived from the
audited financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements.
For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Transition Report
on Form 10-K for the year ended December 31, 1998.
NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS
In the fourth quarter of 1998, the Accounting Standards Executive
Committee of the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-9, "Modification of SOP 97-2 - Software
Revenue Recognition with Respect to Certain Transactions", which retained the
restrictive definition of what qualified for vendor specific objective
evidence ("VSOE") of fair value for allocating a contract fee among the
various elements of an arrangement. VSOE must be known for all undelivered
elements of an arrangement, such as post-sales customer support ("PCS"). As
permitted, the Company adopted the provisions of SOP 98-9 effective October
1, 1998 and, accordingly, revenue on non-cancelable and prepaid lease
agreements is recognized monthly over the term of the agreement, beginning in
the fourth quarter of 1998, since the VSOE of fair value required under SOP
97-2 to allocate the contract fee to the undelivered PCS element of the
arrangements is not available. Because SOP 98-9 does not permit restatements
of prior periods and because there are annual license renewals in every month
of the year, the entire effect of this change in revenue recognition will not
be fully recognized in reported revenue on a quarterly basis until the fourth
quarter of 1999. The year 2000 will be the first reported year that will
reflect a full twelve months of revenue under this method of revenue
recognition for annual licenses.
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended by SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of SFAS No. 133", which is required to be adopted in all
fiscal years beginning after June 15, 2000. Because of the Company's minimal
use of derivatives, management does not anticipate that the adoption of the
new Statement will have a significant effect on earnings or the financial
position of the Company.
6
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 1999
NOTE 3 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings (loss) per share:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ----------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
(Unaudited)
<S> <C> <C> <C> <C>
NUMERATOR:
Numerator for Basic Earnings (Loss) Per
Share - Net Income (Loss) $ 1,213,000 $ 679,000 $ (926,000) $ 5,632,000
Effect of Dilutive Securities - Interest on
7-7/8% Convertible Subordinated
Debentures, Net of Tax -- (1) -- (1) -- (1) -- (1)
---------- ---------- ---------- ----------
Numerator for Diluted Earnings (Loss)
Per Share $ 1,213,000 $ 679,000 $ (926,000) $ 5,632,000
=========== ========== ========== ===========
DENOMINATOR:
Denominator for Basic Earnings (Loss)
Per Share - Weighted-Average
Shares Outstanding 13,818,000 13,596,000 13,885,000 13,637,000
Effect of Dilutive Securities:
Employee Stock Options 67,000 23,000 -- (1) 133,000
7-7/8% Convertible Debentures -- (1) -- (1) -- (1) -- (1)
---------- ---------- ---------- ----------
Dilutive Potential Common Shares 67,000 23,000 - 133,000
---------- ---------- ---------- ----------
Denominator for Diluted Earnings
(Loss) Per Share - Adjusted
Weighted-Average Shares and
Assumed Conversions 13,885,000 13,619,000 13,885,000 13,770,000
========== ========== ========== ==========
BASIC EARNINGS (LOSS) PER SHARE $ 0.09 $ 0.05 $ (0.07) $ 0.41
========== ========== ========== ==========
DILUTED EARNINGS (LOSS) PER SHARE $ 0.09 $ 0.05 $ (0.07) $ 0.41
========== ========== ========== ==========
</TABLE>
(1) ANTI-DILUTIVE OPTIONS AND DEBENTURES ARE EXCLUDED FROM THE CALCULATION OF
DILUTED EARNINGS (LOSS) PER SHARE FOR THE PERIODS INDICATED.
7
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 1999
NOTE 4 - COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss) are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ---------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
(Unaudited)
<S> <C> <C> <C> <C>
Net Income (Loss) $ 1,213,000 $ 679,000 $ (926,000) $ 5,632,000
Change in:
Accumulated Translation Adjustment 1,121,000 (841,000) (1,504,000) (676,000)
Unrealized Gain (Loss) on Securities
Available for Sale -- 3,000 (11,000) 3,000
----------- ----------- ----------- -----------
Comprehensive Income (Loss) $ 2,334,000 $ (159,000) $(2,441,000) $ 4,959,000
=========== =========== =========== ===========
</TABLE>
The Company does not provide any deferred tax benefit for translation
adjustment because the recoverability of the benefit is not anticipated in the
foreseeable future and the amount of tax associated with the unrealized gain
(loss) was immaterial.
NOTE 5 - CAPITALIZED SOFTWARE COSTS
The components of capitalized software costs, as they affected
operating income, are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
(Unaudited)
<S> <C> <C> <C> <C>
Capitalized Internal Software Development Costs $(2,396,000) $(2,916,000) $(6,329,000) $(9,638,000)
Amortization of Capitalized Software Costs 2,112,000 2,871,000 6,341,000 9,314,000
Impairment of Capitalized Software Costs -- -- 1,500,000 --
----------- ----------- ----------- -----------
Net (Increase) Decrease in Operating Income $ (284,000) $ (45,000) $ 1,512,000 $ (324,000)
=========== =========== =========== ===========
</TABLE>
Amortization expense associated with capitalized software costs is
reported in cost of revenue, and capitalized software costs, net of reserves, is
reported as a reduction of research and development expense.
The Company recognizes impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amounts. No loss was recorded in the third quarter of 1999.
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 1999
NOTE 6 - ACCRUED AND OTHER LIABILITIES
The components of accrued and other liabilities are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
----------- -----------
(Unaudited)
<S> <C> <C>
Compensation and Related Expenses $ 5,742,000 $ 6,412,000
Pension and Profit Sharing 3,294,000 3,725,000
Sales Taxes Payable 2,267,000 2,896,000
Incentive Compensation 1,702,000 1,222,000
Commissions Payable 983,000 1,226,000
Royalties Payable 768,000 1,169,000
Interest Payable 583,000 1,332,000
Other 8,018,000 5,856,000
----------- -----------
Total Accrued and Other Liabilities $23,357,000 $23,838,000
=========== ===========
</TABLE>
NOTE 7 - BUSINESS ACQUISITIONS
KNOWLEDGE REVOLUTION INC.
In late December 1998, the Company acquired Knowledge Revolution Inc.
("KR") for approximately $19,200,000 in cash. KR was the world's leading
developer and distributor of 2D and 3D-motion simulation software for design
engineers and analysts. The acquisition has been accounted for as a purchase.
The total purchase price was allocated to the assets and liabilities of KR based
on their approximate fair market value. The appraisal of the acquired business
included $6,000,000 of purchased in-process research and development, which was
related to three products under development. This valuation represents the
five-year after tax cash flow of this in-process technology using a discount
rate of 28%. The acquired technology had not yet reached technological
feasibility and had no future alternative uses. Accordingly, it was written off
at the time of the acquisition. The remaining purchase price was allocated as
follows: $800,000 to net tangible assets; $9,890,000 to identified intangible
assets, including $5,200,000 of value-added reseller distribution channel,
$4,300,000 of developed technology, and $390,000 of assembled work force; and
$2,510,000 to goodwill. Goodwill and identified intangibles are being amortized
over three to ten years.
MARC ANALYSIS RESEARCH CORPORATION
On June 18, 1999, the Company acquired MARC Analysis Research
Corporation ("MARC"), a California corporation. The aggregate fair value of
the consideration paid to shareholders and holders of options of MARC
resulted in a purchase price valued at approximately $36,500,000, which
consisted of approximately $20,300,000 in cash and a package of securities,
including $11,000,000 principal amount of 8% subordinated notes due in 10
years, $3,236,000 principal amount of 8% subordinated notes due in two years,
$2,000,000 principal amount of the Company's 7-7/8% convertible subordinated
debentures due August 18, 2004, and five year warrants to purchase 1,400,000
shares of the Company's common stock at an exercise price of $10.00 per share.
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 1999
NOTE 7 - BUSINESS ACQUISITIONS (Continued)
The acquisition has been accounted for as a purchase and,
accordingly, the operating results of MARC have been included in the
Company's consolidated financial statements since the date of acquisition.
The total purchase price was allocated to the assets and liabilities of MARC
based upon their approximate fair values. The appraisal of the acquired
business included $4,067,000 of purchased in-process research and
development, which was related to two products under development. This
valuation represents the ten-year after-tax cash flow of this in-process
technology using a discount rate of 18%. The acquired technology had not yet
reached technological feasibility and had no future alternative uses.
Accordingly, it was written off at the time of the acquisition. The remaining
purchase price was allocated as follows: $4,653,000 to net tangible assets;
$8,718,000 to deferred income tax liability related to identified intangible
assets; $2,360,000 to restructuring costs related to the integration of MARC;
$29,710,000 to identified intangible assets (including $15,274,000 of
developed technology, $6,322,000 to customer list, $2,390,000 for tradename
recognition, and $1,657,000 of assembled work force); and $13,215,000 to
goodwill. Goodwill and identified intangibles are being amortized over their
estimated useful lives.
UNIVERSAL ANALYTICS INC.
On June 24, 1999, the Company acquired Universal Analytics, Inc.
("UAI"), a California corporation, for cash. UAI is a developer and
distributor of finite element analysis software and engineering services for
the engineering community and to major manufacturers worldwide.
NOTE 8 - COMMON STOCK WARRANTS
On March 9, 1998, the Company entered into a joint-development and
marketing arrangement with Kubota Solid Technology Corporation ("KSTC"). This
arrangement allows KSTC to purchase warrants, with an aggregate exercise
price of up to $3,000,000, to purchase shares of the Company's common stock.
The exercise price is equal to the fair market value of the common stock on
the date of issuance of the warrants. The warrants are non-transferable, have
a five-year term and become exercisable two years after the date of issuance.
The arrangement also provides KSTC with marketing rights to a specific
technology being developed.
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 1999
NOTE 8 - COMMON STOCK WARRANTS (Continued)
The Company records service revenue related to the development
effort and marketing rights provided under the arrangement and issues
warrants to KSTC. The following table shows the service revenue recorded and
warrants issued for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C> <C>
Service Revenue Recorded $ 234,000 $ 713,000 $ 694,000 $ 713,000
Value of Warrants Issued $ 141,000 $ 140,000 $ 289,000 $ 412,000
Shares of Common Stock 64,516 60,606 127,016 131,789
Average Exercise Price $ 5.8125 $ 6.1875 $ 5.9063 $ 9.1250
</TABLE>
The warrants were recorded at fair value under the Black-Scholes
valuation method. From March 9, 1998 through September 30, 1999, the Company
has issued warrants to purchase 312,859 shares of the Company's common stock
at exercise prices which range between $5.8125 per share and $11.375 per
share, for a total exercise price of $2,250,000. KSTC has the right to
purchase additional warrants with an aggregate exercise price of $750,000
through December 31, 1999 under the arrangement.
The Company has no obligation under the arrangement to produce a
commercially viable product or technology or to refund any monies contributed
by KSTC.
NOTE 9 - RESTRUCTURING RESERVE
On February 3, 1999, the Company announced a new organizational
structure following a re-evaluation of its business strategy. The
reorganization plan provided for a 10% reduction in the Company's worldwide
workforce (a reduction of approximately 75 positions), and the consolidation
of 15 field offices. These changes resulted in pre-tax charges of $5,897,000
during the first quarter of 1999. The charges consisted of severance costs of
$3,200,000, costs related to facility consolidations of $2,200,000, and other
charges of $497,000.
During the second quarter of 1999, as part of the acquisitions of
MARC and UAI, the Company recorded $2,566,000 of additional acquisition costs
included in the purchase price allocation, resulting in additional goodwill,
related to the integration of MARC and UAI into the Company. These charges
primarily consisted of severance costs of $1,161,000 and costs related to
facility consolidations of $1,405,000.
As of September 30, 1999, the restructuring liability was
$4,513,000. During the nine months ended September 30, 1999, cash outlays
were $4,245,000 in conjunction with the $8,758,000 of restructuring charges
and acquisition costs in the last quarter of 1998 and the first two quarters
of 1999. These outlays are anticipated to be completed by the end of 1999,
excluding certain lease commitments that may continue into the year 2001.
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 1999
NOTE 9 - RESTRUCTURING RESERVE (Continued)
The following is the activity in the restructuring reserve for the
periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C> <C>
Balance at Beginning of Period $ 5,773,000 $ -- $ 695,000 $ --
Charges to Expense -- -- 5,897,000 --
Reversal of Restructuring Costs -- -- (400,000) --
Acquisition Costs Capitalized -- -- 2,566,000 --
Amounts Paid (1,260,000) -- (4,245,000) --
------------ ------------ ------------ ------------
Balance at End of Period $ 4,513,000 $ -- $ 4,513,000 $ --
============ ============ ============ ============
</TABLE>
NOTE 10 - SEGMENT INFORMATION
The Company operates in a single reportable segment. International
Operations consists primarily of foreign sales offices selling software
developed in the United States combined with local service revenue. The
following table summarizes the revenues of the Company's operations by
geographic location:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C> <C>
Revenues:
The Americas (1) $ 17,590,000 $ 14,133,000 $ 48,027,000 $ 46,779,000
Europe 11,623,000 9,033,000 31,654,000 29,377,000
Asia-Pacific 9,712,000 5,609,000 23,339,000 20,068,000
------------ ------------ ------------ ------------
Total Revenue $ 38,925,000 $ 28,775,000 $103,020,000 $ 96,224,000
============ ============ ============ ============
</TABLE>
(1) Substantially the United States
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEPTEMBER 30, 1999
NOTE 10 - SEGMENT INFORMATION (Continued)
The following table summarizes the identifiable assets of the
Company's operations by geographic location:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- -------------
(Unaudited)
<S> <C> <C>
Identifiable Assets:
The Americas (1) $ 125,120,000 $ 100,267,000
Europe 26,163,000 26,353,000
Asia-Pacific 14,336,000 12,209,000
------------- -------------
Total Identifiable Assets $ 165,619,000 $ 138,829,000
============= =============
</TABLE>
(1) Substantially the United States
The net assets of the Company's foreign subsidiaries (excluding
intercompany items) totaled $17,765,000 and $16,875,000 as of September 30,
1999 and December 31, 1998, respectively. Long-lived assets included in these
amounts were $4,739,000 and $4,413,000 as of September 30, 1999 and December
31, 1998, respectively.
NOTE 11 - SUBSEQUENT EVENT
BUSINESS ACQUISITION - COMPUTERIZED STRUCTURAL ANALYSIS AND RESEARCH
CORPORATION
On November 4, 1999, the Company acquired Computerized Structural
Analysis and Research Corporation ("CSAR") for cash and warrants. The
acquisition has been accounted for as a purchase and, accordingly, the
operating results of CSAR are not included in the Company's consolidated
financial statements presented herein. The pro forma effect of the CSAR
acquisition is immaterial to the consolidated financial statements presented
herein. CSAR is a developer and distributor of finite element analysis
software and services for the engineering community and to major
manufacturers worldwide. The Company financed a portion of the purchase price
through an $8,000,000 term loan.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
RECENT DEVELOPMENTS
CHANGE OF CORPORATION NAME
As previously disclosed in a Form 8-K filed on July 1, 1999,
MSC.Software Corporation ("the Company") changed its name from The
MacNeal-Schwendler Corporation, as voted upon and approved by its
stockholders.
ACCOUNTING CHANGES
In January 1999, the Company changed its reporting period from a
January 31 fiscal year-end to a December 31 calendar year-end basis. As part
of this change, the Company elected to present restated financial results for
previous periods on a calendar year basis.
In the fourth quarter of 1998, the Accounting Standards Executive
Committee of the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-9, "Modification of SOP 97-2 - Software
Revenue Recognition with Respect to Certain Transactions", which retained the
restrictive definition of what qualified for vendor specific objective
evidence ("VSOE") of fair value for allocating a contract fee among the
various elements of an arrangement. VSOE must be known for all undelivered
elements of an arrangement, such as post-sales customer support ("PCS"). As
permitted, the Company adopted the provisions of SOP 98-9 effective October
1, 1998 and, accordingly, revenue on non-cancelable and prepaid lease
agreements is recognized monthly over the term of the agreement, beginning in
the fourth quarter of 1998, since the VSOE of fair value required under SOP
97-2 to allocate the contract fee to the undelivered PCS element of the
arrangements is not available. Because SOP 98-9 does not permit restatements
of prior periods and because there are annual license renewals in every month
of the year, the entire effect of this change in revenue recognition will not
be fully recognized in reported revenue on a quarterly basis until the fourth
quarter of 1999. The year 2000 will be the first reported year that will
reflect a full twelve months of revenue under this method of revenue
recognition for annual licenses.
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended by SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of SFAS No. 133", which is required to be adopted in all
fiscal years beginning after June 15, 2000. Because of the Company's minimal
use of derivatives, management does not anticipate that the adoption of the
new Statement will have a significant effect on earnings or the financial
position of the Company.
BUSINESS ACQUISITIONS
KNOWLEDGE REVOLUTION INC. - In late December 1998, the Company
acquired Knowledge Revolution Inc. ("KR") for approximately $19,200,000 in
cash. KR was the world's leading developer and distributor of 2D and
3D-motion simulation software for design engineers and analysts. The
acquisition has been accounted for as a purchase. The total purchase price
was allocated to the assets and liabilities of KR based on their approximate
fair market value. The appraisal of the acquired business included $6,000,000
of purchased in-process research and development, which was related to three
products under development. This valuation represents the five-year after tax
cash flow of this in-process technology using a discount rate of 28%. The
acquired technology had not yet reached technological feasibility and had no
future alternative uses. Accordingly, it was written off at the time of the
acquisition. The remaining purchase price was allocated as follows: $800,000
to net tangible assets; $9,890,000 to identified intangible assets, including
$5,200,000 of value-added reseller distribution channel, $4,300,000 of
developed technology, and $390,000 of assembled work force; and $2,510,000 to
goodwill. Goodwill and identified intangibles are being amortized over three
to ten years.
14
<PAGE>
MARC ANALYSIS RESEARCH CORPORATION - On June 18, 1999, the Company
acquired MARC Analysis Research Corporation ("MARC"), a California
corporation. The aggregate fair value of the consideration paid to
shareholders and holders of options of MARC resulted in a purchase price
valued at approximately $36,500,000, which consisted of approximately
$20,300,000 in cash and a package of securities, including $11,000,000
principal amount of 8% subordinated notes due in 10 years, $3,236,000
principal amount of 8% subordinated notes due in two years, $2,000,000
principal amount of the Company's 7-7/8% convertible subordinated debentures
due August 18, 2004, and five year warrants to purchase 1,400,000 shares of
the Company's common stock at an exercise price of $10.00 per share.
The acquisition has been accounted for as a purchase and,
accordingly, the operating results of MARC have been included in the
Company's consolidated financial statements since the date of acquisition.
The total purchase price was allocated to the assets and liabilities of MARC
based upon their approximate fair values. The appraisal of the acquired
business included $4,067,000 of purchased in-process research and
development, which was related to two products under development. This
valuation represents the ten-year after-tax cash flow of this in-process
technology using a discount rate of 18%. The acquired technology had not yet
reached technological feasibility and had no future alternative uses.
Accordingly, it was written off at the time of the acquisition. The remaining
purchase price was allocated as follows: $4,653,000 to net tangible assets;
$8,718,000 to deferred income tax liability related to identified intangible
assets; $2,360,000 to restructuring costs related to the integration of MARC;
$29,710,000 to identified intangible assets (including $15,274,000 of
developed technology, $6,322,000 to customer list, $2,390,000 for tradename
recognition, and $1,657,000 of assembled work force); and $13,215,000 to
goodwill. Goodwill and identified intangibles are being amortized over their
estimated useful lives.
UNIVERSAL ANALYTICS INC. - On June 24, 1999, the Company acquired
Universal Analytics, Inc. ("UAI"), a California corporation, for cash. UAI is
a developer and distributor of finite element analysis software and
engineering services for the engineering community and to major manufacturers
worldwide.
COMPUTERIZED STRUCTURAL ANALYSIS AND RESEARCH CORPORATION - On
November 4, 1999, the Company acquired Computerized Structural Analysis and
Research Corporation ("CSAR") for cash and warrants. The acquisition has been
accounted for as a purchase and, accordingly, the operating results of CSAR
are not included in the Company's consolidated financial statements presented
herein. CSAR is a developer and distributor of finite element analysis
software and services for the engineering community and to major
manufacturers worldwide. The Company financed a portion of the purchase price
through an $8,000,000 term loan.
RESTRUCTURING
On February 3, 1999, the Company announced a new organizational
structure following a re-evaluation of its business strategy. The Company now
emphasizes the expansion of the software business into new markets and
value-added integration services. The new structure is designed to better
serve the existing customer base and at the same time address growth
opportunities. The reorganization plan provided for a 10% reduction in the
Company's worldwide workforce (a reduction of approximately 75 positions),
and the consolidation of 15 field offices. These changes resulted in pre-tax
charges of approximately $5,897,000 in the first quarter of 1999. The charges
consisted of severance costs of $3,200,000, costs related to facility
consolidations of $2,200,000 and other charges of $497,000. The Company
anticipates these charges will provide a reduction in its annual operating
costs.
During the second quarter of 1999, as part of the acquisitions of
MARC and UAI, the Company recorded $2,566,000 of additional acquisition costs
included in the purchase price allocation, resulting in additional goodwill,
related to the integration of MARC and UAI into the Company. These charges
primarily consisted of severance costs of $1,161,000 and costs related to
facility consolidations of $1,405,000.
As of September 30, 1999, the restructuring liability was
$4,513,000. During the nine months ended September 30, 1999, cash outlays
were $4,245,000 in conjunction with the $8,758,000 of restructuring charges
and acquisition costs in the last quarter of 1998 and the first two quarters
of 1999. These outlays are anticipated to be completed by the end of 1999,
excluding certain lease commitments that may continue into the year 2001.
15
<PAGE>
ENGINEERING-E.COM
In March 1999, the Company created Engineering-e.com.
Engineering-e.com is an e-commerce marketplace designed to serve the ten
million independent engineers in the world today and their customers.
Independent engineers include entrepreneurs and consultants, engineers in
companies large or small, aspiring student engineers and their professors.
Engineering-e.com's marketplace will bring together these customers with
merchants offering the essentials for engineering. Qualified providers of
software, services, and other engineering resources can apply to be merchants
in the Engineering-e.com marketplace. Engineering-e.com's web site is located
at URL http://www.engineering-e.com.
Engineering-e.com is also providing the e-commerce channel for
selected Company products for broad access by independent engineers through
its onDemand Licensing offering. onDemand Licensing is the first Internet pay
per use licensing facility developed exclusively for the engineering
community. The scalable infrastructure developed allows engineers the ability
to rent the Company's software products to run on their own computer by the
week or the month, significantly lowering their up-front investment.
MSC.Nastran and MSC.Dytran, two of the Company's flagship engineering
software products, are currently offered through onDemand Licensing.
16
<PAGE>
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1999 VS. THREE MONTHS ENDED
SEPTEMBER 30, 1998
Net income was $1,213,000 for the three months ended September 30,
1999 compared to $679,000 for the same period in the prior year, an increase
of $534,000, or 79%.
The Company reported revenue of $38,925,000 for the three months
ended September 30, 1999 compared to revenue of $28,775,000 for the same
period in 1998, an increase of $10,150,000, or 35%. The acquisitions of KR
and MARC accounted for an increase in revenues of $5,652,000 during the
quarter. These purchase acquisitions occurred in December 1998 and June 1999,
respectively, so there was no corresponding revenue in the same period of the
prior year. The revenue and expenses related to UAI products are immaterial.
Software license revenue and maintenance fees account for 94% and
95% of total reported revenue for the three months ended September 30, 1999
and 1998, respectively, with service revenue making up the difference. For
the three months ended September 30, 1999 and 1998, approximately 85% and
79%, respectively, of the Company's software license revenue and maintenance
fees is derived from annual renewable leases and recurring maintenance fees,
with the remaining 15% and 21%, respectively, related to paid-up licenses.
Revenues for the three months ended September 30, 1999 for KR and MARC
include paid-up license revenue of $1,385,000 and $474,000, respectively. The
Company anticipates the same percentage of revenue derived from paid-up
licenses from KR and MARC for the remainder of 1999.
The Company estimates that the adoption of SOP 98-9, beginning
October 1, 1998, had a favorable impact of $3,481,000, or 12%, on the
Company's growth rate in total revenues for the three months ended September
30, 1999 compared to the same period in 1998. If SOP 98-9 had been adopted
beginning on October 1, 1997, the Company estimates that total revenue for
the three months ended September 30, 1998 would have been $3,481,000 higher
than the reported revenues, which would have resulted in a lower growth rate
of 23% in total revenues for the three months ended September 30, 1999
compared to the same period in 1998. An additional $227,000 of revenue
increases was due to those revenues which are unaffected by the adoption of
SOP 98-9: paid-up license revenue, which increased $938,000; embedded
technology revenue, which decreased $752,000; consulting services revenue,
which increased $420,000; and software services revenue, which decreased
$341,000.
Software license revenue consists of licensing fees, which are fees
charged for the right to use the Company's or a third parties' software.
Maintenance and services revenues include PCS and consulting services. PCS
includes telephone support, "bug" fixes and upgrade privileges on a when and
if available basis. Services range from installation and basic consulting to
software modification and customization to meet specific customer needs and
training. Software is sold through monthly, annual or longer lease
arrangements and through paid-up license arrangements, whereby the customer
purchases a perpetual license for the use of the Company's software.
17
<PAGE>
The following table illustrates revenue by geographic region and the
related growth rates between the three months ended September 30, 1999 and
1998 in functional currencies as reported utilizing the current revenue
recognition policy and estimated for the third quarter of 1998 as if SOP 98-9
had been adopted on October 1, 1997:
<TABLE>
<CAPTION>
THREE MONTHS GROWTH RATE
ENDED THREE MONTHS ENDED SEPTEMBER 30, 1999 VS.
SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30, 1998
1999 ------------------------------------------
-------------- IF SOP 98-9 HAD
PERCENTAGE OF BEEN ADOPTED ON
TOTAL REVENUE AS REPORTED OCTOBER 1, 1997
------------- ----------- ---------------
<S> <C> <C> <C>
The Americas 45% 24% 6%
Europe 30% 29% 27%
Asia-Pacific 25% 73% 62%
Total 35% 23%
</TABLE>
The increase in reported revenues for all regions was primarily due
to the acquisitions of KR and MARC in December 1998 and June 1999,
respectively, and due to the adoption of SOP 98-9 in October 1998. The
acquisitions of KR and MARC accounted for an increase in revenues of
$5,652,000, or 19%, in total revenues for the three months ended September
30, 1999 compared to the same period in the prior year, with increases in The
Americas of $1,875,000, or 14%, in Europe of $1,371,000, or 15%, and in
Asia-Pacific of $2,406,000, or 43%. The Company estimates that the adoption
of SOP 98-9, beginning October 1, 1998, had a favorable impact of $3,481,000,
or 12%, on the Company's growth rate in total revenues for the three months
ended September 30, 1999 compared to the same period in 1998, with favorable
impacts in The Americas of $2,671,000, or 18%, in Europe of $170,000, or 2%,
and in Asia-Pacific of $640,000, or 11%.
The Company's international operations in Europe and Asia-Pacific
are sales organizations with high gross profit margins, which is due to these
operations having minimal software development expenses. As a result, the
Company is exposed to the effects of foreign currency fluctuations of the
United States dollar versus the Japanese yen and the German deutsche mark
("DM"). The following table details the effect of the currency rate changes
on revenue for the three months ended September 30, 1999:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, 1999
-------------------------------- CURRENCY
USING EXCHANGE RATES FOR THE FLUCTUATION
THREE MONTHS ENDED SEPTEMBER 30, EFFECT
-------------------------------- FAVORABLE/
1999 1998 (UNFAVORABLE)
----------- ----------- ------------
<S> <C> <C> <C>
Revenues:
The Americas $17,590,000 $17,590,000 $ --
Europe 11,623,000 12,310,000 (687,000)
Asia-Pacific 9,712,000 8,296,000 1,416,000
----------- ----------- -----------
Total Revenue $38,925,000 $38,196,000 $ 729,000
=========== =========== ===========
Exchange Rates:
$ / DM 0.54 0.57
Yen / $ 113.17 139.99
</TABLE>
Operating expenses were $35,393,000 for the three months ended
September 30, 1999 compared to $27,351,000 for the same period in the prior
year, an increase of $8,042,000, or 29%. This increase includes $8,099,000 of
additional operating expenses resulting from the acquisitions of KR and MARC.
18
<PAGE>
In accordance with SFAS 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.
Cost of revenue was $8,649,000, or 22% of total revenues, for the
three months ended September 30, 1999, a decrease of $400,000, or 4%, as
compared to cost of revenue of $9,049,000, or 31% of total revenues, for the
same period in the prior year.
Amortization of capitalized software costs decreased to $2,112,000
for the three months ended September 30, 1999 from $2,871,000 for the same
period in the prior year, a decrease of $759,000, or 26%. Cost of revenue,
excluding amortization of capitalized software costs, was $6,537,000 for the
three months ended September 30, 1999 compared to $6,178,000 for the same
period in the prior year, an increase of $359,000, or 6%. This increase was
primarily due to: (1) a $396,000 increase in the cost of technical support
services due to a change in staffing mix between sales and support resources;
(2) a $164,000 increase in packaging costs; (3) a $144,000 increase in
software licensing costs; offset by (4) a $345,000 decrease in royalty
expense. The increase in labor and related costs were related to the
reallocation of sales resources to support maintenance and consulting
activities from the recent reorganization. $499,000 of these increases are
due to the KR and MARC acquisitions. Royalty expense is paid to third parties
under various agreements. The Company does not consider any royalty expense
related to individual agreements to be material. Royalty expense is expected
to decline with the replacement of a third party product by MARC products.
Gross margin, which is total revenue less cost of revenue, was
$30,276,000, or 78% of total revenues, for the three months ended September
30, 1999, an increase of $10,550,000, or 54%, as compared to a gross margin
of $19,726,000, or 69% of total revenues, for the same period in the prior
year. This increase was primarily due to the acquisitions of KR and MARC and
the favorable impact of adopting SOP 98-8 in October 1998.
Research and development expense for the three months ended
September 30, 1999 was $5,472,000 compared to $3,382,000 for the three months
ended September 30, 1998, an increase of $2,090,000, or 62%. The increase is
due to a $1,570,000 increase in the total gross investment in research and
development activities and a decrease of $520,000 in the amount of research
and development expenditures capitalized under SFAS No. 86.
The total gross investment in research and development activities
for the three months ended September 30, 1999 was $7,868,000, or 20% of total
revenue, compared to $6,298,000, or 22% of total revenue, for the same period
in the prior year. This increase resulted primarily from a $557,000 increase
in development labor and related costs and the addition of $1,280,000 of
development costs from the acquisitions of KR and MARC.
Capitalized software development costs were $2,396,000 for the three
months ended September 30, 1999 compared to $2,916,000 for the same period in
the prior year, a decrease of $520,000, or 18%. 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 and product quality, and to
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 was $18,822,000 for the
three months ended September 30, 1999 compared to $14,353,000 for the same
period in 1998, an increase of $4,469,000, or 31%. The acquisitions of KR and
MARC accounted for an increase of $3,693,000 in selling, general and
administrative expenses. The Engineering-e.com division had expenses of
$935,000. This was offset by the decrease of $396,000 due to the change in
staffing mix, for a comparable increase of only $237,000.
19
<PAGE>
Amortization of goodwill and other intangibles was $2,450,000 for
the three months ended September 30, 1999 compared to $567,000 for the same
period in 1998, an increase of $1,883,000. The increase was due to the
acquisitions of KR, MARC and UAI. Amortization of goodwill is expected to
increase in future periods from the acquisition of CSAR.
As with revenue, the Company's operating expenses are impacted by
foreign currency fluctuations. The following table details the effect of the
currency rate changes on operating expenses for the three months ended
September 30, 1999:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, 1999
-------------------------------- CURRENCY
USING EXCHANGE RATES FOR THE FLUCTUATION
THREE MONTHS ENDED SEPTEMBER 30, EFFECT
-------------------------------- FAVORABLE/
1999 1998 (UNFAVORABLE)
----------- ----------- ------------
<S> <C> <C> <C>
Operating Expenses:
The Americas $23,101,000 $23,101,000 $ --
Europe 6,188,000 6,510,000 322,000
Asia-Pacific 6,104,000 5,382,000 (722,000)
----------- ----------- -----------
Total Operating Expenses $35,393,000 $34,993,000 $ (400,000)
=========== =========== ===========
Exchange Rates:
$ / DM 0.54 0.57
Yen / $ 113.17 139.99
</TABLE>
Operating income was $3,532,000 for the three months ended September
30, 1999 compared to $1,424,000 for the same period in the prior year, an
increase of $2,108,000. Operating income for the three months ended September
30, 1999 includes the effects of the Company's adoption of SOP 98-9 in the
fourth quarter of 1998, in addition to ongoing operating costs necessary for
the operation of the business. If the Company had adopted SOP 98-9 in the
fourth quarter of 1997, the Company estimates operating income would have
been $4,590,000 for the three months ended September 30, 1998, resulting in a
decrease of $1,058,000 from the prior period to the current period, as shown
in the following table:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, 1999
-------------------------
1999 1998
---------- ----------
<S> <C> <C>
Operating Income - As Reported $3,532,000 $1,424,000
Adjustments:
Revenue Change, Net of Cost of Revenue -- 3,166,000
---------- ----------
Operating Income - As Adjusted $3,532,000 $4,590,000
========== ==========
</TABLE>
Total other expense (income) was $1,748,000 for the three months
ended September 30, 1999 compared to $395,000 for the same period in the
prior year, an increase of $1,353,000. This increase was due to increases in
interest expense and currency translation losses, plus a decrease in
investment income.
20
<PAGE>
Interest expense was $1,543,000 for the three months ended September
30, 1999 compared to $1,114,000 for the same period in the prior year, an
increase of $429,000, or 39%. Interest expense reflects the interest on the
convertible subordinated debentures issued as part of the acquisitions of PDA
Engineering ("PDA") in 1994 and MARC in June of 1999, as well as interest on
the subordinated notes payable issued as part of the acquisition of MARC.
Interest payments on the convertible subordinated debentures are due on March
15 and September 15 of each year until the debentures are converted or
redeemed. Interest payments on the subordinated notes payable are due on
January 10 and July 10 of each year. The Company expects that interest
expense will increase due to the $8,000,000 term loan entered into by the
Company as part of the acquisition of CSAR.
Other expense (income) was $205,000 for the three months ended
September 30, 1999 compared to ($719,000) for the same period in the prior
year, a decrease of $924,000. The decrease is primarily attributable to a
$382,000 increase in foreign currency exchange losses and a $288,000 decrease
in interest and investment income. Other expense (income) also includes gains
and losses on property, plant and equipment and other non-operating income or
expense. The Company anticipates that interest and investment income will
continue to decrease throughout 1999 from 1998 levels as a result of the
decrease in its cash balances following the acquisitions of KR, MARC, UAI and
CSAR.
Income taxes were provided at a rate of 32% for the three months
ended September 30, 1999 versus 34% for the same period in the prior year.
21
<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1999 VS. NINE MONTHS ENDED
SEPTEMBER 30, 1998
Net income (loss) was ($926,000) for the nine months ended September
30, 1999 compared to $5,632,000 for the same period in the prior year, a
decrease of $6,558,000.
The Company reported revenue of $103,020,000 for the nine months
ended September 30, 1999 compared to revenue of $96,224,000 for the same
period in 1998, an increase of $6,796,000, or 7%. The acquisitions of KR and
MARC accounted for an increase in revenues of $8,736,000 during the period.
These purchase acquisitions occurred in December 1998 and June 1999,
respectively, so there was no corresponding revenue in the same period of the
prior year.
Software license revenue and maintenance fees account for 94% and
94% of total reported revenue for the nine months ended September 30, 1999
and 1998, respectively, with service revenue making up the difference. For
the nine months ended September 30, 1999 and 1998, approximately 79% and 81%,
respectively, of the Company's software license revenue and maintenance fees
is derived from annual renewable leases and recurring maintenance fees, with
the remaining 21% and 19%, respectively, related to paid-up licenses.
Revenues for the nine months ended September 30, 1999 for KR and MARC include
paid-up license revenue of $2,505,000 and $805,000, respectively. The Company
anticipates the same percentage of revenue derived from paid-up licenses from
KR and MARC for the remainder of 1999.
The Company estimates that the adoption of SOP 98-9, beginning
October 1, 1998, had an unfavorable impact of $5,474,000, or 6%, on the
Company's growth rate in total revenues for the nine months ended September
30, 1999 compared to the same period in 1998. If SOP 98-9 had been adopted
beginning on October 1, 1997, the Company estimates that total revenue for
the nine months ended September 30, 1998 would have been $5,474,000 lower
than the reported revenues, which would have resulted in a higher growth rate
of 13% in total revenues for the nine months ended September 30, 1999
compared to the same period in 1998. An additional $1,738,000 of revenue
increases was due to those revenues which are unaffected by the adoption of
SOP 98-9: paid-up license revenue, which increased $2,864,000; embedded
technology revenue, which decreased $994,000; consulting services revenue,
which decreased $228,000; and software services revenue, which increased
$96,000.
The following table illustrates revenue by geographic region and the
related growth rates between the nine months ended September 30, 1999 and
1998 in functional currencies as reported utilizing the current revenue
recognition policy and estimated for the third quarter of 1998 as if SOP 98-9
had been adopted on October 1, 1997:
<TABLE>
<CAPTION>
GROWTH RATE
NINE MONTHS ----------------------------------------
ENDED NINE MONTHS ENDED SEPTEMBER 30, 1999 VS.
SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, 1998
1999 ----------------------------------------
------------- IF SOP 98-9 HAD
PERCENTAGE OF BEEN ADOPTED ON
TOTAL REVENUE AS REPORTED OCTOBER 1, 1997
------------- ----------- ---------------
<S> <C> <C> <C>
The Americas 47% 3% 6%
Europe 31% 8% 20%
Asia-Pacific 22% 16% 17%
Total 7% 13%
</TABLE>
22
<PAGE>
The increase in reported revenues for all regions was primarily due
to the acquisitions of KR and MARC in December 1998 and June 1999,
respectively. The acquisitions of KR and MARC accounted for an increase in
revenues of $8,736,000, or 9%, in total revenues for the nine months ended
September 30, 1999 compared to the same period in the prior year, with
increases in The Americas of $3,718,000, or 4%, in Europe of $1,841,000, or
2%, and in Asia-Pacific of $3,177,000, or 3%. The Company estimates that the
adoption of SOP 98-9, beginning October 1, 1998, had an unfavorable impact of
$5,474,000, or 6%, on the Company's growth rate in total revenues for the
nine months ended September 30, 1999 compared to the same period in 1998,
with unfavorable impacts in The Americas of $1,770,000, or 3%, in Europe of
$3,522,000, or 12%, and in Asia-Pacific of $182,000, or 1%.
The Company's international operations in Europe and Asia-Pacific
are sales organizations with high gross profit margins, which is due to these
operations having minimal software development expenses. As a result, the
Company is exposed to the effects of foreign currency fluctuations of the
United States dollar versus the Japanese yen and the German deutsche mark.
The following table details the effect of the currency rate changes on
revenue for the nine months ended September 30, 1999:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1999
------------------------------- CURRENCY
USING EXCHANGE RATES FOR THE FLUCTUATION
NINE MONTHS ENDED SEPTEMBER 30, EFFECT
------------------------------- FAVORABLE/
1999 1998 (UNFAVORABLE)
------------ ------------ -------------
<S> <C> <C> <C>
Revenues:
The Americas $ 48,027,000 $ 48,027,000 $ --
Europe 31,654,000 31,803,000 (149,000)
Asia-Pacific 23,339,000 20,535,000 2,804,000
------------ ------------ ------------
Total Revenue $103,020,000 $100,365,000 $ 2,655,000
============ ============ ============
Exchange Rates:
$ / DM 0.55 0.56
Yen / $ 116.77 134.67
</TABLE>
Operating expenses were $109,280,000 for the nine months ended
September 30, 1999, compared to $85,719,000 for the same period in the prior
year, an increase of $23,561,000, or 27%. Operating expenses for the nine
months ended September 30, 1999 include a write-off of acquired in-process
technology of $4,067,000, a software impairment charge of $1,500,000, and
restructuring costs of $5,497,000. Without these charges, operating expenses
would have totaled $98,216,000 for the nine months ended September 30, 1999,
an increase of $12,497,000, or 15%, from the $85,719,000 reported for the
nine months ended September 30, 1998. This increase includes $12,041,000 of
additional operating expenses resulting from the acquisitions of KR and MARC.
Cost of revenue was $27,279,000, or 26% of total revenues, for the
nine months ended September 30, 1999, a decrease of $356,000, or 1%, as
compared to cost of revenue of $27,635,000, or 29% of total revenues, for the
same period in the prior year. Cost of revenue for the nine months ended
September 30, 1999 includes a software impairment charge of $1,500,000.
23
<PAGE>
Amortization of capitalized software costs decreased to $6,341,000
for the nine months ended September 30, 1999 from $9,314,000 for the same
period in the prior year, a decrease of $2,973,000, or 32%. Cost of revenue,
excluding amortization of capitalized software costs and the software
impairment charge, was $19,438,000 for the nine months ended September 30,
1999 compared to $18,321,000 for the same period in the prior year, an
increase of $1,117,000, or 6%. This increase was primarily due to: (1) a
$1,271,000 increase in the cost of technical support services due to a change
in staffing mix between sales and support resources; (2) a $337,000 increase
in software licensing costs; (3) a $322,000 increase in third party
commissions; (4) a $288,000 increase in packaging costs; and (5) a $182,000
in other expenses; offset by (6) a $1,122,000 decrease in royalty expense;
and (7) a $161,000 decrease in product marketing costs; offset by $923,000 of
these increases are due to the KR and MARC acquisitions. Royalty expense is
paid to third parties under various agreements. The Company does not consider
any royalty expense related to individual agreements to be material. Royalty
expense is expected to decline through April 2000 with the replacement of a
third party product by MARC products.
Gross margin, which is total revenue less cost of revenue, was
$75,741,000, or 74% of total revenues, for the nine months ended September
30, 1999, an increase of $7,152,000, or 11%, as compared to a gross margin of
$68,589,000, or 71% of total revenues, for the same period in the prior year.
This increase was due to the increase in revenues and the decrease in cost of
revenue, as noted above.
Research and development expense for the nine months ended September
30, 1999 was $14,927,000 compared to $8,973,000 for the nine months ended
September 30, 1998, an increase of $5,954,000, or 66%. The increase is due to
a $2,645,000 increase in the total gross investment in research and
development activities and a decrease of $3,309,000 in the amount of research
and development expenditures capitalized under SFAS No. 86.
The total gross investment in research and development activities
for the nine months ended September 30, 1999 was $21,256,000, or 21% of total
revenue, compared to $18,611,000, or 19% of total revenue, for the same
period in the prior year. This increase resulted primarily from a $1,523,000
increase in development labor and related costs and the addition of
$1,838,000 of development costs from the acquisitions of KR and MARC.
Capitalized software development costs were $6,329,000 for the nine
months ended September 30, 1999 compared to $9,638,000 for the same period in
the prior year, a decrease of $3,309,000, or 34%. 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 and product quality, and to
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 was $52,695,000 for the
nine months ended September 30, 1999 compared to $47,410,000 for the same
period in 1998, an increase of $5,285,000, or 11%. This increase includes an
additional $6,589,000 of selling, general and administrative expenses
resulting from the acquisitions of KR and MARC. The Engineering-e.com
division had expenses of $1,596,000. This was offset by a decrease of
$1,271,000 due to the change in staffing mix, for a comparable decrease of
$1,629,000.
Amortization of goodwill and other intangibles was $4,815,000 for
the nine months ended September 30, 1999 compared to $1,701,000 for the same
period in 1998, an increase of $3,114,000. The increase was due to the
acquisitions of KR, MARC and UAI. The amount of amortization of goodwill and
other intangibles in future periods for the Company is expected to remain at
or above the level of the third quarter of 1999, and the impact of the
acquisition of CSAR, which is expected to result in higher amortization
expense in future periods.
24
<PAGE>
As with revenue, the Company's operating expenses are impacted by
foreign currency fluctuations. The following table details the effect of the
currency rate changes on operating expenses for the nine months ended
September 30, 1999:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1999
------------------------------- CURRENCY
USING EXCHANGE RATES FOR THE FLUCTUATION
NINE MONTHS ENDED SEPTEMBER 30, EFFECT
------------------------------- FAVORABLE/
1999 1998 (UNFAVORABLE)
------------ ------------ -------------
<S> <C> <C> <C>
Operating Expenses:
The Americas $ 79,245,000 $ 79,245,000 $ --
Europe 18,293,000 18,499,000 206,000
Asia-Pacific 11,742,000 10,440,000 (1,302,000)
------------ ------------ ------------
Total Operating Expenses $109,280,000 $108,184,000 $ (1,096,000)
============ ============ ============
Exchange Rates:
$ / DM 0.55 0.56
Yen / $ 116.77 134.67
</TABLE>
Operating income (loss) was ($6,260,000) for the nine months ended
September 30, 1999 compared to $10,505,000 for the same period in the prior
year, a decrease of $16,765,000. The operating loss for the nine months ended
September 30, 1999 includes the effects of the Company's adoption of SOP 98-9
in the fourth quarter of 1998, a write-off of acquired in-process technology,
a software impairment charge and restructuring costs, in addition to ongoing
operating costs necessary for the operation of the business. Without the
effects of the write-off of acquired in-process technology, the software
impairment charge and the restructuring costs, and had the Company adopted
SOP 98-9 in the fourth quarter of 1997, the Company estimates operating
income would have been $4,804,000 and $5,526,000 for the nine months ended
September 30, 1999 and 1998, respectively, a decrease of $722,000, or 13%, as
shown in the following table:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1999
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
Operating Income (Loss) - As Reported $ (6,260,000) $ 10,505,000
------------ ------------
Adjustments:
Revenue Change, Net of Cost of Revenue -- (4,979,000)
Impairment of Capitalized Software Costs 1,500,000 --
Restructuring Charges 5,497,000 --
Write-Off of Acquired In-Process Technology 4,067,000 --
------------ ------------
Total Adjustments 11,064,000 (4,979,000)
------------ ------------
Operating Income - As Adjusted $ 4,804,000 $ 5,526,000
============ ============
</TABLE>
Total other expense (income) was ($6,676,000) for the nine months
ended September 30, 1999 compared to $1,971,000 for the same period in the
prior year, an increase of $8,647,000. This increase includes a $10,733,000
gain from the sale of the Company's equity investment in LMS International.
Excluding this gain, total other expense (income) was $4,057,000 for the nine
months ended September 30, 1999, an increase of $2,086,000 compared to the
same period in the prior year. The increase was due to increases in interest
expense and currency translation losses, plus a decrease in investment income.
25
<PAGE>
Interest expense was $4,145,000 for the nine months ended September
30, 1999 compared to $3,347,000 for the same period in the prior year, an
increase of $798,000, or 24%. The increase in interest expense is primarily
attributable to increased debt levels as a result of acquisitions. Interest
expense reflects the interest on the convertible subordinated debentures
issued as part of the acquisitions of PDA Engineering in 1994 and MARC in
June of 1999, as well as interest on the subordinated notes payable issued as
part of the acquisition of MARC.
Other expense (income) was ($48,000) for the nine months ended
September 30, 1999 compared to ($1,376,000) for the same period in the prior
year, a decrease of $1,328,000. The decrease is primarily attributable to a
$718,000 increase in foreign currency exchange losses and a $547,000 decrease
in interest and investment income. Other expense (income) also includes gains
and losses on property, plant and equipment and other non-operating income or
expense. The Company anticipates that interest and investment income will
continue to decrease throughout 1999 from 1998 levels as a result of the
decrease in its cash balances following the acquisitions of KR, MARC, UAI and
CSAR.
Provision for income taxes was $1,342,000 compared to $2,902,000 for
the same period in the prior year, a decrease of $1,560,000, or 54%. Income
taxes were provided at a rate of 32% (excluding non-deductible charges) for
the nine months ended September 30, 1999 versus 34% for the same period in
the prior year.
26
<PAGE>
OPERATING PATTERN
The change in year-end to December 31 and the adoption of SOP 98-9
in the fourth quarter of 1998 both have a significant effect on the operating
pattern of the Company. The month of January has historically been the
largest revenue month of the year with the highest volume of renewals.
Under SOP 98-9, the Company is recognizing its software lease
revenue on a monthly basis over the term of the licenses. This change will
reduce the volatility of the revenue stream for the Company's interim
accounting periods. In addition, because the SOP does not permit restatements
of prior periods and because there are annual license renewals in every month
of the year, the entire effect of this change in revenue recognition will not
be fully recognized in reported revenue on a quarterly basis until the fourth
quarter of 1999. The year 2000 will be the first reported year that will
reflect a full twelve months of revenue under this method of revenue
recognition for annual licenses.
The Company anticipates that revenue for the remainder of 1999 will
also be affected by having a full-year of operations of the Working Knowledge
Division, the acquisitions of MARC and UAI in June 1999, and the acquisition
of CSAR in November 1999.
LIQUIDITY AND CAPITAL RESOURCES
In the past, working capital needed to finance the Company's
operations has been provided by cash on hand and from cash flow from
operations. Management believes that cash generated from operations will
continue to provide sufficient capital for normal working capital needs in
the foreseeable future. The Company may engage in additional financing
methods that it believes are advantageous, particularly to finance
acquisitions. Net cash provided by operating activities was $28,958,000 and
$19,916,000 for the nine months ended September 30, 1999 and 1998,
respectively. The Company's working capital (current assets minus current
liabilities) at September 30, 1999 was $5,578,000 compared to $21,736,000 at
December 31, 1998, a decrease of $16,158,000. Working capital at September
30, 1999 was adversely affected by the acquisitions of MARC and UAI.
During the nine months ended September 30, 1999, cash outlays were
$4,245,000 in conjunction with the $8,758,000 of restructuring charges and
acquisition costs in the last quarter of 1998 and the first two quarters of
1999. These outlays are anticipated to be completed by the end of 1999,
excluding certain lease commitments that may continue into the year 2001.
On August 11, 1999, the Company entered into a new Loan and Security
Agreement ("Loan Agreement") with a bank (the "Bank"). On October 29, 1999,
the Company and the Bank amended the terms of the Loan Agreement. The credit
facility now includes a $12,000,000 revolving line of credit and an
$8,000,000 term loan. The amount of the line of credit available in excess of
$5,000,000 is subject to a defined borrowing base of outstanding trade
receivables. The line of credit carries an interest rate equal to the Bank's
prime lending rate or LIBOR plus 200 basis points. Borrowings also involve
certain restrictive covenants. The term of the revolving portion of the Loan
Agreement expires May 31, 2001. No borrowings were outstanding under the Loan
Agreement at September 30, 1999. On November 4, 1999, the Company borrowed
the $8,000,000 term loan at the Bank's prime rate in connection with the
acquisition of CSAR. Borrowings under the Loan Agreement are secured by
nearly all of Company's goods and equipment, inventory, contract rights, and
intellectual property rights.
The Company issued convertible subordinated debentures in August
1994, in connection with its PDA acquisition, in the aggregate amount of
approximately $56,608,000. An additional $2,000,000 principal amount of
convertible subordinated debentures were issued in June 1999 in connection
with the MARC acquisition. The debentures bear interest at 7-7/8% with
interest payments due semi-annually in March and September. A debenture
interest payment was made in September 1999 for $2,306,000. The estimated
interest payment to be paid in March 2000 is $2,367,000. The amount of
interest expense will decrease if the debentures are converted into common
stock. The debentures mature in August 2004 and are convertible into common
stock at a price of $15.15 per share.
27
<PAGE>
The Company also issued subordinated notes payable in June 1999, in
connection with the MARC acquisition, in the aggregate principal amount of
$14,236,000. The subordinated notes payable bear interest at 8% with interest
payments due semi-annually in January and July. The estimated interest
payment to be paid in January 2000 is $577,000. $3,236,000 of the notes
payable are due in June 2001 and the remaining $11,000,000 is due by June
2009.
Management expects to continue to invest a substantial portion of
the Company's revenues in the development of new computer software
technologies and products and the enhancement of certain existing products.
The Company expended a total of $21,256,000 and $18,611,000 for the nine
months ended September 30, 1999 and 1998, respectively, on development
efforts, of which $6,329,000 and $9,638,000, respectively, were capitalized.
Product development costs and the capitalization rate may vary depending, in
part, on the number of products and the stage of development of the products
in process.
During the nine months ended September 30, 1999 and 1998, the
Company acquired $1,912,000 and $4,463,000, respectively, of new property and
equipment. Capital expenditures included upgrades in computer equipment in
order to keep current with technological advances and upgrades of facilities
worldwide. The Company's capital expenditures vary from year to year, as
required by business needs. The Company intends to continue to expand the
capabilities of its computer equipment used in the development and support of
its proprietary software products. Management expects expenditures for
property and equipment in 1999 to be consistent with those for 1998.
COMMON STOCK WARRANTS
On March 9, 1998, the Company entered into a joint-development and
marketing arrangement with Kubota Solid Technology Corporation ("KSTC"). This
arrangement allows KSTC to purchase warrants, with an aggregate exercise
price of up to $3,000,000, to purchase shares of the Company's common stock.
The exercise price is equal to the fair market value of the common stock on
the date of issuance of the warrants. The warrants are non-transferable, have
a five-year term and become exercisable two years after the date of issuance.
The arrangement also provides KSTC with marketing rights to a specific
technology being developed.
From March 9, 1998 through September 30, 1999, the Company has
issued warrants to purchase 312,859 shares of the Company's common stock at
exercise prices which range between $5.8125 per share and $11.375 per share,
for a total exercise price of $2,250,000. KSTC has the right to purchase
additional warrants with an aggregate exercise price of $750,000 through
December 31, 1999 under the arrangement.
The Company has no obligation under the arrangement to produce a
commercially viable product or technology or to refund any monies contributed
by KSTC.
On June 18, 1999, the Company issued five year warrants to purchase
1,400,000 shares of the Company's common stock at an exercise price of $10.00
per share in conjunction with the acquisition of MARC.
IMPACT OF YEAR 2000
Following internal examination and testing, the Company believes
that the purchased software applications and internally developed software
applications that are used internally are Year 2000 compliant. 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
assessed that potential problems associated with embedded technology do not
represent a significant area of risk relative to Year 2000 readiness due to
the nature of Company's operations and its use of non-information technology
systems (i.e., embedded technology such as microcontrollers). The Company's
operations do not include capital-intensive equipment with embedded
microcontrollers. However, there is no guarantee that other systems or
equipment of other companies on which the Company's systems rely will be
timely converted and would not have an adverse effect on the Company's
systems.
The Company has completed its contingency planning for the most
reasonably likely worst case scenarios. Depending on the systems affected,
these plans could include: (1) accelerated replacement of affected equipment
or software; (2) short to medium-term use of back-up equipment and software;
(3) increased work hours for Company personnel or use of contract personnel
to correct on an accelerated schedule any Year 2000 issues which arise or to
28
<PAGE>
provide manual workarounds for information systems; or (4) other similar
approaches. If the Company is required to implement any of these contingency
plans, such plans could have a material adverse effect on the Company's
business, financial condition or results of operations.
Substantially all of the Company's products licensed after January
1, 1998 are Year 2000 compliant. Compliance letters for each product
containing Year 2000 compliance details are posted at the Company's web site
at URL http://www.mscsoftware.com. The Company's policy, in accordance with
generally accepted accounting principles, is to expense as incurred the cost
of maintenance and modification to existing systems, and to capitalize the
cost of any new software or hardware and amortize that cost over the assets'
estimated useful lives. The Company does not separately track the costs
related to Year 2000 compliance, but estimates that the incremental cost of
the modifications to achieve compliance is under $100,000, spread over three
years (1997 through 2000). The Company estimates that approximately 95% of
these costs have already been spent.
Finally, the Company is also subject to external forces that might
generally affect industry and commerce, such as utility or manufacturing
company Year 2000 compliance failures and related service and production
interruptions. Furthermore, the purchasing patterns of analysts and designers
may be affected by Year 2000 issues as companies expend significant resources
to correct their current systems for Year 2000 compliance. The Company does
not currently have any information about the Year 2000 status of its
customers. However, these expenditures may result in constant or reduced
revenues, which could have a material adverse effect on the Company's
business, results of operations, and financial condition.
EURO CONVERSION
On January 1, 1999, eleven of the fifteen member countries of the
European Union (the "participating countries") established fixed conversion
rates between their existing sovereign currencies (the "legacy currencies")
and the Euro currency, adopting the Euro as their common legal currency on
that date. The legacy currencies are scheduled to remain legal tender in the
participating countries as denominations of the Euro between January 1, 1999
and January 1, 2002. During this transition period, public and private
parties may pay for goods and services using either the Euro or the
participating country's legacy currency on a "no compulsion, no prohibition"
basis whereby recipients must accept Euros or the legacy currency as offered
by the payer. A currency translation process known as triangulation dictates
how legacy currencies are converted to the Euro and other legacy currencies.
Beginning January 1, 2002, the participating countries will issue new
Euro-denominated bills and coins and replace the legacy currencies as legal
tender in cash transactions by July 1, 2002.
Because the Company conducts a significant portion of its business
in Europe through its wholly-owned German subsidiary, its business and
operations will be affected by the Euro conversion. Management is addressing
the Euro conversion, but its impact on future operating results is uncertain.
Management expects the conversion to decrease pressure for pricing in legacy
currencies in the participating countries. However, the Company also does
business in many non-participating countries including the United Kingdom.
This could lead to an increase in cross-border competition, which could
affect its allocation of resources within Europe, and eventually the
Company's labor cost.
The Company is implementing an upgrade to its management information
system which includes the ability to simultaneously record transactions in
Euros, perform the prescribed currency conversion computations and convert
legacy currency amounts to Euro. The impact of the conversion on the
Company's currency risk and taxable income is not expected to be significant.
In regard to contracts denominated in legacy currencies, management has not
identified any third party or customer contracts whose performance might be
considered unenforceable due to a currency substitution. Software lease and
maintenance contracts are typically renewed on an annual basis.
INFLATION
Inflation in recent years has not had a significant effect on the
Company's business.
29
<PAGE>
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The forward-looking statements in this report, including statements
concerning projections of the Company's future results, operating profits and
earnings, 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 Company's dependence on certain industries;
- - The impact of the Internet on the Company's business;
- - The successful integration of KR, MARC, UAI and CSAR;
- - Timely development of Computer Aided Engineering technologies which,
among other things, must accommodate industry trends such as increasing
computing power and increased usage of workstations;
- - Fluctuations of the United States dollar versus foreign currencies;
- - Economic conditions in Asia-Pacific, Europe and the United States;
- - The Company's ability to reduce costs without adversely impacting
revenues;
- - Successful involvement of international and domestic business partners
in creating mechanical engineering solutions;
- - The Company's ability to attract, motivate and retain salespeople,
programmers and other key personnel;
- - The adoption by the Company of certain anti-takeover provisions;
- - Continued demand for its products, including MSC.Nastran, MSC.Patran,
MSC.Dytran, MSC.MVision, MSC.Nastran for Windows, MSC.InCheck,
MSC.Working Model, and MARC's products; and
- - Year 2000 issues.
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 report
and by the discussion of "Risk Factors" in the Company's Transition Report on
Form 10-K for the year ended December 31, 1998.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to the impact of foreign currency
fluctuations and interest rate changes. The Company has not experienced a
material change in these market risk areas from the end of the preceding
fiscal year.
30
<PAGE>
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) On July 8, 1999, in connection with a joint-development and
marketing arrangement with Kubota Solid Technology
Corporation, the Company issued warrants to purchase 64,516
shares of the Company's common stock at an exercise price of
$5.8125 per share, for a total exercise price of $375,000. The
exercise price was equal to the fair market value of the
common stock on the date of purchase. The warrants are
non-transferable, have a five-year term and become exercisable
two years after the date of issuance. The warrants were valued
at $1,400,000 under the Black-Scholes valuation method. The
transaction was a private placement involving one offeree and
one purchaser exempt from registration section 4(2) of the
Securities Act of 1933.
The Loan Agreement, as amended, imposes restrictions on the Company's
payment of cash dividends or other distributions or payments on account
of or in redemption, retirement or purchase of the Company's common
stock.
ITEM 5. OTHER INFORMATION
On November 4, 1999, the Company acquired Computerized Structural
Analysis and Research Corporation ("CSAR") for cash and warrants. The
acquisition has been accounted for as a purchase and, accordingly, the
operating results of CSAR are not included in the Company's
consolidated financial statements presented herein. CSAR is a developer and
distributor of finite element analysis software and services for the
engineering community and to major manufacturers worldwide. The Company
financed a portion of the purchase price through an $8,000,000 term loan.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) 10.1 Second Amendment to Loan and Security Agreement
Between MSC.Software Corporation and Comerica
Bank-California.
27.1 Financial Data Schedule for the Nine Months Ended
September 30, 1999
27.2 Financial Data Schedule for the Nine Months Ended
September 30, 1998
(b) On September 1, 1999, the Company filed a Current Report on Form
8-K/A that amended the July 1, 1999 Report to include, pursuant
to Item 7 of Form 8-K:
(1) Audited financial statements of MARC Analysis Research
Corporation for the fiscal year ended December 31, 1998;
and
(2) Unaudited interim financial statements of MARC Analysis
Research Corporation for the three months ended March 31,
1999.
31
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MSC.SOFTWARE CORPORATION
(REGISTRANT)
By: /s/ LOUIS A. GRECO
------------------------------------------------
Date: November 15, 1999 Louis A. Greco - Chief Financial Officer
----------------- (Mr. Greco is the Principal Financial and
Accounting Officer and has been duly
authorized to sign on behalf of the Registrant)
32
<PAGE>
EXHIBIT 10.1
SECOND AMENDMENT
TO
LOAN AND SECURITY AGREEMENT
This Amendment to Loan and Security Agreement (the "Amendment") is
entered into as of October 29, 1999, by and between Comerica Bank-California
("Bank") and MSC.Software Corporation ("Borrower").
RECITALS
Borrower and Bank are parties to that certain Loan and Security
Agreement dated as of August 11, 1999, as amended by the First Amendment to
Loan and Security Agreement dated as of October 4, 1999 (the "Agreement").
The parties desire to amend the Agreement in accordance with the terms of
this Amendment.
NOW, THEREFORE, the parties agree as follows:
1. Section 1.1 of the Agreement is amended by amending the
following defined terms:
"Committed Revolving Line" means a credit extension of
Twelve Million Dollars ($12,000,000).
"Term Loan" means the term loan in the amount of Eight
Million Dollars ($8,000,000) pursuant to the provisions of Section 2.1.2.
2. Sections 2.1.2 (a) and (b) are amended to read as follows:
Section 2.1.2 (a): Subject to and upon the terms and
conditions of this Agreement, Bank agrees to make one term loan to Borrower
by November 30, 1999 in an aggregate amount of Eight Million Dollars
($8,000,000). The Term Loan shall be payable in thirty (30) equal monthly
installments in the amount of Two Hundred Sixty Six Thousand Six Hundred
Sixty Seven Dollars ($266,667), plus all accrued interest, beginning on
December 1, 1999, and continuing on the same day of each month thereafter
through the Maturity Date, at which time all amounts due under this Section
2.12 and any other amounts relating to the Term Loan shall be immediately due
and payable.
Section 2.1.2 (b) Deleted in its entirety.
3. Sections 6.11 and 6.14 are amended to read as follows:
6.11 TOTAL LIABILITIES-EFFECTIVE TANGIBLE NET WORTH.
Borrower shall maintain, as of the last day of each fiscal quarter, a ratio
of Total Liabilities less Subordinated Debt and deferred revenue to Effective
Tangible Net Worth of not more than 3.00 to 1.00 as of March 31, 2000, and
not more than 2.50 to 1.00 thereafter.
6.14 EFFECTIVE TANGIBLE NET WORTH. Borrower shall
maintain a minimum Effective Tangible Net Worth, as follows:
<TABLE>
<CAPTION>
MEASUREMENT DATE MINIMUM EFFECTIVE TANGIBLE NET WORTH
<S> <C>
June 30, 1999 $ 2,000,000
September 30, 1999 $ 6,500,000
December 31, 1999 $10,000,000
March 31, 2000 $15,000,000
</TABLE>
<PAGE>
<TABLE>
<S> <C>
June 30, 2000 $19,000,000
September 30, 2000 and each $19,000,000 plus 75% of Borrower's
fiscal quarter net income per quarter and 100% of
thereafter the net proceeds received from the
sale or issuance of equity securities
after June 30, 2000.
</TABLE>
In determining compliance with Sections 6.11 and 6.14, deferred income taxes
resulting from Borrower's acquisition of Marc Analysis shall be excluded from
the calculation of both intangible assets and liabilities.
4. Borrower shall deliver to Bank agings of Borrower's
accounts payable and accounts receivable effective as of September 30, 1999,
and for each fiscal quarter thereafter, within thirty (30) days of the last
day of each fiscal quarter.
5. The Compliance Certificate is amended to be in
substantially the form of Exhibit D attached hereto.
6. Unless otherwise defined, all capitalized terms in this
Amendment shall be as defined in the Agreement. Except as amended, the
Agreement remains in full force and effect.
7. Borrower represents and warrants that the Representations
and Warranties contained in the Agreement are true and correct as of the date
of this Amendment, and that no Event of Default has occurred and is
continuing. The parties confirm that the Agreement remains in full force and
effect as of the date of this Amendment.
8. This Amendment may be executed in two or more counterparts,
each of which shall be deemed an original, but all of which together shall
constitute one instrument.
IN WITNESS WHEREOF, the undersigned have executed this Amendment as
of the first date above written.
MSC.SOFTWARE CORPORATION
By: /s/ Louis A. Greco
-----------------------------------
Title: Chief Financial Officer
-----------------------------------
COMERICA BANK-CALIFORNIA
By: /s/ David Galst
-----------------------------------
Title: Vice President
-----------------------------------
<PAGE>
EXHIBIT D
COMPLIANCE CERTIFICATE
TO: COMERICA BANK-CALIFORNIA
FROM: MSC.Software Corporation
The undersigned authorized officer, on behalf of MSC.Software
Corporation hereby certifies that in accordance with the terms and conditions
of the Loan and Security Agreement between Borrower and Bank (the
"Agreement"), (i) Borrower is in complete compliance for the period ending
_________________ with all required covenants except as noted below and (ii)
all representations and warranties of Borrower stated in the Agreement are
true and correct in all material respects as of the date hereof; provided,
however that those representations and warranties expressly referring to
another date shall be true and correct as of such date. Attached herewith are
the required documents supporting the above certification. The Officer
further certifies that these are prepared in accordance with Generally
Accepted Accounting Principles (GAAP) and are consistently applied from one
period to the next except as explained in an accompanying letter or footnotes.
PLEASE INDICATE COMPLIANCE STATUS BY CIRCLING YES/NO UNDER "COMPLIES" COLUMN.
<TABLE>
<CAPTION>
REPORTING COVENANT REQUIRED COMPLIES
------------------ -------- --------
<S> <C> <C> <C>
Monthly income statements Monthly within 30 days Yes No
Quarterly balance sheet, income Quarterly within 45 days Yes No
statement and statement of cash flows
Annual (CPA Audited) FYE within 90 days Yes No
10K and 10Q Within 5 days Yes No
Domestic balance sheet, A/R & Monthly within 30 days Yes No
A/P Agings when applicable)
A/R Audit Initial and Annual Yes No
A/R & A/P Agings Quarterly within 30 days Yes No
</TABLE>
<TABLE>
<CAPTION>
FINANCIAL COVENANT REQUIRED ACTUAL COMPLIES
------------------ -------- ------ --------
<S> <C> <C> <C> <C>
Maintain on a Quarterly Basis:
Minimum Quick Ratio 1.50:1.00 _____:1.00 Yes No
Maximum Senior Liabilities-EBITDA (1) _____:1.0 Yes No
Maximum Debt-ETNW 3.00:1.00 (2) _______ Yes No
Minimum Profitability $1.00 (3) $_______ Yes No
Minimum Fixed Charge Coverage 1.10:1.00 (4) _____:1.00 Yes No
Minimum Effective TNW (5)
</TABLE>
(1) 4.5:1.0 on 6/30/99; 3.25:1.0 on 9/30/99; 2.0:1.0 on 12/31/99.
Terminates on 3/31/2000.
(2) Beginning March 31, 2000.
(3) Profitable Annually; no more than 1 quarter of losses.
(4) Beginning December 31, 1999 on Quarterly Basis, increasing to 1.25:1.00
as of June 30, 2000 and thereafter.
(5) $2,000,000 on 6/30/99; $6,500,000 on 9/30/99; $15,000,000 on 12/31/99
to be increased by 75% of net income plus 100% of equity proceeds
received thereafter.
-----------------------------
BANK USE ONLY
COMMENTS REGARDING EXCEPTIONS: See Attached
Received by:________
Sincerely, AUTHORIZED SIGNER
______________ Date: _________
SIGNATURE
______________ Verified: __________
TITLE AUTHORIZED SIGNER
______________ Date: _________
DATE
Compliance Status: Yes No
-----------------------------
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 19,488
<SECURITIES> 2,587
<RECEIVABLES> 31,490
<ALLOWANCES> (3,769)
<INVENTORY> 0
<CURRENT-ASSETS> 67,532
<PP&E> 32,764
<DEPRECIATION> (24,440)
<TOTAL-ASSETS> 165,619
<CURRENT-LIABILITIES> 61,954
<BONDS> 70,274
0
0
<COMMON> 32,452
<OTHER-SE> (13,181)
<TOTAL-LIABILITY-AND-EQUITY> 165,619
<SALES> 0
<TOTAL-REVENUES> 103,020
<CGS> 0
<TOTAL-COSTS> 109,280
<OTHER-EXPENSES> (6,676)<F1>
<LOSS-PROVISION> 188
<INTEREST-EXPENSE> 4,145
<INCOME-PRETAX> 416
<INCOME-TAX> 1,342
<INCOME-CONTINUING> (926)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (926)
<EPS-BASIC> (0.07)
<EPS-DILUTED> (0.07)
<FN>
<F1>INCLUDES $10.7 MILLION GAIN ON SALE OF INVESTMENT
</FN>
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 13,427
<SECURITIES> 17,810
<RECEIVABLES> 40,656
<ALLOWANCES> (1,887)
<INVENTORY> 0
<CURRENT-ASSETS> 83,732
<PP&E> 40,647
<DEPRECIATION> (31,526)
<TOTAL-ASSETS> 138,778
<CURRENT-LIABILITIES> 36,571
<BONDS> 56,574
0
0
<COMMON> 31,754
<OTHER-SE> 2,895
<TOTAL-LIABILITY-AND-EQUITY> 138,778
<SALES> 0
<TOTAL-REVENUES> 96,224
<CGS> 0
<TOTAL-COSTS> 85,719
<OTHER-EXPENSES> 1,971
<LOSS-PROVISION> 541
<INTEREST-EXPENSE> 3,347
<INCOME-PRETAX> 8,534
<INCOME-TAX> 2,902
<INCOME-CONTINUING> 5,632
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,632
<EPS-BASIC> 0.41
<EPS-DILUTED> 0.41
</TABLE>
