<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission file number 1-8722
THE MACNEAL-SCHWENDLER CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 95-2239450
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
815 Colorado Boulevard, Los Angeles, California 90041
-----------------------------------------------------
(Address of principal executive offices)
Registrant's telephone number (323) 258-9111
--------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
--- ---
The number of shares outstanding of Registrant's Common Stock, par value $.01
per share, was 13,770,447 shares at May 7, 1999.
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
INDEX
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets - March 31, 1999 (Unaudited)
and December 31, 1998.............................................3
Consolidated Statements of Operations (Unaudited)
Three Months Ended March 31, 1999 and 1998........................4
Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended March 31, 1999 and 1998........................5
Notes to Consolidated Financial Statements
(Unaudited).......................................................6
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition...........................................9
Item 3. Quantitative and Qualitative Disclosures About Market Risk............16
Part II. Other Information
Item 2. Changes in Securities and Use of Proceeds.............................18
Item 6. Exhibits and Reports on Form 8-K......................................18
</TABLE>
2
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
---------------- ----------------
<S> <C> <C>
ASSETS (UNAUDITED)
Current assets:
Cash and cash equivalents $ 20,434,000 $ 10,822,000
Securities available for sale 15,449,000 16,481,000
Trade accounts receivable, net 34,114,000 39,674,000
Deferred tax charges 8,206,000 6,288,000
Other current assets 8,267,000 7,866,000
---------------- ----------------
Total current assets 86,470,000 81,131,000
Property and equipment, net 8,148,000 8,895,000
Capitalized software costs, net 21,193,000 21,034,000
Goodwill and other intangible assets, net 22,896,000 23,996,000
Other assets 3,725,000 3,773,000
---------------- ----------------
$ 142,432,000 $ 138,829,000
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,768,000 $ 3,159,000
Line of credit 10,800,000 10,800,000
Accrued liabilities 18,844,000 22,510,000
Restructuring reserve 5,647,000 695,000
Deferred revenue 33,149,000 20,903,000
Income taxes payable -- 1,328,000
---------------- ----------------
Total current liabilities 70,208,000 59,395,000
Deferred income taxes 5,173,000 5,173,000
Convertible subordinated debentures 56,574,000 56,574,000
Commitments
Shareholders' equity:
Preferred stock, $0.01 par value, 10,000,000
shares authorized; no shares outstanding
at March 31, 1999 or December 31, 1998 -- --
Common stock, $0.01 par value,
100,000,000 shares authorized;
13,770,000 and 13,711,000 issued and
outstanding at March 31, 1999 and
December 31, 1998, respectively, and
common stock warrants 32,808,000 32,310,000
Accumulated deficit (16,823,000) (11,404,000)
Other comprehensive income (loss) (5,508,000) (3,219,000)
---------------- ----------------
Total shareholders' equity 10,477,000 17,687,000
---------------- ----------------
$ 142,432,000 $ 138,829,000
================ ================
</TABLE>
See accompanying notes.
3
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------------------
1999 1998
------------------ ------------------
<S> <C> <C>
Revenues:
Software licenses $ 20,989,000 $ 28,639,000
Software maintenance and services 9,664,000 9,131,000
------------------ ------------------
Total revenues 30,653,000 37,770,000
Operating expenses:
Cost of revenue 7,498,000 9,424,000
Research and development 4,831,000 2,246,000
Selling, general and administrative 17,645,000 17,154,000
Amortization of goodwill and other intangibles 1,121,000 567,000
Restructuring and other impairment charges 5,897,000 -
------------------ ------------------
Total operating expenses 36,992,000 29,391,000
Operating income (loss) (6,339,000) 8,379,000
Debenture interest 1,114,000 1,114,000
Other expense (income), net 400,000 (259,000)
------------------ ------------------
Income (loss) before income taxes (7,853,000) 7,524,000
Provision (benefit) for income taxes (2,434,000) 2,558,000
------------------ ------------------
Net income (loss) $ (5,419,000) $ 4,966,000
================== ==================
Basic earnings (loss) per share $ (0.39) $ 0.36
================== ==================
Diluted earnings (loss) per share $ (0.39) $ 0.33
================== ==================
Basic weighted average
shares outstanding 13,770,000 13,636,000
================== ==================
Diluted weighted average
shares outstanding 13,770,000 17,539,000
================== ==================
</TABLE>
4
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
-----------------------------------------
1999 1998
------------------ ------------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (5,419,000) $ 4,966,000
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization of property and equipment 1,226,000 1,358,000
Amortization of capitalized software costs 1,950,000 3,312,000
Amortization of goodwill and other intangibles 1,122,000 567,000
Amortization of premiums and discounts on securities
available for sale 30,000 31,000
Deferred income taxes (1,918,000) 3,189,000
(Gain) loss on disposal of property and equipment 8,000 (11,000)
Changes in assets and liabilities:
Trade accounts receivable, net 5,560,000 (1,658,000)
Other current assets (401,000) 314,000
Accounts payable (1,391,000) 191,000
Accrued liabilities (3,665,000) (6,003,000)
Deferred revenue 12,246,000 1,991,000
Restructuring reserve 4,952,000 -
Income taxes payable (1,328,000) (368,000)
------------------ ------------------
Net cash provided by operating activities 12,972,000 7,879,000
Cash flows from investing activities:
Purchase of securities available for sale (2,118,000) (30,000)
Sale of securities available for sale 3,120,000 -
Acquisition of property and equipment (487,000) (1,985,000)
Purchase of software (400,000) (145,000)
Capitalized software costs (1,709,000) (3,467,000)
Increase in other assets 26,000 (251,000)
------------------ ------------------
Net cash used in investing activities (1,568,000) (5,878,000)
Cash flows from financing activities:
Proceeds from capital stock issued 350,000 605,000
Line of Credit draw - 2,000
Proceeds from common stock warrants issued 148,000 -
------------------ ------------------
Net cash provided by financing activities 498,000 607,000
Translation adjustment (2,290,000) (619,000)
------------------ ------------------
Net increase (decrease) in cash and cash equivalents 9,612,000 1,989,000
Cash and cash equivalents at beginning of period 10,822,000 10,845,000
------------------ ------------------
Cash and cash equivalents at end of period $ 20,434,000 $ 12,834,000
================== ==================
</TABLE>
See accompanying notes.
5
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1: BASIS OF PRESENTATION
The accompanying unaudited consolidated financial information is
condensed from that which would appear in the annual financial statements and
should be read in conjunction with the consolidated financial statements
included in The MacNeal-Schwendler Corporation's Transition Report on Form
10-K for the year ended December 31, 1998.
All interim financial data is unaudited but, in the opinion of
management, reflects all adjustments necessary for a fair presentation thereof.
However, it should be understood that accounting measurements at interim dates
might be less precise than at year-end. Operating results for the three months
ended March 31, 1999 are not necessarily indicative of the results that may be
expected for the year ended December 31, 1999.
Basic earnings per share exclude any dilutive effect of options,
warrants and convertible securities. Diluted earnings per share include
dilutive effect of options, warrants and convertible securities. Diluted
earnings per share for the quarters ended March 31, 1999 and 1998 exclude the
effects of options, warrants and convertible securities because the effect
would be anti-dilutive.
In the fourth quarter of 1998, the Accounting Standards Executive
Committee (AcSEC) of the American Institute of Certified Public Accountants
(AICPA) 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.
6
<PAGE>
In June 1998, the Financial Accounting Standards Board issued Statement
No. 133, Accounting for Derivative Instruments and Hedging Activities, which is
required to be adopted in years beginning after June 15, 1999. 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.
During the three months ended March 31, 1999, total comprehensive
income amounted to a loss of ($7,709,000), compared to income of $4,347,000
for the three months ended March 31, 1998, respectively. The primary
difference between net income (loss) and comprehensive income (loss) was the
change in accumulated translation adjustment.
Supplemental cash flow information for taxes paid (refunded) during
the three months ended March 31, 1999 and 1998 were ($1,106,000) and
$2,926,000, respectively. Additionally, the Company paid interest of
$1,114,000 on its Convertible Subordinated Debentures due 2004 during both
the three months ended March 31, 1999 and 1998.
NOTE 2: CAPITALIZED SOFTWARE
The components of net capitalized software costs as it affected
earnings were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-------------------------------
1999 1998
---- ----
<S> <C> <C>
Software costs capitalized $(1,709,000) $(3,467,000)
Amortization of capitalized software 1,950,000 3,312,000
------------------- -------------------
Net capitalized software costs $ 241,000 $ (155,000)
=================== ===================
</TABLE>
Amortization expense associated with capitalized software costs is reported in
cost of revenue, and capitalization of software costs is reported as a reduction
of research and development expense.
NOTE 3: ACCRUED LIABILITIES
The components of accrued liabilities are as follows:
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
---- ----
<S> <C> <C>
Compensation and related expenses $ 5,252,000 $ 6,412,000
Commissions payable 1,049,000 1,226,000
Pension and profit sharing 2,438,000 3,725,000
Sales taxes payable 1,475,000 2,896,000
Debenture interest payable 206,000 1,325,000
Royalties payable 906,000 1,169,000
Incentive compensation 1,314,000 1,222,000
Other 6,204,000 4,535,000
------------ ------------
$ 18,844,000 $ 22,510,000
=========== ============
</TABLE>
7
<PAGE>
NOTE 4: 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 the
issuance. The arrangement also provides KSTC with marketing rights to a
specific technology being developed.
For the quarter ended March 31, 1999, the Company has recorded
$227,000 of service revenue related to the development effort and marketing
rights provided under the arrangement and issued warrants to KSTC valued at
$148,000 to purchase 62,500 shares of the Company's common stock at an
exercised price of $6.00. The warrants were recorded at fair value under the
Black Scholes valuation method. Through March 31, 1999 the Company has issued
warrants to purchase 248,343 shares of the Company's common stock at exercise
prices which range between $6.000 per share and $11.375 per share, for a
total exercise price of $1,875,000, KSTC has the right to purchase additional
warrants with an aggregate exercise price of $1,125,000 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 5: RESTRUCTURING RESERVE
On February 3, 1999 the Company announced a new organizational
structure following a re-evaluation of its business strategy. The
reorganization plan provides for a 10% reduction in the Company's worldwide
workforce (which is approximately 75 positions), and the consolidation of 15
field offices. These changes resulted in pre-tax charges of $5,897,000 in
the first quarter of 1999. The charges consist of severance costs of
$3,200,000, costs related to facility consolidations of $2,200,000 and other
charges of $497,000.
<TABLE>
<CAPTION>
BALANCE AT CHARGES ENDING
BEGINNING OF PERIOD TO EXPENSE DEDUCTIONS BALANCE
----------------------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
RESTRUCTURING RESERVE:
Quarter ended March 31, 1999.............. $ 695,000 $ 5,897,000 $ 945,000 $ 5,647,000
</TABLE>
8
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
RECENT DEVELOPMENTS
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 on a
calendar year basis.
In the fourth quarter of 1998, the Accounting Standards Executive
Committee (AcSEC) of the American Institute of Certified Public Accountants
(AICPA) 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.
RESTRUCTURING.
On February 3, 1999 the Company announced a new organizational
structure following a re-evaluation of its business strategy. The Company will
now emphasize 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 expanding growth
opportunities. The reorganization plan provides for a 10% reduction in the
Company's worldwide workforce (which is approximately 75 positions), and the
consolidation of 15 field offices. These changes resulted in pre-tax charges of
approximately $5,900,000 in the first quarter of 1999. The charges consist of
severance costs of $3,200,000, costs related to facility consolidations of
$2,200,000 and other charges of $500,000. The Company anticipates these charges
will provide a reduction in its annual operating costs. The restructuring
liability at March 31, 1999 was $5,647,000.
THREE MONTHS ENDED MARCH 31, 1999 VS. THREE MONTHS ENDED MARCH 31, 1998
The Company reported revenue of $30,653,000 in the first quarter of
1999, compared to revenue of $37,770,000 in the same period of 1998, a decrease
of $7,117,000 or 19%. Revenue as reported in the first quarter of 1999 was
adversely affected by the change in the Company's revenue recognition policy
effective October 1, 1998. Software license revenue and maintenance fees account
for 94% of total reported revenue for the quarter ended March 31, 1999 and 93%
for the quarter ended March 31, 1998, with service revenue making up the
difference. Of the 94% and 93% of the Company's revenues that consisted of
software license and maintenance revenue, approximately 68% and 78% of this
revenue is derived from annual renewable leases and recurring maintenance fees
with the remaining 32% and 22% in the quarters ended March 31, 1999 and 1998,
respectively, related to paid-up licenses.
The Company estimates revenue would have been $27,261,000 for the
first quarter of 1998, assuming the Company had been able to adopt SOP 98-9
on October 1, 1997. This would suggest a revenue increase of $3,392,000 or a
growth rate of 12% when compared to the reported revenue in the first quarter
of 1999. Increases in paid-up license revenue of $1,591,000, sales of third
party software of $300,000 and $227,000 of other revenue between the periods
are unaffected by the adoption of SOP 98-9. The additional revenue of
$1,274,000 resulted from higher volumes of annual renewable leases and
recurring maintenance fees. Revenues for the first quarter of 1999 include an
increase in revenues of $946,000 from the inclusion of revenues from
Knowledge Revolution Inc. (KR) acquired in December 1998. The KR revenues
include paid-up license revenues of $655,000. The Company anticipates an
increase in the percentage of revenue derived from paid-up licenses from KR for
the remainder of 1999.
9
<PAGE>
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 training, 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.
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.
The following table illustrates revenue by geographic region and the
related growth rates between the first quarter of 1999 and 1998 in functional
currencies as reported utilizing the current revenue recognition policy and
estimated for the first quarter of 1998 as if SOP 98-9 had been applied:
<TABLE>
<CAPTION>
% of With Revenue Change
Total Revenue As Reported In 1998
----------------- ------------------------------- --------------------------------
<S> <C> <C> <C>
The Americas 52% (21%) 22%
Europe 28% (21%) 13%
Asia-Pacific 20% (23%) (18%)
</TABLE>
The decrease in reported revenues in the America's and Europe was
due to the adoption of SOP 98-9 in October 1998. This decrease was offset by
an increase in paid-up license revenue of $2,371,000, sales of third party
software of $267,000 and $227,000 of other revenue. The decrease in revenues
from our Asia-Pacific region is due primarily to a decrease in paid-up
licenses totalling $780,000. This decrease is related to the continuing
economic turmoil in the region. The Company continues to believe this does
not reflect a reduction in the Company's market share from the region. 16% of
the Company's total revenue for the first quarter of 1999 is directly related
to the Japanese market, while only 4% is from the Asia-Pacific region outside
of Japan. This represents a shift from the first quarter of 1998 when 15% of
the Company's total revenue was directly related to the Japanese market,
while 5% was from the Asia-Pacific region outside of Japan. In light of the
continued economic turmoil in the region the Company remains cautious about
its Asia-Pacific prospects. The revenue decrease was also mitigated by a
favorable currency exchange variance.
The Company is exposed to the impact of foreign currency fluctuations.
The following table details the effect of the currency rate changes on revenue
for the first quarter of 1999.
<TABLE>
<CAPTION>
Quarter ended Quarter ended
March 31,1999 March 31,1999
using quarter ended using quarter ended
March 31,1998 March 31, 1999
Revenues exchange rates exchange rates
-------------------------------- ---------------------------- ---------------------------
<S> <C> <C>
Europe $ 8,260,000 $ 8,711,000
Asia-Pacific 5,596,000 6,049,000
---------------------------- ---------------------------
Total Revenue $13,856,000 $14,760,000
============================ ===========================
Exchange Rates:
$/DM 0.55 0.58
Yen/$ 128 116
</TABLE>
Operating expenses of $36,992,000 in the first quarter of 1999
includes both restructuring costs and on-going operating costs necessary for
the operation of the business, and represents an increase of $7,601,000 or
26% from the $29,391,000 reported in the same period of 1998. Operating
expenses include restructuring costs of $5,897,000. Without these charges,
operating expenses totaled $31,095,000 in the first quarter of 1999, an
increase of $1,704,000 or 6% from the $29,391,000 reported in the first
quarter of 1998. This increase was primarily attributable to: (1) a
$2,585,000 increase in net research and development expense (a $827,000
increase in the gross research and development investment and a $1,758,000
decrease in capitalized software costs), (2) a $1,045,000 increase in
selling, general and administrative expense and amortization of goodwill and
other intangibles, offset by (3) a $1,926,000 decrease in costs of revenue
including a $1,362,000 decrease in capitalized software costs amortized and a
$564,000 decrease in the other costs of revenue.
In accordance with the AICPA Statement of Financial Accounting
Standards (SFAS) No. 86, "Accounting for the Costs of Computer Software to be
Sold, Leased, or Otherwise Marketed," cost of revenue expense includes period
10
<PAGE>
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 $7,498,000 and $9,424,000 for the quarters ended
March 31, 1999 and 1998, respectively, or 24% and 25%, respectively, of
revenue. Capitalized software amortization decreased to $1,950,000 in the
first quarter of 1999 from $3,312,000 in the same period of the prior year.
Cost of revenues, excluding software amortization was $5,548,000 for the
first quarter of 1999 compared to $6,112,000 for same period of 1998, a
decrease of $564,000 or 9%. This decrease predominantly resulted from: (1) a
$500,000 decrease in royalty expense, (2) a $300,000 decrease in third party
commissions, (3) a $355,000 decrease in subcontractor costs, offset by (4) a
$151,000 increase in training and maintenance support labor and related costs
and (5) a $440,000 increase in other support labor and related costs. 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. 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.
Gross margin, which is revenue less cost of revenue, was negatively
impacted by the Company's change in its revenue recognition policy offset by the
decrease in its costs of revenue noted above. Gross margin was $23,155,000 or
76% of revenues for the quarter ended March 31, 1999 as compared to $28,346,000
or 75% of revenues for the same period of the prior year representing a decrease
of $5,191,000.
Research and development expense for the quarter ended March 31, 1999
was $4,831,000 compared to $2,246,000 for the quarter ended March 31, 1998
representing an increase of $2,585,000, or 115%. The increase is the result of
an increase of $827,000 in the total gross investment in research and
development activities and a decrease of $1,758,000 in the amount of research
and development expenditures capitalized under SFAS 86.
The total gross investment in research and development activities
for the quarter amounted to $6,540,000 or 21% of current year revenue,
compared to $5,713,000, or 15% of revenue in the prior year. The total
increase in the gross research and development investment was $827,000, or
14%. This increase resulted primarily from: (1) a $200,000 decrease in cost
offsets related to cost sharing development agreements, (2) a $512,000
increase in development labor and related costs and (3) the addition of
$115,000 of development costs from the acquisition of KR. The Company's gross
research and development cost was 21% of revenue for the quarter, which
remains just above management's target of 20% of total annual revenues.
Capitalized software development costs were $1,709,000 in the first
quarter of 1999 compared to $3,467,000 in the same period of 1998, a decrease of
$1,758,000, or 51%. The amount of product development capitalized in any given
period is a function of many factors including the number of products under
development at any point in time as well as their stage of development. The
Company's product development process is continually under review to improve
efficiency, product quality, and reduce time to market. Due to the continual
change in the product development process there can be no assurance that the
level of development capitalized in future periods will be comparable to current
capitalized levels.
Selling, general, and administrative expense and amortization of
goodwill and other intangibles was $18,766,000 in the first quarter of 1999
compared to $17,721,000 in the same period of 1998, an increase of 6%. The
$1,045,000 increase was due to: (1) a $792,000 increase in sales and
marketing costs primarily from additional sales and marketing costs from the
acquisition of KR, (2) a $554,000 increase in goodwill amortization from the
acquisition of KR, offset by (3) a $301,000 decrease in general and
administrative costs.
11
<PAGE>
As with revenue, the Company's expenses are impacted by foreign
currency fluctuations. The following table details the effect of the currency
rate changes on operating expense for the first quarter of 1999.
<TABLE>
<CAPTION>
Quarter ended Quarter ended
March 31, 1999 March 31, 1999
using quarter ended using quarter ended
March 31, 1998 March 31,1999
Local Operating Expenses * exchange rates exchange rates
-------------------------------------- ---------------------------- ----------------------------
<S> <C> <C>
Europe $ 5,805,000 $ 6,122,000
Asia-Pacific 2,068,000 2,282,000
---------------------------- ----------------------------
Total Local Operating Expense $ 7,873,000 $ 8,404,000
============================ ============================
Exchange Rates:
$/DM 0.55 0.58
Yen/$ 128 116
</TABLE>
* Does not include U.S. based cost incurred on behalf of the International
Operations.
Operating income or loss, including software capitalization and
amortization and restructuring costs was a loss of ($6,339,000) in the first
quarter of 1999 compared to income of $8,379,000 in the same period of 1998.
The first quarter of 1999 operating loss includes both the effects of the
Company's adoption of SOP 98-9 in the fourth quarter of 1998 and
restructuring costs in addition to on-going operating costs necessary for the
operation of the business. The $14,718,000 decrease in operating income is
primarily attributable to (1) restructuring costs of $5,897,000, (2) a
decrease in reported revenue of $7,117,000 offset by a decrease in cost of
revenue of $1,926,000 for a decrease in gross margin of $5,191,000, (3) an
increase in research and development expense of $2,585,000 and (4) an
increase in selling, general and administrative expense and amortization of
goodwill and other intangibles of $1,045,000. Without the effect of the
restructuring charges and had the Company adopted SOP 98-9 in the last
quarter of 1997, the Company estimates the operating loss would
have been $442,000 and $1,179,000 for the quarters ended March 31, 1999 and
1998, respectively, a decrease of 63%.
<TABLE>
<CAPTION>
Quarter Ended March 31,
------------------------------
1999 1998
---- ----
<S> <C> <C>
Operating income (loss), as reported $ (6,339,000) $ 8,379,000
Adjustments:
Revenue change, net of costs of revenue --- (9,558,000)
Restructuring charges 5,897,000 ---
----------------- ------------------
Total adjustments 5,897,000 (9,558,000)
----------------- ------------------
Operating income (loss), as adjusted $ (442,000) $ (1,179,000)
================= ==================
</TABLE>
Debenture interest reflects the interest on the convertible
subordinated debentures issued as part of the acquisition of PDA Engineering in
1994. Interest payments are due on March 15 and September 15 of each year until
the debentures are converted or redeemed.
Other expense was $400,000 in the first quarter of 1999 compared to
income of $259,000 in the same period of 1998, a decrease of $659,000. The
decrease is attributable to (1) a change in foreign exchange gains and losses
from a loss of $64,000 in the first quarter of 1998 to a loss of $451,000 in
the first quarter of 1999 due primarily to unrealized translation losses, (2)
additional interest expense of $220,000 during the current quarter from the
Company's outstanding balance under its line of credit,(3) a decrease in
interest and investment income of $52,000. Other income also includes gains
and losses on property, plant and equipment and other non-operating income.
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 acquisition of Knowledge Revolution.
Net loss was ($5,419,000) in the first quarter of 1999 compared to
net income of $4,966,000 in the same period of 1998, a decrease of
$10,385,000. Income taxes were provided at a rate of 34% in the first quarter
of 1998 versus recording a benefit at 31% in the first quarter of 1999. This
rate change decreased the income tax benefit by $236,000.
12
<PAGE>
COMPANY TRENDS.
On February 3, 1999 the Company announced a new organizational
structure following a re-evaluation of its business strategy. The Company will
now emphasize 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 expanding growth
opportunities.
The new organization includes the Working Knowledge Division, the
result of the Company's acquisition of KR in December 1998. KR is the world's
leading developer and distributor of 2D and 3D-motion simulation software for
design engineers and analysts. The acquisition of KR created the Company's
newest product line, MSC.Working Model. MSC.Working Model is linked to popular
mid-range CAD systems such as SolidWorks, Autodesk's Mechanical Desktop, and
Solid Edge, and answers the questions "Will it break?" and "Will it work?" by
providing stress and motion analysis capabilities. The Company expects that
these changes to its organizational structure will allow the Company to continue
its leadership in the high-end market and deliver tools and expertise to the
mid-range and desktop markets.
During March 1999, the Company created the Engineering-e.com group.
This group will provide a full-service engineering software and solutions
marketplace on the Internet. Additionally, Engineering-e.com will provide the
e-commerce channel for selected Company products.
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 will be 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 interim accounting periods of
the Company. 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, which was created in December 1998.
Effective January 1, 1999 the Company has changed the estimated useful
life of its capitalized software assets from three and four years to two and
three years. The Company has always estimated the expected life of these assets
based on the release cycle of its products. The Company believes that as
software production cycles decrease, amortization periods should also decrease
in order to coincide with a version's revenue stream. The Company is making this
change prospectively. 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. Therefore the
effect of this change is not determinable.
LIQUIDITY AND CAPITAL RESOURCES.
Working capital needed to finance the Company's growth in the past
has been provided by cash on hand and cash flow from operations. Management
believes that cash generated from operations will continue to provide
sufficient capital for normal working capital needs in the foreseeable
future. The Company may engage in additional financing methods we believe are
advantageous. Net cash provided by operating activities was $12,972,000 and
$7,879,000 for the quarters ended March 31, 1999 and 1998, respectively. The
Company's working capital at March 31, 1999 was $16,262,000, compared to
$21,736,000 at December 31, 1998. Working capital at March 31, 1999 was
adversely affected by the restructuring cost accrual. The KR acquisition
adversely affected the Company's working capital position and its cash
reserves at December 31, 1998.
Cash outlays were $945,000 in conjunction with the $6,592,000
restructuring charge taken in the last quarter of 1998 and the first quarter
of 1999 . These outlays are to be completed by the end of 1999, excluding
certain lease commitments that may continue through January 2000.
13
<PAGE>
At March 31, 1999, the Company had an agreement with its principal
bank for a $15,000,000 unsecured line of credit. The Company drew down on its
line of credit in the amount of $10,800,000 late in the fourth quarter of
1998 in lieu of having to liquidate a portion of its securities held for sale
portfolio. The line of credit bears interest at the bank's prime rate of
interest with an option to fix the rate at LIBOR plus 1.9% for a period of
179 days. The interest rate was fixed under the LIBOR option at March 31,
1999 at 7% with interest payments due monthly. The line of credit matures in
July 2000. The Company is in violation of certain covenants under the line of
credit at December 31, 1998 and March 31, 1999. The Company repaid all of
these borrowings in May of 1999 and is in the process of negotiating a new
line of credit agreement.
The Company issued convertible subordinated debentures in August 1994,
in connection with its PDA acquisition, in the aggregate amount of approximately
$56,608,000. The debentures bear interest at 7 7/8% with interest payments due
semi-annually in March and September. A debenture interest payment was made in
March 1999 for $2,228,000. 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.
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 $6,540,000 and $5,713,000 for the quarters ended March 31, 1999 and
1998, respectively, on development efforts, of which $1,709,000 and $3,467,000,
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 quarters ended March 31, 1999 and 1998, the Company
acquired $487,000 and $1,985,000, 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.
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.
For the quarter ended March 31, 1999, the Company recorded $227,000
of service revenue related to the development effort and marketing rights
provided under the arrangement and issued warrants to KSTC valued at $148,000
to purchase 62,500 shares of the Company's common stock. The warrants were
recorded at fair value under the Black Scholes valuation method. The warrants
issued have an exercise price of $6.00 per share. KSTC has the right to
purchase additional warrants with an aggregate exercise price of $1,125,000
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.
IMPACT OF YEAR 2000.
The Company has determined 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 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
14
<PAGE>
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 expects to complete its contingency planning for the most
reasonably likely worst case scenarios by August 1999. 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 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.
During 1998, the Company made significant progress in its' Year 2000
compliance testing on the software that is sold to customers. The tests certify
that our currently supported products will operate and correctly process dates
over a supported date range which extends from before January 1, 2000 and
encompasses a time period reasonably suitable for the intended use of the
product. 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 GAAP, 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 incremental cost of the
modifications to achieve compliance was immaterial to operating results.
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.
Based on the actions taken to date as discussed above, the Company is
reasonably certain that it has or will identify all Year 2000 issues that could
materially adversely affect its business and operations. The cost of this study
has been immaterial.
EURO CONVERSION.
On January 1, 1999, eleven of the fifteen member countries of the
European Union (the "participating countries") 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
15
<PAGE>
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.
16
<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 successful integration of Knowledge Revolution;
- timely development of CAE technologies which, among other things, must
accommodate industry trends such as increasing computing power and
increased usage of workstations;
- fluctuations of the U.S. dollar versus foreign currencies;
- economic conditions in Asia-Pacific, Europe and the U.S.;
- 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, and
Knowledge Revolutions products; and
- Year 2000 issues.
Subsequent written and oral forward-looking statements attributable
to MSC 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 Transition Report on Form 10-K
for the period 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.
17
<PAGE>
THE MACNEAL-SCHWENDLER CORPORATION
PART II: OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.
(c) On March 31, 1999, in connection with completing a marketing
arrangement with KSTC, the Company issued warrants to purchase
62,500 shares of the Company's common stock at $6.000 per share
for an exercise price of $375,000. The exercise price was equal
to the fair market value of the common stock on the dates of purchase.
The warrants are non-transferable, have a five-year term and become
exercisable two years after the date of issuance. The warrants were
valued using the Black Scholes valuation method at $148,000. The
transaction was a private placement involving one offeree and one
purchaser exempt from registration section 4(2) of the Securities
Act of 1933.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibit 27 - Financial Data Schedule for the quarter ended March 31, 1999.
(b) Exhibit 27.1 - Restated Financial Data Schedule for the quarter ended March
31, 1998.
(c) Current Report on Form 8-K, event dates January 4, 1999 (Item 2) and
January 29, 1999 (Item 8).
18
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE MACNEAL-SCHWENDLER CORPORATION
----------------------------------
(Registrant)
Date: May 12, 1999
/s/ LOUIS A. GRECO
-----------------------------------------
Louis A. Greco, Chief Financial Officer
(Mr. Greco is the Principal Financial and
Accounting Officer and has been duly
authorized to sign on behalf of the
registrant.)
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 20,434
<SECURITIES> 15,449
<RECEIVABLES> 38,745
<ALLOWANCES> 4,631
<INVENTORY> 0
<CURRENT-ASSETS> 86,470
<PP&E> 29,042
<DEPRECIATION> 20,894
<TOTAL-ASSETS> 142,432
<CURRENT-LIABILITIES> 70,208
<BONDS> 56,574
0
0
<COMMON> 32,808
<OTHER-SE> (22,331)
<TOTAL-LIABILITY-AND-EQUITY> 142,432
<SALES> 0
<TOTAL-REVENUES> 30,653
<CGS> 7,498
<TOTAL-COSTS> 36,992
<OTHER-EXPENSES> 400
<LOSS-PROVISION> 150
<INTEREST-EXPENSE> 1,114
<INCOME-PRETAX> (7,853)
<INCOME-TAX> (2,434)
<INCOME-CONTINUING> (5,419)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,419)
<EPS-PRIMARY> (0.39)
<EPS-DILUTED> (0.39)
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<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 12,835
<SECURITIES> 16,082
<RECEIVABLES> 41,500
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0
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