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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
COMMISSION FILE NUMBER 1-8722
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MSC.SOFTWARE CORPORATION
(Exact Name of Registrant as Specified in its Charter)
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DELAWARE 95-2239450
(State or Other Jurisdiction of Incorporation or (I.R.S. Employer Identification No.)
Organization)
815 COLORADO BOULEVARD 90041
LOS ANGELES, CALIFORNIA (Zip Code)
(Address of Principal Executive Offices)
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(Registrant's Telephone Number, Including Area Code): (323) 258-9111
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Securities Registered Pursuant to Section 12(b) of the Act:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock, Par Value $0.01 Per Share New York Stock Exchange
7 7/8% Convertible Subordinated
Debentures Due August 18, 2004 New York Stock Exchange
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Securities Registered Pursuant to Section 12(g) of the Act: WARRANTS
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
As of March 1, 2000, the approximate aggregate market value of MSC.Software
Corporation's voting stock held by non-affiliates was $176,932,000.
As of March 1, 2000, there were outstanding 13,877,044 shares of Common
Stock of MSC.Software Corporation.
Documents Incorporated By Reference: Part III: Proxy Statement for
Registrant's Annual Stockholders Meeting to be filed within 120 days of fiscal
year end.
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MSC.SOFTWARE CORPORATION
INDEX TO FORM 10-K
DECEMBER 31, 1999
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PART I
Item 1. Business................................................................. 1
Item 2. Properties............................................................... 14
Item 3. Legal Proceedings........................................................ 14
Item 4. Submission of Matters to a Vote of Security Holders...................... 14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.... 15
Item 6. Selected Financial Data.................................................. 16
Management's Discussion and Analysis of Financial Condition and Results
Item 7. of Operations............................................................ 16
Item 7.A. Quantitative and Qualitative Disclosures about Market Risk............... 32
Item 8. Financial Statements and Supplementary Data.............................. 34
Changes In and Disagreements With Accountants on Accounting and Financial
Item 9. Disclosure............................................................... 67
PART III
Item 10. Directors and Executive Officers of the Registrant....................... 67
Item 11. Executive Compensation................................................... 67
Item 12. Security Ownership of Certain Beneficial Owners and Management........... 67
Item 13. Certain Relationships and Related Transactions........................... 67
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.......... 68
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PART I
ITEM 1. BUSINESS
BUSINESS DEVELOPMENTS
On January 29, 1999, MSC changed its fiscal year from a year beginning
February 1 and ending January 31, to a calendar year. All financial information
for prior periods has been restated to coincide with the new fiscal year.
Therefore, any references to a fiscal year mean the twelve months ended
December 31 of that year.
On July 1, 1999, MSC.Software Corporation ("MSC") changed its name from The
MacNeal-Schwendler Corporation to MSC.Software Corporation.
During 1999, MSC acquired the following companies: MARC Analysis Research
Corporation ("MARC"), Universal Analytics Inc. ("UAI"), and Computerized
Structural Analysis and Research Corporation ("CSAR"). In late December 1998,
MSC acquired Knowledge Revolution Inc. ("KR"). Refer to Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations and
Note 4--Business Acquisitions and Divestitures in Notes to Consolidated
Financial Statements for additional information with respect to MSC's
acquisitions.
GENERAL
MSC was incorporated in Delaware in 1994. Since its inception in 1963, MSC
has been engaged in mechanical computer-aided engineering ("MCAE"), including
the development and marketing of software for use principally by engineers and
designers in industry, research laboratories and universities. MSC's MCAE
solutions are intended to allow the "design-to-manufacture" team greater freedom
to innovate design concepts, optimize complex solutions and exploit materials as
a design variable.
In the current computer-aided manufacturing environment, designs are
simulated before manufacturing has begun. MCAE analysis is used to simulate the
performance of a design before its physical manufacture, reducing the costly
physical testing of prototypes and permitting a substantial increase in the
number of design trade-offs and design cycles. Mechanical simulation helps
manufacturers design and build better products faster and more efficiently.
Engineers use MSC's simulation software worldwide in several industries,
including aerospace, automotive, shipbuilding, consumer products and electronic
packaging. MSC also provides strategic consulting services to customers to
improve the integration and performance of their MCAE technologies.
Our principal software products include MSC.Nastran, MSC.Marc, MSC.Dytran,
MSC.Patran and the MSC.Working Model product family. MSC.Nastran is a basic MCAE
analysis software program that determines a product's stresses and deformations.
MSC.Marc is a non-linear finite element analysis ("FEA") program that offers
automated non-linear analysis of contact problems commonly found in rubber or
metal forming and many other applications. MSC.Dytran is for non-linear analyses
such as those found in impact scenarios. MSC.Patran is an interactive MCAE
environment that facilitates the use of geometric data from popular
computer-aided design ("CAD") systems such as CATIA, Pro/ENGINEER and
Unigraphics in a variety of commercial analysis programs, including MSC.Nastran.
MSC.Working Model provides mechanical simulation and virtual prototyping
software for use in both professional engineering and design markets.
The Mechanical Solutions Division markets all of MSC's products and services
internationally to aerospace, automotive and other industrial concerns, computer
and electronics manufacturers and universities. MSC's strong reputation has
earned it the business of many companies, including BMW, DaimlerChrysler, Fiat,
GM, Ford, Nissan, Toyota, Boeing, Airbus, Lockheed Martin, DuPont, Eastman Kodak
and Motorola.
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In addition to being a leader in providing high-end engineering analysis
technology, MSC has moved to package its technology in lower-priced offerings
for multi-disciplinary engineers that perform simulation on occasion and design
engineers who need to verify design concepts. The Working Knowledge Division,
created following the acquisition of KR in late December 1998, offers products
for this latter market mainly through a network of resellers.
MSC is concentrating on becoming more Internet focused by continuing to make
its products Web-enabled and through the launch of a new division and web portal
in March 1999, Engineering-e.com. This division leverages the core strengths,
competencies and infrastructure of MSC to create an engineers' marketplace on
the web.
In January 2000, the MSC.Linux Division was created to support Linux
products and services. MSC.Linux will leverage MSC's strengths in software
technology development, professional services, hardware and software
partnerships. The division will initially provide MSC's global customer base
with cost-effective Linux-based applications of MSC's current products and
infrastructure.
PRODUCTS AND SERVICES
CORE SOFTWARE
Our core software products are designed to be world-class in their own
right, and they also function as platforms on which we build some of our
aerospace and automotive-specific software and services. Our core software
consists of a complement of solvers linked to a pre and post processor
(MSC.Patran). These solvers are capable of simulating virtually any
mechanical/structural phenomena, ranging from MSC's flagship general-purpose
linear based solver (MSC.Nastran) to a dedicated non-linear solver (MSC.Marc) to
a specialty non-linear solver (MSC.Dytran). Future work will be undertaken to
create seamless transitions between them. In addition, MSC will expand beyond
the "traditional" uses of FEA to move into manufacturing process simulation
utilizing the capabilities of MSC.Marc and MSC.Dytran.
The governing principles for our core software are to provide:
- Enhanced engineering productivity, in terms of process/task automation
(via dedicated environments, templates, and workflow managers), numerical
and graphics performance, and overall ease of use;
- Greater range of simulation, including loads analysis (and kinematics),
non-linear effects, robust design (including probabilistic analysis),
manufacturing process simulation, and test correlation;
- Increased modeling, manipulation, and analysis of assemblies, from
geometry to full FEA models to super-elements/substructures to matrices
from analysis and test;
- Continued commitment to data exchange standards such as AP203, AP214, and
AP209; and
- Increased emphasis on advanced visualization techniques and dedicated
results processing utilities.
SOLVERS: MSC.NASTRAN, MSC.MARC AND MSC.DYTRAN
MSC.Nastran is a descendant of NASTRAN-TM-, a computer program owned by the
United States Government and leased to others. MSC has improved upon NASTRAN-TM-
since NASTRAN-TM- was first released in 1970 and the current capabilities and
scope of MSC.Nastran are substantially greater than those of NASTRAN-TM-. MSC
has been selling MSC.Nastran since 1971. Pursuant to a 1982 agreement with the
National Aeronautics and Space Administration ("NASA"), MSC acquired the
perpetual rights to commercially use those elements of NASTRAN-TM- which are
embodied in MSC.Nastran. See "Intellectual Property Rights" below. However,
certain of MSC's competitors sell other variations of NASTRAN-TM-.
MSC.Nastran is based upon the "finite element method" ("FEM") of analysis.
With FEM analysis, complex structures are divided into small elements, which
form a finite element model, which is then
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subjected to computer analysis. MSC.Nastran is used to analyze structures in
order to determine, among other things, their strength, safety and performance
characteristics. For example, in the aerospace industry, MSC.Nastran is employed
to determine the stress distribution in the major parts of an aircraft, such as
engines, wings, fuselage and tail. A computer analysis could be applied to
improve the design of aircraft by suggesting the removal of material where
stresses are low and the addition of material where stresses are high, while
reducing the usage of physical prototypes and other testing. With this
knowledge, aircraft can be made both stronger and lighter. The same principles
have been applied to improve the design of jets, rockets, engines, automobiles,
trucks, tires, ships, farm equipment, heavy industrial equipment, nuclear
containment vessels, helicopters, spacecraft and other products and structures.
Because MSC.Nastran has been designed in a modular way, new features can be
added and obsolete features replaced without disrupting the other modules of the
system. As a result, major changes in computer hardware have been systematically
accommodated. For example, the program has been adapted to be used on a variety
of computer types, from supercomputers to personal computers. MSC believes that
the continued development and maintenance of MSC.Nastran, together with the
modular design features of that program, have prevented, and will continue to
prevent, its obsolescence, although no assurance can be given that future
changes in hardware or breakthroughs in software design will not result in the
obsolescence of the program.
Version 70.7 was released in October 1999, with the main feature being
support for distributed parallel processing for statics, normal modes, and
frequency response analysis. As an example, this feature now makes it possible
for large automotive NVH jobs to be run during the workday, enabling this type
of simulation to be an integral part of the design process. Material sensitivity
was also added. Over the next two years, our emphasis will expand to include
more non-linear capabilities, utilizing MSC.Marc technologies, which are needed
for large, system-type simulation. Selected capabilities from UAI.Nastran and
CSAR.Nastran will be merged into MSC.Nastran, based on market needs. Some
performance enhancements have already been merged in, with more to come.
MSC.Marc is the newest addition to the MSC suite of solvers, filling the gap
between linear MSC.Nastran and its non-linear specialty MSC.Dytran. MSC.Marc
also has extensive distributed parallel processing capabilities, and it is
world-renowned for its contact algorithms and its extensive material library,
both of which have found extensive use in the tire and rubber industries.
The MSC.Dytran product is for highly-non-linear analyses such as those found
in impact. It uniquely combines fluid-structure interaction to facilitate the
simulation of tire hydroplaning and occupant safety (airbag-occupant
interaction).
MSC.PATRAN
MSC.Patran provides finite element modeling, analysis data integration,
analysis simulation, and results evaluation capabilities to simulate product
performance early in the design-for-manufacture process. All of the functions of
MSC.Patran may be integrated, automated and tailored to the user's specific
requirements using a powerful programming command language.
MSC.Patran system provides three fundamental functions:
- MSC.PATRAN CORE SOFTWARE--The core of the MSC.Patran software enables the
engineer to visualize the design, preprocess the design into a computer
model for engineering analysis, and post-process the results of the
analysis into a graphical representation. The software interfaces with
many popular CAD programs and many analysis packages such as MSC.Nastran.
- APPLICATION MODULES--Through a series of modules that can be added to the
core software, engineers can perform analysis on stress, thermal
mechanisms and dynamics, fluid flow, solid modeling, and fatigue. Some of
these application modules have been developed by third parties and are
marketed under joint development or marketing agreements.
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- INTERFACES--MSC.Patran uses a series of interfaces that allow it to
interact with programs developed by other companies in the CAD/MCAE
industry. These interfaces either involve direct links into other software
or translate data to and from other software so that it can be processed
within MSC.Patran.
MSC.Mentat continues to be the pre and post processor for MSC.Marc, and its
features will eventually be merged into MSC.Patran.
OTHER CORE PRODUCTS
Other core products include MSC.Fatigue for durability analysis, MSC.Akusmod
for internal acoustic modeling and analysis, and MSC.Construct for topology and
shape optimization.
In addition, MSC has a variety of other products, none of which accounts for
more than 5% of MSC's revenue, including MSC.SuperModel, MSC.SuperForge and
MSC.Mvision.
MSC.WORKING MODEL
The December 1998 acquisition of KR led to the MSC.Working Model suite of
products for motion and visualization/animation. These products can be linked to
mid-range, solid modelers such as Solid Works, Mechanical Desktop and Solid
Edge. MSC plans to extend their visualization capabilities to work with our core
solvers.
During 1999, MSC introduced MSC.Working Model 4D, which combined MSC.Working
Model Motion with MSC.InCheck. MSC.Working Model Motion is used to simulate
motion such as falling and colliding objects, pistons or conveyor. This
simulation answers the question "Will it work?" MSC.InCheck is used to simulate
stress, deformation and vibration. This simulation answers the question "Will it
break?" These products run on Microsoft Windows-based personal computers and are
closely linked to desktop-based CAD programs such as Solid Works, Mechanical
Desktop and Solid Edge.
SERVICES
MSC develops educational tools designed to train users of its products as an
extension of its software business. Training seminars are conducted in local
languages on a frequent basis at the MSC Institute of Technology in Costa Mesa,
California, at MSC's offices worldwide, and at client sites. MSC also offers
both its Mechanical Solutions and Working Knowledge products to schools and
universities.
In addition, MSC provides a broad range of engineering software consulting
services. A typical consulting assignment might include all or some of the
following activities:
- PROCESS ADVICE AND AUTOMATION--We work closely with our key customers to
advise them on product development processes, enabling them to make better
products in less time and for less cost. We automate the advice by
providing software systems that integrate our software with PDM, CAD,
test, and in-house software. The advice and automation moves simulation up
front in the conceptual and detailed design phases to enable simulation to
be performed by design engineers and to be an integral part of the product
development process. In many of our service engagements, we use the
MSC.Acumen toolkit to create design engineering workflow templates that
capture and automate the engineering process, providing tremendous
productivity gains.
- ENGINEERING SERVICES--We provide engineering analysis and design services
to our existing software customers and to companies who do not use our
software. These are delivered to our current customers to provide analysis
or design expertise that they may not have, and to augment their
capabilities if they have a manpower shortage. These services are provided
to other companies who do not have any analysis or design professionals on
staff, but who need these capabilities provided via outsourcing. We
deliver the expertise of over 200 highly trained engineers who write,
support,
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and use the MSC software on a daily basis. We have provided services to
automotive, aerospace, biomedical, electronic packaging, petrochemical,
nuclear, and consumer product manufacturers and suppliers. In addition to
analysis and design services before a product's manufacture, we have also
investigated the cause of in-service failures for a wide range of
products.
- AUTOMOTIVE-SPECIFIC SERVICES--Automotive manufacturers and suppliers are
increasing their use of engineering simulation early in the design
process, to reduce dependence on physical testing, improving overall
product quality, and reducing cost/time to market. Our automotive-specific
services capabilities are in the areas of NVH ("noise, vibration, and
harshness") and durability. We have successfully completed automotive
services projects providing fees in excess of $5,000,000 including:
--Development of a custom system for Cooper Tire to integrate simulation,
design, and test, helping to reduce tire development time by 70%;
--Funded enhancements to integrate MSC.AMS with BMW's in-house Product
Design & Manufacturing ("PDM") system, substantially reducing modeling
time for full-vehicle assemblies and spot weld modeling;
--Durability process automation for Navistar; and
--Brake squeal analyses for several companies.
A major trend within automotive manufacturers is to move the development of
components and subsystems to their first-tier suppliers, providing
significant services growth opportunities for us within the supply chain.
- AEROSPACE-SPECIFIC SERVICES--Aerospace manufacturers and suppliers are
increasing their efficiency by utilizing simulation to improve product
performance and reduce design costs. Simulation is an integral part of the
aerospace design process and is used early and throughout the processes.
We are known for having a core competency in aerospace and our products
are considered the industry standard. As a result, MSC's two main service
opportunities are in the areas of custom software development and process
automation. A major opportunity for aerospace specific services is in
supply chain integration; pushing design and certification
responsibilities down the supply chain. Today, we believe that there is
little supply chain optimization within the aerospace market, while it is
generally recognized that such optimization is needed. Most aerospace
OEMs and suppliers are struggling to implement such programs.
- TRAINING SERVICES--We provide custom and standard versions of live, web
and video/DVD courses and course materials joining the engineering
fundamentals with MSC product specific knowledge to enable customers to
make more efficient use of our software. We are the acknowledged leader in
CAE training, more than five times the expertise and size of our largest
competitor. In 2000, we expect to deliver several new courses on video and
DVD and via the web.
- ONSITE SUPPORT--As an optional service, we provide onsite support for our
software. This "pay as you go" service enables our customers to receive a
dedicated level of technical support, with Company personnel becoming or
adding to the in-house experts.
- SOFTWARE IMPLEMENTATION--Implementation services are a combination of
training, onsite support, and engineering services to install software at
customer sites. These are provided to new or existing software customers
so they can make quick, effective use of new versions or new products.
- CUSTOM SOFTWARE DEVELOPMENT, COLLABORATIVE DEVELOPMENT, AND PORTING--We
can customize our software in order to provide customer requested
capabilities on a funded basis. Some of our major software
capabilities--including dynamic sensitivity and optimization, acoustics,
and static aeroelasticity--were developed as custom projects, and in 2000
we will do others. In many cases, the
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projects are fully funded by the customer (custom development), but there
are cases we absorb part of the cost if there is a future commercial
benefit (collaborative development). One type of custom development is
funded porting, where the hardware provider pays us to port our software
to their new hardware or to new versions of operating systems.
- LINUX SERVICES--A new services area for MSC will be for porting to the
Linux operating system. For Linux, we will help our customers move from
Unix, configuring systems for them, porting their in-house software,
customizing the operating system for special needs, and training them. We
will also offer "turn-key" systems that include computers, the operating
system, and software (ours and others). The computers will range from
single PCs or workstations to high-performance clusters of multiple
machines.
RESEARCH AND DEVELOPMENT
MSC continually expends significant amounts on the development and
maintenance of its suite of MCAE software products, as well as on new product
research and development. During the years ended December 31, 1999, 1998 and
1997, gross research and development expenditures were approximately
$27,766,000, $25,266,000 and $22,723,000, respectively. Of the amounts expended,
$8,255,000, $11,600,000 and $12,545,000, respectively, were included in software
costs capitalized. Effective January 1, 1999, MSC changed the estimated useful
life of its capitalized software assets from three and four years to two and
three years. MSC has always estimated the expected life of these assets based on
the release cycle of its products. MSC believes that as software production
cycles decrease, amortization periods should also decrease in order to coincide
with each version's revenue stream. MSC made this change prospectively.
MSC's development activities have historically involved adding new
capabilities to its family of MCAE programs or converting those programs for use
on new computer platforms. These activities are intended to prevent
technological obsolescence and assure MSC's clients the maximum flexibility in
selecting computer hardware. MSC considers the feasibility, cost and the size of
the market its software program for a particular computer when determining
whether to undertake development activity to adapt the program for a particular
computer.
Maintenance of MSC software products includes system integration, quality
assurance testing, error correction, and modifications to accommodate changes to
computer system software. Given the maturity of MSC's software, most maintenance
efforts stem from continuing new developments. Maintenance costs are expensed as
incurred.
MSC has recently increased its expenditure for software development. This
increase resulted primarily from the acquisitions of Marc, UAI, CSAR and KR and
changes within it's product management function in staffing and staff mix
related to a strategic revision in product development activity. This shift in
strategy de-emphasizes features upgrades for specific products and promotes the
development of technologies and integrated software solutions for targeted
customers. MSC's total development cost before software capitalization was 19%
of revenue for 1999, which was consistent with management's target of 20% of
total annual revenues under the new strategy.
SALES AND MARKETING
MSC markets its products through advertising in trade publications,
participation in industry trade shows and exhibits, training seminars conducted
worldwide, its existing client base and through complementary marketing
agreements with computer hardware manufacturers. MSC also uses its own dedicated
sales force as well as value added resellers ("VARs") and the Internet for
domestic marketing.
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Foreign marketing is generally conducted in the same manner as marketing
within the United States. The basic licensing agreements are substantially the
same. Prices for agreements originating with MSC's German subsidiary are
generally stated in German Marks and agreements originating with MSC's Japanese
subsidiary are generally stated in Japanese Yen. Agreements with customers are
typically denominated in United States Dollars. The agreements stated in other
foreign currencies are subject to currency fluctuations.
REVENUE POLICY
MSC provides a variety of licensing alternatives for the use of its software
products. MSC's software products have been primarily offered on an annual
non-cancelable, pre-paid license basis. An annual non-cancelable, pre-paid
license is set at a fixed rate for the period and provides for payment in
advance of use. Prior to October 1, 1998, license revenue was recognized at the
time of sale, while maintenance revenue, representing approximately 15% of the
revenue from a non-cancelable, pre-paid license, was recognized ratably over the
term of the maintenance period. Effective October 1, 1998, MSC adopted the
Accounting Standards Executive Committee of the American Institute of Certified
Public Accountants ("AICPA") Statement of Position ("SOP") 98-9, "MODIFICATION
OF SOP 97-2, SOFTWARE REVENUE RECOGNITION WITH RESPECT TO CERTAIN TRANSACTIONS",
pursuant to which revenue will be recognized ratably over the life of the
contract for a non-cancelable, pre-paid annual license. In recent years, demand
has also increased for paid-up licenses for engineering software products. A
paid-up license provides significant revenue at the original time of sale of the
product, with smaller payments for maintenance following the time of sale. The
growth of paid-up licenses creates higher earnings volatility since larger
amounts of revenue are recognized at one time instead of over a period of time.
Service revenue was less than 10% of revenue for 1999. See Note 1--Summary of
Significant Accounting Policies and Business Information of Notes to
Consolidated Financial Statements for additional information with respect to
MSC's revenue recognition policy.
SALES AND SUPPORT OFFICES
MSC maintains North American sales and client support offices in Costa Mesa,
California; San Mateo, California; Palo Alto, California; Atlanta, Georgia;
Dayton, Ohio; Southfield, Michigan; Lowell, Massachusetts; and Mount Laurel, New
Jersey. Sales and/or technical support representatives who have engineering
backgrounds and experience using MSC's products are staffed in these offices.
These representatives market MSC's products, provide training in their use,
respond to user support calls and provide solutions for MCAE analysis throughout
North America. In addition, sales and support personnel work out of numerous
home offices throughout the United States. The Los Angeles office serves as
MSC's corporate headquarters and e-commerce office. MSC will be relocating its
Costa Mesa office to new office space nearby in the South Coast Metro area of
Orange County, California. The earliest move-in date is anticipated to be
January 2001.
MSC's products are marketed, distributed and supported outside of North
America through a network of foreign subsidiary offices. MSC's wholly owned
European subsidiary, headquartered in Munich, Germany, manages MSC's network of
wholly-owned subsidiaries in the United Kingdom, Italy, Spain, France, Norway,
The Netherlands, Poland, and the Czech Republic. Other sales offices are located
in Greece, Russia, Hungary, Belgium, Romania, Slovenia and Turkey. In the
Asia-Pacific region, sales and service are handled through MSC's wholly-owned
subsidiary in Tokyo, Japan, with a branch office in Osaka, Japan, as well as
other sales and services offices in Korea, Taiwan and the People's Republic of
China. A foreign subsidiary office is also located in Brazil.
Representative arrangements are also utilized in several other European and
Asia-Pacific countries as well as in India, Australia and parts of Latin
America.
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POST CONTRACT SUPPORT
Client service is an integral aspect of MSC's marketing program. MSC
maintains toll-free numbers and a "hot line" service for its clients. MSC has
invested in advanced "call center" technology to improve its capabilities.
User manuals, training and quality assurance are also essential to MSC's
marketing program. MSC's user manuals are comprehensive and updated on a regular
basis. A staff of writers and editors manage the design, writing, editing and
preparation of user manuals as well as of training materials and promotional
literature.
MSC conducts formal training for clients, ranging from three-day
introductory courses to intensive courses on specialized subjects for
experienced users. Onsite courses for clients are provided for larger user
organizations.
MSC also hosts annual users' conferences in the United States, Europe,
Asia-Pacific, Australia and Latin America to gather data on client needs, new
engineering applications, and new trends in computing technology.
CUSTOMERS
MSC's products are marketed internationally to clients from aerospace,
automotive, other manufacturers and universities. These categories of clients
accounted for 33%, 24%, 40% and 3%, respectively, of MSC's revenues for 1999.
For 1999, foreign export sales accounted for approximately 54% of gross
revenues, most of which was attributable to Europe (32%) and Asia-Pacific (22%).
The balance was attributable to Canada and South America. The operating margins
derived from MSC's foreign export sales do not materially differ from its
domestic operations. See Notes 12--Taxes Based on Income and Note 13--Segment
Information of Notes to Consolidated Financial Statements for additional
information with respect to MSC's foreign operations.
No single customer accounted for more than 10% of MSC's consolidated
revenues in 1999.
BACKLOG
MSC does not maintain backlog statistics for its products because software
is generally available for delivery upon execution of a licensing agreement or
contract. Backlog for consulting services work is currently not material.
INTELLECTUAL PROPERTY RIGHTS
MSC, MSC/, MSC/Aries, MSC/Patran, MSC/Mvision and MSC/Dytran are registered
trademarks of MSC. Working Model is a registered trademark of MSC's wholly owned
subsidiary, Knowledge Revolution, Inc. NASTRAN-TM- is a registered trademark of
NASA. MSC.Nastran is an enhanced proprietary version of NASTRAN-TM-.
MSC/Nastran, MSC/Nastran for Windows, MSC/SuperModel, MSC/InCheck,
MSC/SuperForge, MSC/NVH Manager, MSC/DropTest, MSC/FEA, MSC/Fatigue, MSC/Working
Knowledge, MSC/Construct, and MSC/AMS are trademarks of MSC. MSC also obtained
the registered trademarks of MARC, Mentat, M/AutoForge, CSA and CSAR as part of
our 1999 acquisitions. Registration is pending on certain of these trademarks.
Most of MSC's trademarks have also been registered in foreign countries. MSC
believes that it could successfully defend the use of its trademarks, whether
registered or pending registration, under federal or common law existing in the
State of California.
In addition, MSC maintains federal statutory copyright protection with
respect to its software programs and products and has registered copyrights on
all documentation and manuals related to these programs and maintains trade
secret protection on its software products.
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COMPETITION
MSC competes in highly competitive markets, including the development and
marketing of software for use principally by engineers and designers in
industry, research laboratories and universities. MSC believes that it is a
leading supplier of software and services to the MCAE markets in which it
competes.
MSC believes that MSC.Nastran is the leading program for engineering
analysis worldwide, based upon capability, functionality, international
acceptance and sales volume, and that MSC.Patran is the standard MCAE
environment for manufacturers worldwide, based upon its enhanced usability,
direct CAD access, intelligent use of geometry, automated finite element
modeling and completeness of analysis integration. MSC believes that MSC.Working
Model Motion is the unit volume leader for desktop-based motion simulation,
based principally on its ease of use and on its association with leading
university textbook publishers that bundle our software with their texts.
MSC must continue to offer attractive prices and performance capabilities in
order to retain existing clients and further extend its markets. See "Research
and Development" and "Sales and Marketing" above. MSC competes primarily based
upon product quality, service, price and technological innovation.
EMPLOYEES
At December 31, 1999, MSC and its subsidiaries employed 831 persons, of whom
413 were involved in technical activities, 312 in sales and marketing, and 106
in administration. Of these employees, 302 hold advanced degrees. MSC's business
is dependent in part upon its ability to attract and retain highly skilled
personnel who are in great demand. MSC has no contracts with labor organizations
and believes its relations with its employees are good.
EXECUTIVE OFFICERS OF THE REGISTRANT
The table below sets forth certain information about executive officers that
are not also directors of MSC. MSC is not aware of any arrangement or
understanding between these persons and any other persons pursuant to which the
executive officers were selected as such. MSC is not aware of any family
relationships between these executive officers and any other executive officers.
<TABLE>
<CAPTION>
OFFICER AGE CURRENT POSITION
- ------- -------- ------------------------------------------
<S> <C> <C>
Louis A. Greco............................ 52 Chief Financial Officer and Corporate
Secretary
Kenneth D. Blakely........................ 45 Senior Vice President and General Manager
Mechanical Solutions Division
David Baszucki............................ 37 Vice President and General Manager Working
Knowledge Division
John Di Lullo............................. 56 Vice President and General Manager
Engineering-e.com Division
Jeff Morgan............................... 54 Vice President--Worldwide Product and
Business Development
Richard C. Murphy......................... 36 Vice President--The Americas
Greg Sikes................................ 37 Vice President and General Manager Linux
Division
Dr. Christopher St. John.................. 53 Vice President--Europe
Masaru Tateishi........................... 54 Vice President--Asia-Pacific
</TABLE>
LOUIS A. GRECO has served as Chief Financial Officer of MSC since
March 1983. He has served as Corporate Secretary since December 1985.
9
<PAGE>
Mr. Greco has a Bachelor of Science Degree in Business with an Accounting
Emphasis from California State University at Los Angeles and a Masters Degree in
Business Administration from the University of Southern California. He is also a
Certified Public Accountant.
KENNETH D. BLAKELY has served as Senior Vice President and General Manager
of the Mechanical Solutions Division since January 1999. Prior positions at MSC
include Vice President and General Manager of the Aerospace Business Unit; Vice
President of Marketing; Director of Product Management; and Manager of Technical
Planning and Product Services. He also headed the MSC.Nastran for Windows team,
responsible for conceiving, developing and launching the product. Mr. Blakely
has authored the MSC.Nastran Basic Dynamic Analysis User's Guide and written
more than 40 technical papers, primarily on test-analysis correlation,
structural dynamics, PC applications, and CAD-FEA interoperability.
Mr. Blakely has a Bachelors Degree in Engineering and a Masters Degree in
Structural Dynamics from the University of California at Los Angeles.
DAVID BASZUCKI has served as Vice President and General Manager of Working
Knowledge Division since January 1999, when he joined MSC upon the acquisition
of KR. Mr. Baszucki was the President and Founder of Knowledge Revolution Inc.
from August 1989 to December 1998. Mr. Baszucki is the original architect of
Interactive Physics and the Working Model platform-dependent dynamics engine.
Mr. Baszucki has 12 years of experience in the simulation software industry.
Before founding KR, he held engineering and marketing positions at ROLM
Corporation and CIC Corporation.
Mr. Baszucki has a Bachelors Degree in Electrical Engineering from Stanford
University. He is also a recipient of the General Motors Stanford Scholarship
and a winner of the Stanford Mechanical Engineering Design Competition.
JOHN DI LULLO has served as Vice President and General Manager of
Engineering e.com Division of MSC since March 2000. He came to MSC in October of
1999. Prior to that Mr. Di Lullo was the General Manager of Education Systems at
Systems and Computer Technology where he web-enabled their software products and
was a Senior Director at Time-Warner from October 1994 through December 1997
where he led various internet commerce initiatives.
Mr. Di Lullo has a Bachelor of Science Degree in Mathematics and Masters
Degree in Information Systems from Temple University.
JEFF MORGAN has served as Vice President, Worldwide Product and Business
Development of Mechanical Solutions Division since March 2000. Mr. Morgan came
to MSC with the acquisition of UAI where he served as President since 1992.
Mr. Morgan has a Bachelor of Science Degree in Flight Sciences from Columbia
University.
RICHARD C. MURPHY has served as Vice President--The Americas of Mechanical
Solutions Division since January 1999. Prior to that, he was Vice President and
General Manager of the Growth Industries Business Unit from February 1997 to
December 1998; Vice President and General Manager of the General Manufacturing
Unit from September 1996 to January 1997; Department Director of North American
Sales and Support from March 1997 to August 1996; Regional Office Manager of
North American Sales and Sales Support from February 1994 to February 1996; and
Sales Representative of North American Sales and Support from April 1991 to
January 1994.
GREG SIKES has served as Vice President and General Manager of Linux
Division of MSC since March 2000. Mr. Sikes joined MSC in 1993 and has held
various positions including Director of Aerospace Development, Manager of
Aerospace Products and Product Manager for MSC.Patran.
Mr. Sikes has a Bachelor of Science Degree in Aeronautical Engineering from
the University of Illinois and a Masters Degree in Mechanical Engineering from
the University of California at Berkeley.
10
<PAGE>
DR. CHRISTOPHER ST. JOHN has served as Vice President--Europe of Mechanical
Solutions Division since April 1997. Prior to that, he was Director of European
Engineering Services from January 1995 to March 1997.
MASARU TATEISHI has served as Vice President--Asia-Pacific of Mechanical
Solutions Division since February 1995. Before that, he was General Manager of
MSC Japan from March 1993 to January 1995.
FORWARD-LOOKING STATEMENTS
The forward-looking statements in this report, including statements
concerning projections of MSC'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 MSC's
software products;
- MSC's dependence on certain industries;
- The impact of the Internet on MSC's business;
- 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;
- MSC's ability to reduce costs without adversely impacting revenues;
- Successful involvement of international and domestic business partners in
creating mechanical engineering solutions;
- MSC's ability to attract, motivate and retain salespeople, programmers and
other key personnel;
- The adoption by MSC of certain anti-takeover provisions; and
- Continued demand for its products, including MSC.Nastran, MSC.Patran,
MSC.Marc, MSC.Dytran, MSC.Mvision, MSC.Nastran for Windows, and
MSC.Working Model 4D.
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.
RISK FACTORS
HISTORICAL RESULTS OF OPERATIONS AND FINANCIAL POSITION OF MSC ARE NOT
NECESSARILY INDICATIVE OF FUTURE FINANCIAL PERFORMANCE--MSC derives most of its
revenue from selling software products and services to high end users of the
product design markets. Our revenue growth and our ability to match spending
levels with revenue growth rates will directly affect our future operating
results. Historically, a significant portion of our revenue has been generated
from shipments in the last month of a quarter. In addition, higher volumes of
orders have been experienced in the fourth quarter. The concentration of orders
makes projections of quarterly financial results difficult. In addition, over
50% of our revenue is derived from international markets and are denominated in
foreign currencies. As a result, our financial results could be impacted by
weakened general economic conditions in various parts of the world, differing
technological advances or preferences, volatile foreign exchange rates, and
government trade restrictions in any country in which we do business.
11
<PAGE>
RISK ASSOCIATED WITH EXPENSE MANAGEMENT--MSC plans its operating expense
levels, in part, on expected revenue growth. Our expense levels, however, are
generally committed in advance and, in the near term, we are able to change only
a relatively small portion of our expenses. As a result, our ability to convert
operating outlays into expected revenue growth at profitable margins will affect
our future operating results. If our future revenues are less than expected, our
net income may be disproportionately affected since expenses are relatively
fixed.
RISKS OF COMPETITION--The software industry is highly competitive. The
entire industry may experience pricing and margin pressure which could adversely
affect our operating results and financial position. Our success depends on our
ability to continue to develop, enhance and market new products to meet our
customers' sophisticated needs within competitive pricing structures and in a
timely manner. Shortened product development cycles may impact product quality,
performance, reliability, ease of use, functionality, breadth and integration.
Our success also depends, in part, on our ability to: (1) attract and retain
technical and other key employees who are in great demand; (2) protect the
intellectual property rights of our products; and (3) continue key relationships
with product development partners.
Some of our current and possible future competitors have greater financial,
technical, marketing and other resources than we do, and some have
well-established relationships with our current and potential customers. It is
also possible that alliances among competitors may emerge and rapidly acquire
significant market share or that competition will increase as a result of
software industry consolidation. Increased competition may result in price
reductions, reduced profitability and loss of market share, any of which could
have a material adverse effect our business, financial condition and results of
operations.
RISKS RELATED TO DEPENDENCE ON CORE PRODUCTS--We currently earn a
significant portion of our revenues from sales and maintenance of a core group
of analysis and design software derived primarily from our MSC.Nastran and
MSC.Patran products. As a result, any factor adversely affecting sales of these
core products could have a material adverse effect on our business. Our future
performance will depend upon successful development, introduction and customer
acceptance of new products or enhanced versions of our existing products. We can
give no assurance that we will continue to be successful in marketing our
current products or any new or enhanced products that we may develop in the
future. In addition, competitive pressures or other factors may result in price
erosion that could have a material adverse effect on our business, financial
condition and results of operations.
DEPENDENCE ON CERTAIN INDUSTRIES--We primarily market our products to
aerospace, automotive and other industrial customers. For 1999, aerospace
clients accounted for 33% of our revenues and automotive clients accounted for
24% of our revenues. Changes in capital spending by, and cyclical trends
affecting, these customers may adversely affect our offerings to these
industries. In addition, these types of customers tend to adhere to a technology
choice for long periods (i.e., an entire development cycle). As a result, a lost
opportunity with a given customer may not again become a new opportunity for
several years.
RISKS RELATED TO INTERNATIONAL ACTIVITIES--Revenues from foreign export
sales represented approximately 54% of our gross revenue for 1999. Risks
inherent in our international business activities include the following:
- Imposition of government controls;
- Foreign exchange fluctuations, as many of our agreements originating with
our German and Japanese subsidiaries are stated in foreign currencies (see
also "Euro Conversion" in Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations);
- Export license requirements;
- Restrictions on the export of critical technology or other trade
restrictions;
- Foreign political and economic instability;
12
<PAGE>
- Ineffective copyright and trade secret protection under foreign law;
- Changes in regulatory practices, tariffs and taxes;
- Difficulties in staffing and managing international operations;
- Longer accounts receivable payment cycles; and
- Burdens of complying with a wide variety of foreign laws and regulations.
In 1998, unfavorable economic and political conditions in the Asian markets
affected our international results. 24% of MSC's total revenue for 1999 is
directly related to the Japanese market, while 5% is from the Asia-Pacific
region outside of Japan. Although the Asia-Pacific economies have shown signs of
recovery, we still remain cautious about MSC's Asia-Pacific prospects. We can
give no assurance that the economic and currency issues are going to improve
further or remain constant. Any downturn may have a material adverse effect on
our future international sales and, consequently, on our business, financial
condition and results of operations.
CERTAIN ANTI-TAKEOVER PROVISIONS
Certain provisions of our Restated Certificate of Incorporation and Restated
Bylaws could make it more difficult for a third party to acquire control us,
even if the change in control would be beneficial to stockholders. These
provisions include the following:
- Division of our Board of Directors into three classes, with each class
serving a staggered three-year term;
- Vesting of exclusive authority in the Board, the Chairman of the Board and
the President (except as otherwise required by law) to call special
meetings of stockholders;
- Elimination of stockholder voting by consent;
- Removal of Directors for cause only;
- Ability of the Board to authorize the issuance of preferred stock in
series;
- Vesting of exclusive authority in the Board to determine the size of the
Board (subject to certain limited exceptions) and to fill vacancies
thereon; and
- Advance notice requirements for stockholder proposals and nominations for
election to the Board.
RISKS RELATED TO STOCK MARKET VOLATILITY--The trading price of our stock,
like other software and technology stocks, is subject to significant volatility.
If our revenues or earnings fail to meet securities analysts' expectations,
there could be an immediate and significant adverse impact on the trading price
of our stock. In addition, broader market factors unrelated to our performance
may affect our stock price.
In addition to the above provisions, we adopted a new stockholder rights
plan in 1998. Such plan entitles our stockholders, if an entity acquires more
than 20% of our stock or, in the event of a "squeeze-out merger"(1), to purchase
either our common stock or the common stock of the merged entity at one-half of
such stock's market value. Until ten days after the announcement of the
acquisition of such a 20% interest, we may redeem the rights for a nominal
amount.
- ------------------------
1 A "squeeze-out merger" is a merger transaction in which a minority interest
in a corporation is intenionally eliminated or reduced. This often
accomplished by setting up the merger transaction to provide such holders of
minority interests with effective no choice but to accept cash (as opposed
to interests in the continuing entity) in exchange for their shares.
13
<PAGE>
ITEM 2. PROPERTIES
MSC's offices are leased under agreements expiring at various times over the
next one to 12 years. MSC's principal offices are in Los Angeles, California and
Costa Mesa, California, and include 28,035 square feet and 81,178 square feet,
respectively, under leases expiring in 2005 and 2002, respectively. As part of
its restructuring, MSC relocated a portion of its Los Angeles operations into
the Costa Mesa office. Management believes that this move provided cost savings
as well as providing enhanced productivity by having key personnel in one
office. MSC will be relocating the Costa Mesa office to new office space nearby
in the South Coast Metro area of Orange County, California. The new office
includes 125,043 square feet under a lease expiring in 2012. The earliest
move-in date is anticipated to be January 2001. MSC also leases its other
offices throughout the United States and internationally. See Note 16--
Commitments and Contingencies of Notes to Consolidated Financial Statements of
this report for additional information regarding MSC's lease obligations.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the last quarter
of MSC's fiscal year ended December 31, 1999.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MSC's common stock is listed for trading on the New York Stock Exchange
("NYSE") under symbol "MNS". The following table sets forth through
December 31, 1999, the high, low, average and closing prices, as reported on the
NYSE composite trading system, for the periods shown:
<TABLE>
<CAPTION>
SALES PRICES
-----------------------------------------
HIGH LOW AVERAGE CLOSE
-------- -------- -------- --------
<S> <C> <C> <C> <C>
CALENDAR YEAR 1999:
Fourth Quarter............................. $10.31 $6.25 $ 7.45 $10.13
Third Quarter.............................. $ 7.25 $4.88 $ 5.77 $ 6.69
Second Quarter............................. $ 6.13 $5.19 $ 5.71 $ 5.81
First Quarter.............................. $ 7.63 $5.06 $ 6.15 $ 6.00
CALENDAR YEAR 1998:
Fourth Quarter............................. $ 7.38 $5.19 $ 5.96 $ 7.00
Third Quarter.............................. $ 9.81 $5.75 $ 7.73 $ 6.19
Second Quarter............................. $12.13 $9.25 $10.58 $ 9.81
First Quarter.............................. $12.38 $9.06 $10.21 $11.88
</TABLE>
As of March 1, 2000, there were 320 record holders of MSC's Common Stock.
MSC eliminated its dividend in September of 1996 and does not anticipate paying
a dividend in the foreseeable future. In addition, MSC's loan agreement with its
principal bank imposes restrictions on MSC's payment of cash dividends or
payments on account of or in redemption, retirement or purchase of MSC's common
stock or other distributions.
On November 4, 1999, in connection with the acquisition of CSAR, MSC issued
warrants to purchase 110,000 shares of MSC's common stock at $10.00 per share
for an aggregate exercise price of $1,100,000. 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 approximately $258,000. The transaction was a private placement exempt
from registration under section 4(2) of the Securities Act of 1933.
During the fourth quarter of 1999, in connection with a marketing
arrangement with Kubota Solid Technology Corporation, MSC issued warrants to
purchase 38,216 shares of MSC's common stock at $9.8125 per share and 52,632
shares of MSC's common stock at $7.125 per share for an aggregate exercise price
of $750,000. 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 approximately $287,000. The exercise price
was equal to the fair market value of the common stock on the date of purchase.
The transaction was a private placement involving one offeree and one purchaser
exempt from registration under section 4(2) of the Securities Act of 1933.
See Note 15--Stock Options and Warrants of Notes to Consolidated Financial
Statements for additional information with respect to warrants issued by MSC.
15
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ITEM 6. SELECTED FINANCIAL DATA
The selected financial data for the years ended December 31, 1999, 1998,
1997, 1996 and 1995 is derived from MSC's audited consolidated financial
statements. The selected financial data should be read in conjunction with
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations, the Consolidated Financial Statements of MSC and the related
Notes to Consolidated Financial Statements.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------
1999(1) 1998(2) 1997 1996 1995
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenue........................ $149,235,000 $125,397,000 $132,804,000 $132,081,000 $127,374,000
Operating Income (Loss)........ $ 2,636,000 $(10,041,000) $ 18,963,000 $ 18,685,000 $ 22,648,000
Net Income (Loss).............. $ 5,097,000 $(12,979,000) $ 9,887,000 $ 9,711,000 $ 12,743,000
Basic Earnings (Loss)
Per Share.................... $ 0.37 $ (0.95) $ 0.73 $ 0.72 $ 0.97
Diluted Earnings (Loss)
Per Share.................... $ 0.37 $ (0.95) $ 0.73 $ 0.72 $ 0.90
Cash Dividends Declared
Per Share.................... $ -- $ -- $ -- $ 0.22 $ 0.48
Total Assets................... $187,220,000 $140,617,000 $129,053,000 $119,786,000 $114,704,000
Long-Term Debt:
Note Payable, Less Current
Portion.................... $ 4,533,000 $ -- $ -- $ -- $ --
Convertible Subordinated
Debentures, Net............ $ 58,287,000 $ 56,574,000 $ 56,574,000 $ 56,574,000 $ 56,574,000
Subordinated Notes
Payable, Net............... $ 11,804,000 $ -- $ -- $ -- $ --
</TABLE>
- ------------------------
(1) Reflects an in-process research and development charge of $4,067,000 related
to the acquisition of MARC, impairment charges of $1,500,000 in cost of
revenue, restructuring charges of $5,497,000, and a gain on sale of equity
investment of $10,773,000.
(2) Reflects a reduction in revenue of $9,398,000 related to the change in how
MSC recognizes revenue, an in-process research and development charge of
$6,000,000 related to the acquisition of KR, impairment charges of
$8,164,000 in cost of revenue, and restructuring and other impairment
charges of $2,365,000.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RECENT DEVELOPMENTS
On July 1, 1999, MSC.Software Corporation ("MSC") changed its name from The
MacNeal-Schwendler Corporation.
On January 29, 1999, MSC changed its fiscal year from a year beginning
February 1 and ending January 31, to a calendar year. All financial information
for prior periods has been restated to coincide with the new fiscal year.
Therefore, any references to a fiscal year mean the twelve months ended
December 31 of that year.
During 1999, MSC acquired the following companies: MARC Analysis Research
Corporation ("MARC"); Universal Analytics Inc. ("UAI"), and Computerized
Structural Analysis and Research Corporation ("CSAR"). In late December 1998,
MSC acquired Knowledge Revolution Inc. ("KR"). Refer
16
<PAGE>
to Note 4--Business Acquisitions and Divestitures in Notes to Consolidated
Financial Statements for additional information with respect to MSC's
acquisitions.
ACCOUNTING CHANGES
In the fourth quarter of 1998, the Accounting Standards Executive Committee
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, MSC adopted the
provisions of SOP 98-9 effective October 1, 1998 and, accordingly, revenue on
non-cancelable and pre-paid 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 elements of the arrangements is not available. This resulted in
a decrease in revenues that otherwise would have been recognized in the fourth
quarter of 1998 since only a portion of the revenues related to annual lease
agreements was recognized. The revenue reduction was $9,398,000 compared to the
amount of revenue that would have been recognized under SOP 97-2. This revenue
was recognized ratably, primarily over the first three quarters of 1999.
Future quarters will also reflect the deferral of revenue associated with
non-cancelable and pre-paid annual lease arrangements entered into in those
quarters under SOP 98-9. 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 was not 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.
ASSET IMPAIRMENT AND RESTRUCTURING
MSC has consistently followed the policy of capitalizing software
development costs related to product development in accordance with the
guidelines established under Statement of Financial Accounting Standard ("SFAS")
No. 86, "ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE TO BE SOLD, LEASED OR
OTHERWISE MARKETED". Capitalized software costs are then amortized over a period
of time (expected useful life) that is estimated to equate to the term during
which meaningful revenue from the related product is expected to be recognized.
Previously capitalized product development costs and projected revenues are
reviewed quarterly to determine if any impairment in value has occurred that
would require an adjustment in the carrying value or change in expected useful
lives under the guidelines established in SFAS No. 86 and SFAS No. 121,
"ACCOUNTING FOR THE IMPAIRMENT OF LONG LIVED ASSETS AND FOR LONG LIVED ASSETS TO
BE DISPOSED OF". MSC recognizes impairment losses on long lived assets 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.
Accordingly, during the second quarter of 1999, MSC recognized non-cash
pre-tax charges of $1,500,000 related to the write-off of the net book value of
certain previously capitalized software development costs and to provide for the
remaining payments due. Theses costs were deemed impaired because they
represented duplicate technologies from those acquired in the MARC acquisition.
During the fourth quarter of 1998, MSC recognized non-cash pre-tax charges of
$7,771,000 related to the write-off of the net book value of certain previously
capitalized software development costs and $393,000 of other impairment charges
recorded in cost of revenues and a non-cash pre-tax charge of $1,670,000
recorded as part of restructuring and other impairment charges related to the
write-off of previously reported goodwill from the acquisition of Silverado
Software & Consulting ("Silverado"). Refer to Note 3--Impairment of Assets in
Notes to Consolidated Financial Statements.
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<PAGE>
On February 3, 1999, MSC announced a new organizational structure following
a re-evaluation of its business strategy. MSC is now emphasizing 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
provided for a reduction in MSC's worldwide workforce (a reduction of
approximately 75 positions) and the consolidation of 15 field offices. These
changes resulted in pre-tax charges of $5,497,000 in the first two quarters of
1999. The charges consist of severance costs of $2,908,000, costs related to
facility consolidations of $2,262,000 and other charges of $327,000. MSC
believes these charges provided a reduction in its annual operating costs. The
restructuring liability at December 31, 1998 represents $695,000 of severance
charges for certain employee terminations that occurred in December 1998. The
restructuring and other impairment charges for 1998 of $2,365,000 include the
$695,000 of severance costs and the $1,670,000 of goodwill write-off discussed
above.
BUSINESS ACQUISITIONS
ACQUISITION OF MARC ANALYSIS RESEARCH CORPORATION--On June 18, 1999, MSC
acquired all of the outstanding stock of MARC, a software developer and supplier
whose products include MARC (a non-linear finite element analysis ("FEA")
program for engineering structural analysis), Mentat (a graphical user interface
for MARC), and MARC/Autoforge (a simulation program for the bulk forging
industry).
The aggregate fair value of the consideration paid to shareholders and
holders of options of MARC resulted in a purchase price valued at approximately
$36,100,000 including approximately $20,300,000 in cash and a package of
securities to the MARC shareholders, including $11,000,000 principal amount of
8% subordinated notes due in 10 years, approximately $3,236,000 principal amount
of 8% subordinated notes due in two years, $2,000,000 principal amount of MSC's
7 7/8% convertible subordinated debentures due August 18, 2004, and five-year
warrants to purchase 1,400,000 shares of MSC's common stock at an exercise price
of $10.00 per share.
In allocating the purchase price to the acquired assets and assumed
liabilities, MSC has recorded a $8,719,000 deferred income tax liability related
to identified intangible assets, offset by $1,933,000 for deferred income tax
assets, and $2,360,000 for restructuring costs related to the integration of
MARC, primarily severance costs and costs related to facility consolidations.
Refer to Note 10--Restructuring Reserve.
The acquisition was accounted for as a purchase and, accordingly, the
operating results of MARC are included in MSC's consolidated financial
statements from the date of acquisition. The total purchase price was allocated
to the assets and liabilities of MARC based upon their approximate fair values.
The independent 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: $3,433,000 to net tangible
assets; $25,643,000 to identified intangible assets (including $15,274,000 of
developed technology, $6,322,000 to customer list, $2,390,000 for trade name
recognition, and $1,657,000 of assembled work force); and $12,126,000 to
goodwill. Goodwill and identified intangibles are being amortized over
15 years.
On the date of its acquisition, MARC's technology was classified between
core or developed technology and in-process research and development. Three MARC
products that had been released were grouped under developed technology and two
development projects under way were identified as in-process research and
development. The completion of the two development projects was estimated to be
24% and 91% at the time of acquisition. The technology assets were valued using
a relief from royalty
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and discounted cash flow approach. The concept of the relief from royalty
approach is that the value of a technology is the avoided cost of licensing the
technology from a third party that the company would otherwise incur if it did
not own the technology in question.
These research and development valuations represent the ten-year after-tax
cash flow of the technology using a discount rate of 15% for developed
technology and 18% for in-process research and development. The discount rate is
based upon MARC's weighted-average cost of capital ("WACC") of 16%. This WACC
was derived by considering various factors to quantify the risk above a
risk-free rate of return of approximately 6%. The discount rate selected for the
in-process research and development was determined to be higher due to the
relatively higher risk of these cash flows.
In valuing both the developed technology and in-process research and
development, the initial focus was on the revenue contribution generated by each
of the products. Revenue estimates were based on the following: (1) aggregate
revenue growth rates for the business as a whole; (2) individual product
revenues; (3) growth rates for related products; (4) anticipated product
development and introduction schedules; (5) product sales cycles; and (6) the
estimated useful life of a product's underlying technology. The aggregate
product revenue amounts were estimated and segregated between the developed
technology and each in-process research and development project. In valuing the
developed technology, an after-tax royalty rate of 10% was combined with a 2%
after-tax royalty rate attributable to the in-process technology to arrive at
the "free cash flow" of the developed technology. This cash flow was then
discounted to determine the value of the developed technology at the acquisition
date. In valuing the in-process technology, an after-tax royalty rate of 8% was
applied to the revenues associated with the technology and the resulting avoided
royalty payments were discounted to determine the value of the technology.
Percentage of completion factors, based on historical and planned future
development expenditures, were applied to the unadjusted projected cash flows of
the in-process technologies.
Management believes that MSC is positioned to continue development of these
MARC products, integrate these and other MARC products with existing MSC
products and expand MSC's market share in the non-linear market. However, there
is risk associated with the completion, marketing and integration of these MARC
products into MSC. There is no assurance that the in-process technology will
meet with either technological or commercial success. The substantial or
outright failure of this integration could adversely impact MSC's financial
condition.
ACQUISITION OF UNIVERSAL ANALYTICS INC.--On June 24, 1999, MSC acquired UAI
for approximately $8,400,000 in cash. UAI is a developer and distributor of FEA
software and engineering services for the engineering community and to major
manufacturers worldwide. The acquisition was accounted for as a purchase and,
accordingly, the operating results of UAI are included in MSC's consolidated
financial statements from the date of acquisition. The excess of the aggregate
purchase price over the fair market value of net assets acquired was
approximately $6,800,000. Goodwill and identified intangibles are being
amortized over ten years. The pro forma effect of the UAI acquisition as if it
had occurred on January 1, 1999 or 1998 is immaterial to the consolidated
financial statements presented herein.
ACQUISITION OF COMPUTERIZED STRUCTURAL ANALYSIS AND RESEARCH CORPORATION--On
November 4, 1999, MSC acquired CSAR for approximately $9,650,000 in cash and
five-year warrants to purchase 110,000 shares of MSC's common stock at an
exercise price of $10.00 per share. MSC financed a portion of the purchase price
through a $8,000,000 term loan. Refer to Note 5--Financial Instruments of Notes
to Consolidated Financial Statements. CSAR is a developer and distributor of FEA
software and services for the engineering community and to major manufacturers
worldwide. The acquisition has been accounted for as a purchase and,
accordingly, the operating results of CSAR have been included in MSC's
consolidated financial statements since the date of acquisition. The excess of
the aggregate purchase price over the fair market value of net assets acquired
was approximately $9,800,000. Goodwill and identified intangibles are being
amortized over five years. The pro forma effect of the CSAR acquisition as if it
had occurred on January 1, 1999 or 1998 is immaterial to the consolidated
financial statements presented herein.
19
<PAGE>
ACQUISITION OF KNOWLEDGE REVOLUTION INC.--In late December 1998, MSC
acquired KR for approximately $19,200,000 in cash. KR is the world's leading
developer and distributor of 2D and 3D-motion simulation software for design
engineers and analysts. The acquisition was 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: $1,549,000 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
$1,786,000 to goodwill. Goodwill and identified intangibles are being amortized
over three to ten years.
On the date of its acquisition, KR's technology was classified between core
or developed technology and in-process research and development. Four KR
products, one released and the others under development, were identified and
their reliance on the developed technology and in-process research and
development was determined. The reliance on in-process research and development
ranged from 0% to 90% on these products. In-process research and development was
further segmented into classifications of completed and to-be-completed based on
three criteria: (1) the estimated time required to complete the development;
(2) the estimated cost to complete; and (3) the complexity involved in
overcoming technological obstacles that must be resolved during development. The
completion of development at the time of acquisition ranged from 39% to 72%. The
in-process technology was incorporated in MSC's Working Model Motion product
that was released in the second quarter of 1999.
These research and development valuations represent the five-year after-tax
cash flow of this technology using a discount rate of 23% for developed
technology and 28% for in-process research and development. The discount rate is
based upon KR's WACC of 22%. This WACC was derived by considering various
factors to quantify the risk above a risk-free rate of return of approximately
5%. The discount rate selected for the in-process research and development was
determined to be significantly higher than the WACC due to the fact that the
technology had not yet reached technological feasibility as of the date of
acquisition.
In valuing KR's developed technology and in-process research and
development, the initial focus was on the revenue contribution generated by each
of the products. Revenue estimates were made using the same principles as we
used with respect to Marc. The aggregate product revenue amounts were estimated
and segregated between the developed technology and in-process research and
development. Operating expenses were deducted from the revenue estimates to
arrive at operating income. Operating expenses included cost of revenue, selling
and marketing, and general and administrative expenses but no non-cash charges
such as depreciation and amortization. Certain adjustments were made to
operating income to derive the after-tax cash flow. These adjustments included
the calculation of an applicable tax expense and an appropriate charge for the
use of contributory assets necessary to generate revenue and operating income
associated with the subject intangible assets.
20
<PAGE>
RESULTS OF OPERATIONS
1999 COMPARED TO 1998
NET INCOME (LOSS)--Consolidated net income was $5,097,000, or $0.37 per
diluted share, in 1999 compared to a net loss of ($12,979,000), or ($0.95) per
diluted share, in 1998.
REVENUE--MSC reported revenue of $149,235,000 in 1999 compared to revenue of
$125,397,000 in 1998, an increase of $23,838,000, or 19%. The increase in
reported revenue from 1998 to 1999 was primarily due to MSC's acquisitions at
the end of 1998 and during 1999, as well as a favorable impact from the adoption
of SOP 98-9, beginning October 1, 1998. The acquisitions of KR, MARC, UAI and
CSAR accounted for an increase in revenues of $14,559,000, or 12%, during the
period. These acquisitions were all accounted for under the purchase method of
accounting, so there was $711,000 of KR revenue in the same period of the prior
year. As permitted, MSC adopted the provisions of SOP 98-9 effective October 1,
1998 and, accordingly, revenue on non-cancelable, pre-paid annual lease
agreements is recognized monthly over the term of the agreement, beginning in
the fourth quarter of 1998, as compared to only deferring the fee related to
maintenance for licenses sold before October 1, 1998.
Software license revenue and maintenance fees account for 93% and 94% of
total reported revenue for 1999 and 1998, respectively, with service revenue
making up the difference. For 1999 and 1998, approximately 76% and 79%,
respectively, of MSC's software license revenue and maintenance fees is derived
from annual renewable leases and recurring maintenance fees, with the remaining
24% and 21%, respectively, related to paid-up licenses.
Due to the adoption of SOP 98-9, it is difficult to make comparisons of
revenues between 1999 and 1998. For comparative purposes, MSC estimates that
total revenue for the year ended December 31, 1998 would have been $1,335,000
lower than the reported revenues if SOP 98-9 had been adopted beginning on
October 1, 1997. This would have resulted in a 20% growth rate in 1999 in total
revenues. An additional $11,338,000 of revenue increases were due to those
revenues which are unaffected by the adoption of SOP 98-9: paid-up license
revenue, which increased $9,459,000; embedded technology license revenue, which
decreased $802,000; consulting services revenue, which increased $2,711,000; and
other software services revenue, which decreased $31,000. Revenues for 1999 from
the acquired companies include paid-up license revenue of $7,094,000.
Software license revenue consists of licensing fees, which are fees charged
for the right to use MSC's or a third parties' software. 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
MSC's software. Maintenance and services revenues include PCS, consulting and
training 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.
The following table illustrates revenue by geographic region and the related
growth rates between 1999 and 1998 in functional currencies as reported
utilizing the current revenue recognition policy adopted on October 1, 1998 for
1999 and estimated for the year ended December 31, 1998 as if the policy had
been adopted on October 1, 1997:
<TABLE>
<CAPTION>
GROWTH RATE
-----------------------------
YEAR ENDED DECEMBER 31, 1999
VS.
YEAR ENDED YEAR ENDED DECEMBER 31, 1998
DECEMBER 31, -----------------------------
1999 IF SOP 98-9 HAD
------------ BEEN ADOPTED
% OF TOTAL ON
REVENUE AS REPORTED OCTOBER 1, 1997
------------ ----------- ---------------
<S> <C> <C> <C>
The Americas................................. 46% 17% 16%
Europe....................................... 31% 14% 17%
Asia-Pacific................................. 23% 31% 34%
Total.................................... 100% 19% 20%
</TABLE>
21
<PAGE>
The increase in reported revenues for all regions was due to increases from
core business revenue and from the acquisitions of KR and MARC in December 1998
and June 1999, respectively. The acquisitions of KR, MARC, UAI and CSAR
accounted for increases in revenue in Asia-Pacific of $5,767,000, or 5%, in the
Americas of $5,346,000, or 4%, and in Europe of $3,446,000, or 3%. MSC estimates
that the $1,335,000 decline in 1998 reported revenues had SOP 98-9 been adopted
beginning on October 1, 1997 would have had unfavorable impacts in Europe of
$1,012,000, or 1%, and in Asia-Pacific of $774,000, or 1%, partially offset by a
favorable impact in The Americas of $451,000, or 1%.
Revenue growth in 1999 was also impacted from favorable foreign currency
translation rates for the Japanese Yen. Revenue in the current year would have
been approximately $147,893,000, if translated using the prior year's foreign
currency translation rates. MSC'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, MSC 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
1999 and the risk of change in 2000. The trend exchange rate was determined by
prorating the rate change between 1998 and 1999 and is used to illustrate the
sensitivity to foreign currency fluctuations. The trend rate is for illustration
purposes only and may or may not reflect the actual translation rate in the
future period.
<TABLE>
<CAPTION>
1999 1999 1999 USING
USING 1998 USING 1999 1998/1999 TREND
EXCHANGE RATES EXCHANGE RATES EXCHANGE RATES
-------------- -------------- ---------------
<S> <C> <C> <C>
Revenues:
The Americas..................................... $ 68,092,000 $ 68,092,000 $ 68,092,000
Europe........................................... 48,071,000 45,672,000 43,826,000
Asia-Pacific(1).................................. 31,730,000 35,471,000 40,475,000
------------ ------------ ------------
Total Revenue.................................. $147,893,000 $149,235,000 $152,393,000
============ ============ ============
Exchange Rates:
$/ DM 0.569 0.546 0.523
Yen /$........................................... 130.81 113.68 96.56
</TABLE>
(1) Includes revenue denominated in United States Dollars of $7,260,000.
OPERATING EXPENSES--Operating expenses were $146,599,000 for 1999 compared
to $135,438,000 for the prior year, an increase of $11,161,000, or 8%. Operating
expenses for 1999 include a restructuring charge of $5,497,000, a write-off of
acquired in-process technology of $4,067,000 and a software impairment charge of
$1,500,000. Operating expenses for 1998 include a write-off of acquired
in-process technology of $6,000,000, a software impairment charge of $7,771,000,
and restructuring and other impairment charges of $2,365,000. Without these
charges in 1999 and 1998, operating expenses would have totaled $135,535,000 for
1999, an increase of $16,233,000, or 14%, from the $119,302,000 for 1998. This
increase includes $12,315,000 of additional operating expenses resulting from
the companies acquired.
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--Cost of revenue was $38,261,000, or 26% of total revenues,
for 1999, a decrease of $7,994,000, or 17%, as compared to cost of revenue of
$46,255,000, or 37% of total revenues, for the prior year. Cost of revenue for
1999 and 1998 includes software amortization of $8,816,000 and $11,974,000 and
software impairment charges of $1,500,000 and $7,771,000, respectively under
Cost of Revenue-Software Licenses (COS-LIC). Amortization of capitalized
software costs decreased $3,158,000, or 26% primarily as a result of the
impairment costs recorded in 1998.
22
<PAGE>
Cost of revenue, excluding amortization of capitalized software costs and
software impairment charges, was $27,945,000 or 19% of total revenues for 1999
compared to $26,510,000 or 21% of total revenues for the prior year, an increase
of $1,435,000, or 5%. This increase was primarily due to: (1) a $528,000
increase in the cost of technical support services due to a change in staffing
mix between sales and support resources under Cost of Revenue-Software
Maintenance and Services (COS-MS); (2) a $485,000 increase in software licensing
costs under COS-LIC; (3) a $470,000 increase in packaging costs under COS-MS;
(4) a $443,000 decrease in cost sharing reimbursements under COS-MS; (5) a
$282,000 increase in third party commissions under COS-LIC; (6) and an increase
of $227,000 in other costs; offset by (7) a $1,000,000 decrease in royalty
expense under COS-LIC. Royalty expense is paid to third parties under various
agreements. MSC 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 PROFIT--Gross profit, which is total revenue less cost of revenue, was
$110,974,000, or 75% of total revenues, for 1999, an increase of $31,832,000, or
40%, as compared to a gross profit of $79,142,000, or 63% of total revenues, for
1998. This increase was due to the MARC and KR acquisitions, plus the favorable
impact of the change in revenue recognition method, and due to the decrease in
cost of revenues, primarily as a result of $7,771,000 of impairment costs
recorded in 1998.
RESEARCH AND DEVELOPMENT--Research and development expense for 1999 was
$19,511,000 compared to $13,666,000 for 1998, an increase of $5,845,000, or 43%.
The increase is due to a $2,500,000 increase in the total gross investment in
research and development activities and a decrease of $3,345,000 in the amount
of research and development expenditures capitalized under SFAS No. 86.
The total gross investment in research and development activities for 1999
was $27,766,000, or 19% of total revenue, compared to $25,266,000, or 20% of
total revenue, for the prior year. This increase resulted primarily from an
additional $3,,283,000 of development costs from the acquisitions of KR, MARC,
UAI and CSAR.
Capitalized software development costs were $8,255,000 for 1999 compared to
$11,600,000 for the prior year, a decrease of $3,345,000, or 29%. 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. MSC'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--Selling, general and administrative
expense was $72,152,000 for 1999 compared to $64,884,000 for 1998, an increase
of $7,268,000, or 11%. This increase includes an additional $8,402,000 resulting
from the acquisitions of KR and MARC. The remaining decrease of $1,134,000 was
primarily due to: (1) a decrease of $1,958,000 in bad debt expense as a result
of the reversal of prior year provisions due to collections of older receivable
balances primarily in the fourth quarter of 1999; (2) a decrease of $528,000 as
a result of the reallocation of sales resources to support maintenance and
consulting activities from the recent reorganization; offset by (3) an increase
of $1,157,000 as a result of 1998's gain from the termination of the Post
Retirement Health Care Plan; and (4) $195,000 of other increases.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES--Amortization of goodwill and
other intangibles was $7,111,000 for 1999 compared to $2,268,000 for 1998, an
increase of $4,843,000. The increase was due to the acquisitions of KR, MARC,
UAI and CSAR. The amount of amortization of goodwill and other intangibles in
2000 is expected to be approximately $11,000,000, excluding the impact of any
new acquisitions subsequent to December 31, 1999.
As with revenue, MSC's expenses are impacted by foreign currency
fluctuations. The following table details the effect of the currency rate
changes on operating expense for 1999 and the risk of change in 2000. The trend
exchange rate was determined by prorating the rate change between 1998 and 1999
and is
23
<PAGE>
used to illustrate the risk of foreign currency fluctuations. The trend rate is
for illustration purposes only and may or may not reflect the actual translation
rate in the future period.
<TABLE>
<CAPTION>
1999 1999 1999 USING
USING 1998 USING 1999 1998/1999 TREND
EXCHANGE RATES EXCHANGE RATES EXCHANGE RATES
-------------- -------------- ---------------
<S> <C> <C> <C>
Operating Expense:
The Americas..................... $ 68,006,000 $ 68,006,000 $ 68,006,000
Europe........................... 26,001,000 24,935,000 23,927,000
Asia-Pacific..................... 15,049,000 15,397,000 17,824,000
------------ ------------ ------------
Total Operating Expense........ $109,056,000 $108,338,000 $109,757,000
============ ============ ============
Exchange Rates:
$/ DM 0.569 0.546 0.523
Yen /$........................... 130.81 113.68 96.56
</TABLE>
OPERATING INCOME (LOSS)--Operating income was $2,636,000 for 1999 compared
to an operating loss of $10,041,000 for 1998, an increase of $12,677,000.
Operating income (loss) for the years ended December 31, 1999 and 1998 includes
the effects of MSC's adoption of SOP 98-9 in the fourth quarter of 1998,
write-offs of acquired in-process technology, software impairment charges, and
restructuring and other impairment charges, in addition to ongoing operating
costs necessary for the operation of the business. The operating loss for 1998
also includes a $1,157,000 gain from the termination of the Post Retirement
Health Care Plan and a $393,000 charge for minimum royalty payments on the
impaired software. Without the effects of these items, and had MSC adopted SOP
98-9 in the fourth quarter of 1997 with respect to the 1998 results, MSC
estimates operating income would have been $13,700,000 and $4,116,000 for 1999
and 1998, respectively, an increase of $9,584,000, as shown in the following
table:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1999 1998
----------- ------------
<S> <C> <C>
Operating Income (Loss)--As Reported.............. $ 2,636,000 $(10,041,000)
----------- ------------
Adjustments:
Revenue Change, Net of Cost of Revenue.......... -- (1,215,000)
Restructuring and Other Impairment Charges...... 5,497,000 2,365,000
Write-Off of Acquired In-Process Technology..... 4,067,000 6,000,000
Impairment of Capitalized Software Costs........ 1,500,000 7,771,000
Gain on Termination of Post Retirement Health
Care Plan..................................... -- (1,157,000)
Accrued Liabilities for Impaired Software....... -- 393,000
----------- ------------
Total Adjustments............................. 11,064,000 14,157,000
----------- ------------
Operating Income--As Adjusted..................... $13,700,000 $ 4,116,000
=========== ============
</TABLE>
TOTAL OTHER EXPENSE (INCOME)--Total other expense (income) was income of
$6,399,000 for 1999 compared to expense of $3,134,000 for 1998, an increase of
$9,533,000. This increase includes a $10,733,000 gain from the sale of MSC's
equity investment in LMS International. Excluding this gain, total other expense
(income) was expense of $4,334,000 for 1999, an increase of $1,200,000 compared
to the prior year. The increase in expense was due to an increase in interest
expense, a decrease in investment income offset by a decrease in currency
losses.
Interest expense was $5,788,000 for 1999 compared to $4,461,000 for the
prior year, an increase of $1,327,000, or 30%. 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 1999, as well as interest
24
<PAGE>
on the subordinated notes payable issued as part of the acquisition of MARC and
interest on the note payable taken out as part of the CSAR acquisition in
November 1999. For financial statement purposes, the convertible subordinated
debentures and subordinated notes payable were issued with a discount. Such
discount is amortized over the terms of the convertible subordinated debentures
and subordinated notes payable and treated as additional interest expense. As a
result, reported interest will be higher than the cash amount of interest that
will actually be paid to the holders of the convertible subordinated debentures
and subordinated notes payable.
Other expense (income) was income of $1,414,000 for 1999 compared to income
of $1,327,000 for 1998, an increase of $87,000. The increase is primarily
attributable to a $914,000 decrease in foreign currency exchange losses, offset
by a $827,000 decrease in interest and investment income. Other expense (income)
also includes gains and losses on property and equipment and other non-operating
income or expense. MSC anticipates that interest and investment income will
continue to decrease throughout 2000 from the 1998 and early 1999 levels as a
result of the decrease in its cash balances following the acquisitions of KR,
MARC, UAI and CSAR.
PROVISION (BENEFIT) FOR INCOME TAXES--The effective tax rate for 1999 was a
provision of 44% compared to a benefit of 2% in the same period of the prior
year. The rate in 1999 was higher than historical rates before 1998 due
primarily to certain non-deductible charges from MSC's acquisitions during 1999,
including goodwill and acquired in-process technology. Refer to Note 12--Taxes
Based on Income in Notes to Consolidated Financial Statements.
1998 COMPARED TO 1997
NET INCOME (LOSS)--Consolidated net loss was $12,979,000, or $0.95 per
diluted share, in 1998 compared to net income of $9,887,000, or $0.73 per
diluted share, in 1997.
REVENUE--MSC reported revenue of $125,397,000 in 1998, compared to revenue
of $132,804,000 in 1997, a decrease of $7,407,000, or 6%. Revenue growth in 1998
was adversely affected by the change in MSC's revenue recognition policy
effective October 1, 1998 and the strength of the United States Dollar compared
to foreign currencies in which it operates. Revenue in the current year would
have been approximately $127,374,000, if translated using prior year foreign
currency translation rates. Revenue would have been $134,795,000, if recorded
under previous revenue recognition policies, because the adoption of SOP 98-9 in
the fourth quarter of 1998 deferred $9,398,000 into subsequent periods or
$9,485,000, if valued using prior year foreign currency translation rates.
Software license revenue and maintenance fees account for 93% of total reported
revenue for the year ended December 31, 1998 and 96% for the year ended
December 31, 1997, with service revenue making up the difference.
The following table illustrates revenue by geographic region and the related
growth rates in functional currencies:
<TABLE>
<CAPTION>
1997 FUNCTIONAL CURRENCY GROWTH RATE
-------------------------------------
% OF TOTAL WITH WITHOUT
REVENUE REVENUE CHANGE REVENUE CHANGE
---------- ------------------- ---------------
<S> <C> <C> <C>
The Americas...................... 46 % (3)% 6 %
Europe............................ 32 % 8 % 16 %
Asia-Pacific...................... 22 % (17)% (15)%
</TABLE>
The increase in reported revenues in Europe resulted from higher volumes of
software licenses and related maintenance revenue. The decrease in reported
revenues from our Asia-Pacific region is due primarily to the continued economic
turmoil the region experienced during the past year and is not an indication of
a reduction in it's market share from the region. 16% of it's total revenue for
1998 is directly related to the Japanese market, while 6% is from the
Asia-Pacific region outside of Japan. In light of the continued economic turmoil
in the region, MSC remains cautious about its Asia-Pacific prospects.
25
<PAGE>
Of the 93% and 96% of it's revenues in 1998 and 1997, respectively, that
consisted of software license and maintenance revenue, approximately 79% in 1998
and 78% in 1997 of this revenue is derived from annual renewable leases and
recurring maintenance fees with the remaining 21% in 1998 and 22% in 1997
related to paid-up licenses.
MSC is exposed to the impact of foreign currency fluctuations. The following
table details the effect of the currency rate changes on revenue for 1998 and
the risk of change in 1999. The trend exchange rate was determined by prorating
the rate change between 1997 and 1998 and is used to illustrate the sensitivity
to foreign currency fluctuations. The trend rate is for illustration purposes
only and may or may not reflect the actual translation rate in the future
period.
<TABLE>
<CAPTION>
CY 1998 CY 1998 CY 1998 USING
USING 1997 USING 1998 1997/1998 TREND
EXCHANGE RATES EXCHANGE RATES EXCHANGE RATES
-------------- -------------- ---------------
<S> <C> <C> <C>
Revenues:
The Americas..................... $ 58,409,000 $ 58,409,000 $ 58,409,000
Europe........................... 40,436,000 39,875,000 39,314,000
Asia-Pacific..................... 28,529,000 27,113,000 25,357,000
------------ ------------ ------------
Total Revenue.................. $127,374,000 $125,397,000 $123,080,000
============ ============ ============
Exchange Rates:
$/ DM 0.577 0.569 0.561
Yen /$........................... 121.75 130.81 139.87
</TABLE>
OPERATING EXPENSES--Operating expenses of $135,438,000 in 1998 includes both
restructuring and impairment costs in addition to ongoing operating costs
necessary for the operation of the business, and represents an increase of
$21,597,000, or 19%, from the $113,841,000 reported in 1997. Operating expenses
included restructuring and impairment costs and other unusual items consisting
of: (1) a $8,164,000 non-cash charge included in cost of revenues; (2) a
$6,000,000 in-process research and development charge; (3) restructuring and
other impairment costs of $2,365,000; and (4) a gain from the reversal of a
$1,157,000 of Post Retirement Health Care liability resulting from the
termination of the Post Retirement Health Care Plan. Without these charges and
the gain, operating expenses totaled $120,066,000 in 1998, an increase of
$6,225,000, or 5%, from the $113,841,000 reported in 1997. This increase was
primarily attributable to: (1) a $3,325,000 increase in cost of revenue
exclusive of the $3,200,000 reclassification of post-sales customer support
expense; (2) a $3,488,000 increase in research and development cost including a
$2,543,000 increase in the gross research and development investment and a
$945,000 decrease in capitalized software costs; offset by (3) a $588,000
decrease in selling, general and administrative expenses exclusive of the
$3,200,000 reclassification of post-sales customer support expense and the gain
from the reversal of $1,157,000 of Post Retirement Health Care liability.
COST OF REVENUE--Cost of revenue of $46,255,000 in 1998 includes impairment
costs in addition to ongoing operating costs necessary for the operation of the
business. Cost of revenue as a percent of revenue was 37% and 24% for 1998 and
1997, respectively, or 30% and 24% exclusive of the impairment charges.
Impairment costs included a charge of $7,771,000 against capitalized software
and $393,000 of other non-cash impairment charges. Capitalized software
amortization decreased slightly to $11,974,000 in 1998 from $12,043,000 in the
prior year. Cost of revenues, excluding these impairment charges, was
$38,091,000 for 1998 compared to $31,566,000 for 1997, an increase of
$6,525,000, or 21%. This increase resulted from: (1) a $3,200,000
reclassification of post-sales customer support expense from sales and marketing
in 1998; and (2) a $3,300,000 increase in labor and related costs. During 1998,
MSC reclassified $3,200,000 of sales and marketing expense to cost of revenue
for post-sales customer support costs. The increase in labor and related costs
were related to increases in staffing and the utilization of development and
sales resources to support maintenance and consulting activities. Royalty
expense is also included in cost of revenue and paid to third parties under
various agreements. MSC does not consider any royalty expense related to
individual agreements to be material.
26
<PAGE>
GROSS PROFIT--Gross profit, which is revenue less cost of revenue, was
negatively impacted by MSC's change in its revenue recognition policy and the
increase in its costs of revenue noted above. Gross profit was $79,142,000, or
63%, of revenues for the year ended December 31, 1998, as compared to
$101,238,000, or 76%, of revenues for the year ended December 31, 1997,
representing a decrease of $22,096,000.
RESEARCH AND DEVELOPMENT--Research and development expense for the year
ended December 31, 1998 was $13,666,000 compared to $10,178,000 for the year
ended December 31, 1997, representing an increase of $3,488,000, or 34%. The
increase is the result of an increase of $2,543,000 in the total gross
investment in research and development activities and a decrease of $945,000 in
the amount of research and development expenditures capitalized under SFAS 86.
The total gross investment in research and development activities for the
year ended December 31, 1998 amounted to $25,266,000, or 20%, of revenue for the
year ended December 31,1998 compared to $22,723,000, or 17%, of revenue in the
prior year. The total increase in the gross research and development investment
was $2,543,000, or 11%. This increase resulted primarily from changes within
MSC's product management staffing and staff mix related to a strategic revision
in product development activity. This shift in strategy de-emphasizes features
upgrades for specific products and promotes the development of technologies and
integrated software solutions for targeted customers. MSC's total development
cost before software capitalization was 20% of revenue for 1998, which remains
consistent with management's target of 20% of total annual revenues.
Capitalized software development costs were $11,600,000 in 1998 compared to
$12,545,000 in 1997, a decrease of $945,000, or 8%. 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. MSC'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--Selling, general, and administrative
expense was $64,884,000 in 1998 compared to $69,829,000 in 1997, a decrease of
7%. The $4,945,000 decrease was primarily due to: (1) $3,200,000 of post-sales
customer support costs included in cost of revenue; and (2) a reduction of Post
Retirement Health Care expense of $280,000 and a gain from the reversal of
$1,157,000 of Post Retirement Health Care liability resulting from the
termination of the Post Retirement Health Care Plan.
As with revenue, MSC's expenses are impacted by foreign currency
fluctuations. The following table details the effect of the currency rate
changes on operating expense for 1998 and the risk of change in 1999. The trend
exchange rate was determined by prorating the rate change between 1997 and 1998
and is used to illustrate the risk of foreign currency fluctuations. The trend
rate is for illustration purposes only and may or may not reflect the actual
translation rate in the future period.
<TABLE>
<CAPTION>
CY 1998 CY 1998 CY 1998 USING
USING 1997 USING 1998 1997/1998 TREND
EXCHANGE RATES EXCHANGE RATES EXCHANGE RATES
-------------- -------------- ---------------
<S> <C> <C> <C>
Operating Expense:
The Americas..................... $53,003,000 $53,003,000 $53,003,000
Europe........................... 25,030,000 24,683,000 24,336,000
Asia-Pacific..................... 12,353,000 11,497,000 10,752,000
----------- ----------- -----------
Total Operating Expense........ $90,386,000 $89,183,000 $88,091,000
=========== =========== ===========
Exchange Rates:
$/ DM 0.577 0.569 0.561
Yen /$........................... 121.75 130.81 139.87
</TABLE>
OPERATING INCOME (LOSS)--Operating income or loss, including software
capitalization and amortization, restructuring costs and impairment charges, was
a loss of $10,041,000 in 1998 compared to income of
27
<PAGE>
$18,963,000 in 1997. The $29,004,000 decrease in operating income is primarily
attributable to the decrease in gross margin of $22,096,000, an increase in
research and development expense of $3,488,000, offset by a decrease in selling,
general and administrative expense of $4,945,000. The 1998 operating loss
includes both effects of MSC's adoption of SOP 98-9 in the fourth quarter of
1998 that deferred $9,398,000 of revenue into subsequent periods and
restructuring and impairment charges in addition to on-going operating costs
necessary for the operation of the business. Restructuring and other impairment
charges included: (1) a $8,164,000 non-cash charge included in cost of revenues;
(2) a $6,000,000 in-process research and development charge; (3) restructuring
and other impairment charges of $2,365,000; and (4) a gain from the reversal of
a $1,157,000 Post Retirement Health Care liability resulting from the
termination of the Post Retirement Health Care Plan. Without the effect of
adoption of SOP 98-9, these charges and the gain, operating income, including
software capitalization and amortization, would have been $14,729,000 in 1998
compared to $18,963,000 in 1997, a decrease of 22%, as shown in the following
table:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1998 1997
------------ -----------
<S> <C> <C>
Operating Income (Loss)--As Reported.............. $(10,041,000) $18,963,000
Adjustments:
Revenue Change, Net of Cost of Revenue.......... 9,398,000 --
Restructuring and Other Impairment Charges...... 2,365,000 --
Write-Off of Acquired In-Process Technology..... 6,000,000 --
Impairment of Capitalized Software Costs........ 7,771,000 --
Gain on Termination of Post Retirement Health
Care Plan..................................... (1,157,000) --
Accrued Liabilities for Impaired Software....... 393,000 --
------------ -----------
Total Adjustments............................. 24,770,000 --
------------ -----------
Operating Income--As Adjusted..................... $ 14,729,000 $18,963,000
============ ===========
</TABLE>
Interest expense reflects the interest on the convertible subordinated
debentures issued as part of the acquisition of PDA Engineering in 1994.
Interest payments are due on March 15 and September 15 of each year until the
debentures are converted or redeemed.
OTHER INCOME--Other income was $1,327,000 in 1998 compared to income of
$474,000 in 1997. The fluctuation is primarily attributable to an increase in
interest and investment income from $940,000 in 1997 to $1,651,000 in 1998, a
change in foreign exchange gains and losses from a loss of $502,000 in 1997 to a
gain of $295,000 in 1998, and a $110,000 decrease in gains and losses on the
sale of property and equipment.
PROVISION (BENEFIT) FOR INCOME TAXES--The effective tax rate for the year
was a benefit of 2% compared to a provision of 34% in 1997. The expected benefit
in 1998 was reduced due to foreign losses not benefited and certain
non-deductible charges related to the write-off of the Silverado goodwill and
acquired in-process technology of KR.
COMPANY TRENDS
REORGANIZATION
On February 3, 1999, MSC announced a new organizational structure following
a re-evaluation of its business strategy. MSC 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. MSC believes that these
changes to its organizational structure allow it to continue its leadership in
the high-end market and deliver tools and expertise to the mid-range and desktop
markets.
28
<PAGE>
MSC is concentrating on becoming more Internet focused by continuing to make
its products Web-enabled and through the launch of a new division and web
portal, Engineering-e.com. This division leverages the core strengths,
competencies and infrastructure of MSC to create the engineers' marketplace on
the web.
MSC.VISUALNASTRAN
In March 2000, MSC announced the creation of MSC.VISUALNASTRAN, which will
be the overall name for all of it's software. The new name will serve several
functions: (1) it will leverage the "Nastran" name; (2) it will unify MSC's
current set of software into one integrated, scalable family of software to
address simulation needs in several markets; (3) it will finalize the
integration of the Working Knowledge and MARC software products into MSC's
product line; and (4) it will provide a framework for the future direction of
our software products.
We anticipate several benefits from this: (1) a logical structure that shows
where all of its software fits and how they interrelate in function, intended
market, and pricing; (2) removing the confusion that currently exists when
discussing our products; (3) leveraging promotional efforts for all software
from all divisions; and (4) MSC will be able to define a pricing structure that
allows customers to move easily between our product families and find the right
price/functionality point.
There are four product families within MSC.visualNastran:
- VISUALNASTRAN ENTERPRISE: Software for dedicated analysts at major
manufacturers to simulate a wide variety of mechanical conditions. This
family will include Mechanical Solutions' core products (Nastran, Patran,
Marc, Dytran, Mvision, and Fatigue) as well as the automotive and
aerospace vertical applications. This software will link to other
enterprise software such as CAD, PDM, test software, and other CAE
software.
- VISUALNASTRAN PROFESSIONAL: Software for multi-disciplinary engineers at
large or small companies that perform simulation on occasion, though this
is not their primary task. This family will include our new Ultima
product, MSC.Nastran for Windows, and new integrated products whose
functionality and ease of use will be targeted to these engineers.
- VISUALNASTRAN DESKTOP: Software for design engineers at large or small
companies who need to verify design concepts. This family will include the
current Working Knowledge products and others to be defined.
- E.VISUALNASTRAN: Software from the other three families that runs across
the web in an Internet ASP ("Application Services Provider") model that is
similar to data centers.
The MSC.visualNastran framework provides a structure for positioning all of
our software, current and future. There will be some overlap in capabilities and
price, and other families may be defined later.
OPERATING PATTERN
The change in year-end to December 31 and the adoption of SOP 98-9 in the
fourth quarter of 1998 both had a significant effect on the operating pattern of
MSC. The month of January has historically been the largest revenue month of the
year with the highest volume of renewals. Having this month as the first
accounting period versus the last accounting period allows management to better
forecast the annual results. Under SOP 98-9, MSC is recognizing software lease
revenue on a monthly basis over the term of the licenses. This change has
reduced the volatility of its revenue stream between 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 was not recognized in
reported revenue on a quarterly basis until the fourth quarter of 1999. The year
2000
29
<PAGE>
will be the first reported year that will reflect a full twelve months of
revenue under this method of revenue recognition for annual licenses. MSC
anticipates that revenue for 2000 will also be affected by having a full-year of
operations of MARC and UAI, which were acquired in June 1999, and CSAR, which
was acquired in November 1999.
Effective January 1, 1999, MSC changed the estimated useful life of its
capitalized software assets from three and four years to two and three years.
MSC has always estimated the expected life of these assets based on the release
cycle of its products. MSC believes that as software production cycles decrease,
amortization periods should also decrease in order to coincide with a version's
revenue stream. MSC made 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 MSC's growth in the past has been provided
by cash on hand, the sale of its marketable securities and cash flow from
operations. Management believes that cash generated from operations and the
unused portion of its line of credit will continue to provide sufficient capital
for normal working capital needs in the foreseeable future. Net cash provided by
operating activities was $32,116,000 and $27,197,000 for the years ended
December 31, 1999 and 1998, respectively. At December 31, 1999, MSC's working
capital was $11,656,000 compared to $23,524,000 at December 31, 1998.
During 1999, cash outlays were made of $6,047,000 in conjunction with the
$8,922,000 of restructuring charges and acquisition costs recorded in 1998 and
1999. The remaining cash outlays are anticipated to be completed by the end of
2000, excluding certain lease commitments that may continue into the year 2001.
During 1999, MSC expended approximately $32,703,000 of cash in connection
with the acquisitions of MARC, UAI and CSAR. In late December 1998, MSC expended
$19,140,000 of cash in connection with the acquisition of KR and Silverado.
These acquisitions adversely affected MSC's working capital position and cash
reserves, and lowered its investment income. MSC does not expect to have
significant amounts of investment income in the near future.
As of December 31, 1998, MSC had a balance outstanding on a line of credit
with its previous principal bank of $10,800,000. In May 1999, this amount was
repaid. On August 11, 1999, MSC entered into a new Loan and Security Agreement
("Loan Agreement") with its new principal bank (the "Bank"). On October 29,
1999, MSC 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. As of
December 31, 1999, the amount available under the line of credit, based on the
defined borrowing base, was approximately $10,000,000. The term of the revolving
portion of the Loan Agreement expires May 31, 2001. As of December 31, 1999,
there was no balance outstanding on the line of credit and there were no
borrowings from the line of credit during 1999. On November 4, 1999, MSC
borrowed $8,000,000 at the Bank's prime rate in connection with the acquisition
of CSAR. The term of the loan is two years and requires monthly principal
payments of $267,000. As of December 31, 1999, the balance on the loan was
$7,733,000. All borrowings under the Loan Agreement carry an interest rate equal
to the Bank's prime lending rate or LIBOR plus 200 basis points. Borrowings
under the Loan Agreement are secured by nearly all of Company's goods and
equipment, inventory, contract rights, and intellectual property rights.
Borrowings also involve certain restrictive covenants, including restrictions on
dividends and investments. As of December 31, 1999, MSC is in compliance with
all covenants. Refer to Note 5--Financial Instruments.
MSC issued $56,608,000 of convertible subordinated debentures in connection
with the acquisition of PDA Engineering in 1994. An additional $2,000,000
principal amount of convertible subordinated debentures was issued, at a
discount, in June 1999 in connection with the MARC acquisition. Refer to
Note 4--
30
<PAGE>
Business Acquisitions and Divestitures. The debentures bear interest at 7 7/8%
with interest payments due semi-annually on March 15 and September 15. The
conversion feature permits the holder to convert the debentures into shares of
MSC's common stock at a conversion price of $15.15 per share. The debentures
mature August 18, 2004, but are redeemable at MSC's option at any time after
August 18, 1997 upon payment of a premium. At December 31, 1999, the balance of
the convertible subordinated debentures, excluding unamortized discount of
$269,000, was $58,556,000.
Management expects to continue to invest a substantial portion of MSC's
revenues in the development of new computer software technologies and products
and the enhancement of certain existing products. During 1999 and 1998, MSC
expended a total of $27,766,000 and $25,266,000, respectively, on development
efforts, of which $8,255,000 and $11,600,000, 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 1999 and 1998, MSC acquired $3,107,000 and $6,003,000, 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. MSC's capital expenditures vary from year to
year, as required by business needs. MSC 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 2000 and 2001 to be consistent with those for 1999.
In 1998, MSC's Board of Directors authorized the repurchase of common stock
in the open market for up to a total aggregate amount of $3,000,000. MSC
repurchased and retired approximately $2,226,000 of common stock in 1998 before
this authorization was rescinded.
In June 1999, the principal shareholders of LMS International ("LMS")
exercised a repurchase option for an equity position that MSC had held in LMS.
MSC realized a pre-tax gain of $10,733,000. LMS is a privately held company
based in Leuven, Belgium.
MSC does not plan to pay dividends in the foreseeable future. In addition,
MSC's loan agreement with its principal bank contains restrictions on the
payment of dividends.
IMPACT OF YEAR 2000
In prior years, MSC discussed the nature and progress of its plans to become
Year 2000 ready. In late 1999, MSC completed its remediation and testing of
systems. As a result of those planning and implementation efforts, MSC
experienced no significant disruptions in mission critical information
technology and non-information technology systems and believes those systems
successfully responded to the Year 2000 date change. The amount of money MSC
expended in 1999 in connection with remediating its systems was not material.
MSC is not aware of any material problems resulting from Year 2000 issues,
either with its products, its internal systems, or the products and services of
third parties. MSC will continue to monitor its mission critical computer
applications and those of its suppliers and vendors throughout the year 2000 to
ensure that any latent Year 2000 matters that may arise are addressed promptly.
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
31
<PAGE>
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 MSC 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, it 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 MSC's labor cost.
MSC 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 MSC'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 MSC's
business.
ITEM 7.A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MSC is exposed to the impact of foreign currency fluctuations and interest
rate changes.
FOREIGN CURRENCY RISK--International revenues are 54% of MSC's total
revenues. International sales are made mostly from MSC's two foreign sales
subsidiaries in Germany and Japan and are typically denominated in the local
currency of each country. These subsidiaries also incur most of their expenses
in the local currency. Accordingly, all foreign subsidiaries use the local
currency as their functional currency.
MSC's international business is subject to risks typical of an international
business, including, but not limited to, differing economic conditions, changes
in political climate, differing tax structures, other regulations and
restrictions, and foreign exchange rate volatility. Accordingly, MSC's future
results could be materially adversely impacted by changes in these or other
factors.
MSC's exposure to foreign exchange rate fluctuations arises in part from
intercompany accounts in which cash from sales of it's foreign subsidiaries
costs are transferred back to the United States. These intercompany accounts are
typically denominated in the functional currency of the foreign subsidiary in
order to centralize foreign exchange risk with the parent company in the United
States. MSC is also exposed to foreign exchange rate fluctuations as the
financial results of foreign subsidiaries are translated into United States
Dollars in consolidation. As exchange rates vary, these results, when
translated, may vary from expectations and adversely impact overall expected
profitability. The effect of foreign exchange rate fluctuations on MSC in 1999
was not significant.
MSC may enter into forward exchange contracts to hedge certain anticipated
repayments of its intercompany debt with its foreign subsidiaries. The forward
exchange contracts do not qualify as a hedge for financial reporting purposes
and, accordingly, unrealized gains or losses, based on the current forward
foreign exchange rates, are reflected directly in income. At December 31, 1999,
MSC had no such forward exchange contracts. At December 31, 1998, MSC had two
forward exchange contracts maturing in January and February 1999 to exchange a
total of 4,000,000 German Marks for United States Dollars in the amount of
approximately $2,500,000. The unrealized gains were immaterial at December 31,
1998.
32
<PAGE>
INTEREST RATE RISK--MSC's exposure to market rate risks for changes in
interest rates relate to any borrowings under its line of credit. Refer to
Note 5--Financial Instruments of Notes to Consolidated Financial Statements.
MSC has not used derivative financial instruments in its investment
portfolio. MSC invests its excess cash primarily in debt instruments of U.S.
municipalities and other high-quality issuers and, by policy, limits the amount
of credit exposure to any one issuer. MSC protects and preserves its invested
funds by limiting default, market and reinvestment risk. The following table is
a summary of available-for-sale securities:
<TABLE>
<CAPTION>
DECEMBER 31, 1999 DECEMBER 31, 1998
------------------- ----------------------
FAIR FAIR
MARKET RATE OF MARKET RATE OF
VALUE RETURN VALUE RETURN
-------- -------- ----------- --------
<S> <C> <C> <C> <C>
Municipal Securities.................. $ -- -- $15,782,000 5.8%
Equity Securities..................... 183,000 -- -- --
Other Debt Securities................. -- -- 699,000 6.4%
-------- -----------
$183,000 $16,481,000
======== ===========
</TABLE>
In 1999, MSC sold its securities and used the proceeds to help pay for the
acquisitions of Marc, UAI and CSAR.
33
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and Cash Equivalents................................. $ 21,735,000 $ 10,822,000
Securities Available-for-Sale............................. 183,000 16,481,000
Trade Accounts Receivable, Net............................ 37,995,000 39,674,000
Deferred Tax Charges...................................... 15,282,000 8,076,000
Other Current Assets...................................... 7,294,000 7,866,000
------------ ------------
Total Current Assets.................................... 82,489,000 82,919,000
Property and Equipment, Net................................. 8,585,000 8,895,000
Capitalized Software Costs, Net............................. 20,117,000 21,034,000
Goodwill, Net............................................... 36,746,000 10,756,000
Other Intangible Assets, Net................................ 35,534,000 13,240,000
Other Assets................................................ 3,749,000 3,773,000
------------ ------------
Total Assets.......................................... $187,220,000 $140,617,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts Payable.......................................... $ 4,692,000 $ 4,405,000
Current Portion of Note Payable........................... 3,200,000 --
Line of Credit............................................ -- 10,800,000
Deferred Revenue.......................................... 34,013,000 20,903,000
Compensation and Related Expenses......................... 9,534,000 8,317,000
Restructuring Reserve..................................... 2,875,000 695,000
Other Current Liabilities................................. 16,519,000 14,275,000
------------ ------------
Total Current Liabilities............................... 70,833,000 59,395,000
------------ ------------
Deferred Income Taxes....................................... 16,957,000 6,961,000
Note Payable, Less Current Portion.......................... 4,533,000 --
Convertible Subordinated Debentures, Net.................... 58,287,000 56,574,000
Subordinated Notes Payable, Net............................. 11,804,000 --
Commitments and Contingencies (Note 16)
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; 13,841,600 and 13,710,700 Issued and
Outstanding at December 31, 1999 and December 31, 1998,
Respectively............................................ 32,451,000 31,754,000
Common Stock Warrants..................................... 4,428,000 556,000
Accumulated Deficit....................................... (6,307,000) (11,404,000)
Accumulated Other Comprehensive Loss...................... (5,426,000) (3,219,000)
Treasury Stock, At Cost (49,000 and 0 Shares at
December 31, 1999 and December 31, 1998,
Respectively)........................................... (340,000) --
------------ ------------
Total Shareholders' Equity.............................. 24,806,000 17,687,000
------------ ------------
Total Liabilities and Shareholders' Equity............ $187,220,000 $140,617,000
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
34
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
REVENUE:
Software Licenses.................................... $ 99,529,000 $ 89,077,000 $102,889,000
Software Maintenance and Services.................... 49,706,000 36,320,000 29,915,000
------------ ------------ ------------
Total Revenue...................................... 149,235,000 125,397,000 132,804,000
COST OF REVENUE:
Software Licenses.................................... 19,171,000 29,601,000 24,372,000
Software Maintenance and Services.................... 19,090,000 16,654,000 7,194,000
------------ ------------ ------------
Total Cost of Revenue.............................. 38,261,000 46,255,000 31,566,000
------------ ------------ ------------
GROSS PROFIT........................................... 110,974,000 79,142,000 101,238,000
OPERATING EXPENSE:
Research and Development............................. 19,511,000 13,666,000 10,178,000
Selling, General and Administrative.................. 72,152,000 64,884,000 69,829,000
Amortization of Goodwill and Other Intangibles....... 7,111,000 2,268,000 2,268,000
Restructuring and Other Impairment Charges........... 5,497,000 2,365,000 --
Write-Off of Acquired In-Process Technology.......... 4,067,000 6,000,000 --
------------ ------------ ------------
Total Operating Expense............................ 108,338,000 89,183,000 82,275,000
------------ ------------ ------------
OPERATING INCOME (LOSS)................................ 2,636,000 (10,041,000) 18,963,000
OTHER EXPENSE (INCOME):
Interest Expense..................................... 5,788,000 4,461,000 4,456,000
Gain on Sale of Investment........................... (10,773,000) -- --
Other Expense (Income), Net.......................... (1,414,000) (1,327,000) (474,000)
------------ ------------ ------------
Total Other Expense (Income), Net.................. (6,399,000) 3,134,000 3,982,000
------------ ------------ ------------
INCOME (LOSS) BEFORE PROVISION (BENEFIT) FOR INCOME
TAXES................................................ 9,035,000 (13,175,000) 14,981,000
Provision (Benefit) for Income Taxes................... 3,938,000 (196,000) 5,094,000
------------ ------------ ------------
NET INCOME (LOSS)...................................... $ 5,097,000 $(12,979,000) $ 9,887,000
============ ============ ============
BASIC EARNINGS (LOSS) PER SHARE........................ $ 0.37 $ (0.95) $ 0.73
============ ============ ============
DILUTED EARNINGS (LOSS) PER SHARE...................... $ 0.37 $ (0.95) $ 0.73
============ ============ ============
Basic Weighted-Average Shares Outstanding.............. 13,800,000 13,655,000 13,514,000
============ ============ ============
Diluted Weighted-Average Shares Outstanding............ 13,905,000 13,655,000 13,628,000
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
35
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE PERIOD JANUARY 1, 1997 TO DECEMBER 31, 1999
<TABLE>
<CAPTION>
SHAREHOLDERS' EQUITY
-------------------------------------------------------
SHARES OF COMMON STOCK ACCUMULATED
------------------------- COMMON OTHER
ISSUED AND TREASURY COMMON STOCK ACCUMULATED COMPREHENSIVE
OUTSTANDING STOCK STOCK WARRANTS DEFICIT LOSS
----------- ----------- ----------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997............... 13,453,800 -- $30,250,000 $ -- $(8,312,000) $ (2,625,000)
Net Income............................. 9,887,000
Currency Translation Adjustment........ (1,857,000)
Comprehensive Income.................
Shares Issued Under Stock Option and
Employee Stock Purchase Plans........ 116,600 -- 802,000 -- -- --
----------- ----------- ----------- ----------- ----------- ------------
Balance at December 31, 1997............. 13,570,400 -- 31,052,000 -- 1,575,000 (4,482,000)
Net Loss............................... (12,979,000)
Currency Translation Adjustment........ 1,252,000
Unrealized Investment Gain............. 11,000
Comprehensive Loss...................
Shares Issued Under Stock Option and
Employee Stock Purchase Plans........ 168,000 -- 1,386,000 -- -- --
Shares Issued for Business Acquired.... 222,200 -- 1,542,000 -- -- --
Warrants Issued........................ -- -- -- 556,000 -- --
Purchase and Retirement of Stock....... (249,900) -- (2,226,000) -- -- --
----------- ----------- ----------- ----------- ----------- ------------
Balance at December 31, 1998............. 13,710,700 -- 31,754,000 556,000 (11,404,000) (3,219,000)
Net Income............................. 5,097,000
Currency Translation Adjustment........ (2,204,000)
Unrealized Investment Loss............. (3,000)
Comprehensive Income.................
Shares Issued Under Employee Stock
Purchase Plan........................ 130,900 -- 697,000 -- -- --
Warrants Issued for Business
Acquired............................. -- -- -- 3,296,000 -- --
Warrants Issued........................ -- -- -- 576,000 -- --
Purchase of Stock...................... -- (49,000) -- -- -- --
----------- ----------- ----------- ----------- ----------- ------------
Balance at December 31, 1999............. 13,841,600 (49,000) $32,451,000 $ 4,428,000 $(6,307,000) $ (5,426,000)
=========== =========== =========== =========== =========== ============
<CAPTION>
SHAREHOLDERS' EQUITY
-------------------------
TREASURY TOTAL
STOCK, SHAREHOLDERS'
AT COST EQUITY
--------- -------------
<S> <C> <C>
Balance at January 1, 1997............... $ -- $19,313,000
Net Income............................. 9,887,000
Currency Translation Adjustment........ (1,857,000)
-----------
Comprehensive Income................. 8,030,000
Shares Issued Under Stock Option and
Employee Stock Purchase Plans........ -- 802,000
--------- -----------
Balance at December 31, 1997............. -- 28,145,000
Net Loss............................... (12,979,000)
Currency Translation Adjustment........ 1,252,000
Unrealized Investment Gain............. 11,000
-----------
Comprehensive Loss................... (11,716,000)
Shares Issued Under Stock Option and
Employee Stock Purchase Plans........ -- 1,386,000
Shares Issued for Business Acquired.... -- 1,542,000
Warrants Issued........................ -- 556,000
Purchase and Retirement of Stock....... -- (2,226,000)
--------- -----------
Balance at December 31, 1998............. -- 17,687,000
Net Income............................. 5,097,000
Currency Translation Adjustment........ (2,204,000)
Unrealized Investment Loss............. (3,000)
-----------
Comprehensive Income................. 2,890,000
Shares Issued Under Employee Stock
Purchase Plan........................ -- 697,000
Warrants Issued for Business
Acquired............................. -- 3,296,000
Warrants Issued........................ -- 576,000
Purchase of Stock...................... (340,000) (340,000)
--------- -----------
Balance at December 31, 1999............. $(340,000) $24,806,000
========= ===========
</TABLE>
See accompanying notes to consolidated financial statements.
36
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss)......................................... $ 5,097,000 $(12,979,000) $ 9,887,000
Adjustments to Reconcile Net Income (Loss) to Net Cash
Provided
By Operating Activities:
Depreciation and Amortization of Property and
Equipment............................................. 4,672,000 6,026,000 5,751,000
Amortization of Capitalized Software Costs.............. 8,816,000 11,974,000 12,043,000
Impairment of Capitalized Software Costs................ 1,500,000 7,771,000 --
Amortization of Goodwill and Other Intangibles.......... 7,111,000 2,268,000 2,268,000
Impairment of Goodwill.................................. -- 1,670,000 --
Write-Off of Acquired In-Process Technology............. 4,067,000 6,000,000 --
Amortization of Premiums and Discounts.................. 244,000 69,000 (216,000)
Loss (Gain) on Disposal of Property and Equipment....... 60,000 (115,000) (68,000)
Gain on Sale of Investment.............................. (10,733,000) -- --
Changes in Assets and Liabilities:
Trade Accounts Receivable, Net........................ 6,511,000 (354,000) (9,581,000)
Deferred Tax Charges.................................. (4,127,000) (2,872,000) --
Other Current Assets.................................. 3,332,000 2,714,000 (1,209,000)
Accounts Payable...................................... (967,000) 771,000 307,000
Deferred Revenue...................................... 7,773,000 10,211,000 272,000
Compensation and Related Expenses..................... (657,000) 277,000 (149,000)
Restructuring Reserve................................. (725,000) 695,000 --
Other Current Liabilities............................. (906,000) (1,464,000) (718,000)
Deferred Income Taxes................................. 1,048,000 (5,465,000) 182,000
------------ ------------ ------------
Net Cash Provided By Operating Activities........... 32,116,000 27,197,000 18,769,000
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Securities Available-for-Sale................. -- (6,517,000) (16,814,000)
Sale of Securities Available-for-Sale..................... 16,347,000 6,050,000 2,000,000
Acquisition Property and Equipment........................ (3,107,000) (6,003,000) (3,993,000)
Proceeds from Sale of Investment.......................... 12,000,000 -- --
Businesses Acquired, Net of Cash Received................. (32,703,000) (19,140,000) --
Purchase of Software...................................... (1,088,000) (1,313,000) (182,000)
Capitalized Internal Software Development Costs (8,255,000) (11,600,000) (12,545,000)
Other..................................................... (41,000) (466,000) 22,000
------------ ------------ ------------
Net Cash Use In Investing Activities................ (16,847,000) (38,989,000) (31,512,000)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
(Repayment) Borrowing on Line of Credit................... (10,800,000) 10,800,000 --
Proceeds from Note Payable................................ 8,000,000 -- --
Repayments of Note Payable................................ (267,000) -- --
Issuance of Common Stock.................................. 697,000 1,386,000 802,000
Issuance of Common Stock Warrants......................... 576,000 556,000 --
Purchase of Stock......................................... (340,000) -- --
Purchase and Retirement of Stock.......................... -- (2,226,000) --
Other..................................................... (18,000) -- --
------------ ------------ ------------
Net Cash (Used In) Provided By Financing
Activities........................................ (2,152,000) 10,516,000 802,000
------------ ------------ ------------
Translation Adjustment...................................... (2,204,000) 1,252,000 (1,857,000)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ 10,913,000 (24,000) (13,798,000)
Cash and Cash Equivalents at Beginning of Period............ 10,822,000 10,846,000 24,644,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 21,735,000 $ 10,822,000 $ 10,846,000
============ ============ ============
Supplemental Cash Flow Information:
Income Taxes Paid (Refunded).............................. $ 4,884,000 $ (161,000) $ 5,813,000
Interest Paid............................................. $ 5,021,000 $ 4,461,000 $ 4,456,000
Reconciliation of Businesses Acquired, Net of Cash Received:
Fair Value of Assets Acquired............................. $ 71,449,000 $ 22,218,000 $ --
Non-Cash Financing of Purchase Price and Liabilities
Assumed:
Issuance of Convertible Subordinated Debentures......... (1,700,000) -- --
Issuance of Subordinated Notes Payable.................. (11,704,000) -- --
Issuance of Common Stock and Common Stock Warrants...... (3,296,000) (1,542,000) --
Liabilities Assumed..................................... (22,046,000) (1,536,000) --
------------ ------------ ------------
Businesses Acquired, Net of Cash Received........... $ 32,703,000 $ 19,140,000 $ --
============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
37
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 1998 AND 1997
NOTE 1-- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS
INFORMATION
BUSINESS--MSC.Software Corporation (the "Company") designs, produces and
markets proprietary computer software products and provides related services for
use in computer-aided engineering. The Company's products are marketed
internationally to aerospace, automotive and other industrial concerns, computer
and electronics manufacturers, and universities.
CHANGE IN YEAR-END--In January 1999, the Company changed its reporting
period from a January 31 fiscal year basis to a December 31 calendar year basis.
As part of this change, the Company elected to present restated financial
results on a calendar year basis for all reported prior periods.
PRINCIPLES OF CONSOLIDATION--The accounting and reporting policies of the
Company conform to generally accepted accounting principles ("GAAP") in the
United States. The consolidated financial statements include the accounts of the
Company and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
BUSINESS ACQUISITIONS--During 1999, the Company acquired the following
companies: MARC Analysis Research Corporation ("MARC"), Universal
Analytics Inc. ("UAI"), and Computerized Structural Analysis and Research
Corporation ("CSAR"). In late December 1998, the Company acquired Knowledge
Revolution Inc. ("KR"). Refer to Note 4--Business Acquisitions and Divestitures.
USE OF ESTIMATES--The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying notes. Actual
results could differ from those estimates.
RECLASSIFICATIONS--Certain amounts in the 1998 and 1997 consolidated
financial statements have been reclassified to conform to the 1999 presentation.
REVENUE RECOGNITION--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 post-sales customer support
("PCS"), training and consulting services. PCS includes telephone support, bug
fixes and upgrade privileges on a when and if available basis. Services range
from installation, training, 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.
Revenue was recognized through December 31, 1997 in accordance with
Statement of Position ("SOP") 91-1, "SOFTWARE REVENUE RECOGNITION", issued by
the American Institute of Certified Public Accountants ("AICPA"). Revenue from
monthly leases of the Company's computer software products was recognized
monthly as earned. The license fee from non-cancelable, pre-paid annual leases
and paid-up license arrangements were recognized upon delivery of the software,
as long as the collectibility of the sales proceeds was considered probable and
there were no significant obligations, other than PCS, remaining to be fulfilled
subsequent to delivery. PCS associated with a license (generally 15%) was
deferred and recognized on a straight-line basis over the period the PCS was
provided, which was generally one year. There were no material incremental costs
associated with PCS or upgrade privileges. Discounts on the sale of computer
software products and PCS were proportionately allocated to each element of a
sale based on the list price of each element.
38
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 1-- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS
INFORMATION (CONTINUED)
As of January 1, 1998, the Company adopted SOP 97-2, "SOFTWARE REVENUE
RECOGNITION", as modified by SOP 98-4, "DEFERRAL OF THE EFFECTIVE DATE OF A
PROVISION OF SOP 97-2". SOP 97-2, as modified by SOP 98-4, provides for revenue
recognition only when there is pervasive evidence of an arrangement, delivery
has occurred, the vendor's fee is fixed or determinable, and collectibility of
the sales proceeds is considered probable. If an arrangement includes multiple
elements, the vendor must allocate the revenue to the various elements based on
vendor-specific objective evidence ("VSOE") of fair value. The significant
restrictions of what qualified for VSOE were deferred under SOP 98-4 and,
therefore, no changes in the Company's revenue recognition policy were necessary
upon adoption of SOP 97-2, as modified by SOP 98-4.
In the fourth quarter of 1998, the Accounting Standards Executive Committee
of the AICPA issued SOP 98-9, "MODIFICATION OF SOP 97-2, SOFTWARE REVENUE
RECOGNITION WITH RESPECT TO CERTAIN TRANSACTIONS." SOP 98-9 retained SOP 97-2's
restrictions related to the definition of what qualified for VSOE of fair value
for allocating a contract fee among the various elements of a multiple element
arrangement. In addition, SOP 98-9 instituted what is known as the "residual"
method. The residual method is an exception to the requirement to have VSOE of
fair value for all elements in the arrangement. However, the residual method
only allows for the calculation of a residual amount for the delivered element
(i.e., VSOE must be known for all undelivered elements). As permitted, the
Company adopted the provisions of SOP 98-9 effective October 1, 1998, the
earliest time possible under published guidelines. Accordingly, beginning in the
fourth quarter of 1998, revenue on non-cancelable, pre-paid annual lease
agreements is recognized monthly over the term of the agreement, since the VSOE
of fair value required under SOP 97-2 needed to allocate the contract fee to the
undelivered PCS elements of the arrangements is not available. This resulted in
a decrease in revenues that otherwise would have been recognized in the fourth
quarter of 1998 since only a portion of the revenues related to annual lease
agreements was recognized. For purposes of allocating lease revenues between
software licenses or maintenance revenues in the line items in the accompanying
statements of operations, the Company continues to use the same percentages used
for allocating paid-up licenses sold with annual maintenance agreements.
Revenue is derived through the Company's direct sales force, a network of
value-added resellers and other sales agents. Revenue from the sale of products
to resellers is recorded upon delivery to the reseller. Revenue from the sale of
products by other sales agents, for which a commission is due the sales agent,
is reported as gross revenues earned from the product sale. Commissions due to
these sales agents represent an operating expense and are recorded as commission
expense in cost of license revenue. Revenue from the sale of products provided
by other suppliers, for whom a royalty is due the suppliers, is reported as
gross revenues earned from the product sale. Royalties due to these other
suppliers represent an operating expense and are recorded as royalty expense in
cost of license revenue.
Service and other revenues are recognized when the service is provided and
the revenue has been earned. Long-term contracts are recognized using the
percentage of completion method. Service revenue and the costs associated with
service revenue are not material.
CASH AND CASH EQUIVALENTS--The Company considers investments with original
maturities of three months or less to be cash equivalents.
39
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 1-- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS
INFORMATION (CONTINUED)
INVESTMENT SECURITIES--Marketable equity securities and debt securities are
classified as held for investment, held-to-maturity or available-for-sale.
Management determines the appropriate classification of securities at the time
of purchase and re-evaluates such designation as of each balance sheet date.
Securities available-for-sale are carried at fair value, with the unrealized
gains and losses, net of tax, reported as a separate component of shareholders'
equity. Realized gains and losses on sales of investment securities are included
in the consolidated statements of operations and has not been material for any
period presented. Refer to Note 5--Financial Instruments.
TRADE ACCOUNTS RECEIVABLE--Accounts receivable are reported net of
allowances for doubtful accounts. The Company's revenue is generated from
customers in diversified industries, primarily in North America, Europe and
Asia-Pacific. The Company performs ongoing credit evaluations of its customers
and generally does not require collateral. The Company maintains reserves for
potential credit losses and such losses have been within management's
expectations. Refer to Note 6--Trade Accounts Receivable.
PROPERTY AND EQUIPMENT--Property and equipment are recorded at cost, less
accumulated depreciation and amortization. Depreciation is computed on the
straight-line method over the estimated useful lives of the assets, ranging from
two to five years. Amortization of leasehold improvements is calculated on the
straight-line method over the shorter of the estimated useful lives of the
assets or the corresponding lease term.
CAPITALIZED SOFTWARE COSTS--Capitalized software costs are comprised of
purchased software and internal software development costs. Software costs
incurred subsequent to the determination of the technological feasibility of the
software product are capitalized. Capitalization ceases and amortization of
capitalized costs begins when the software product is available for general
release to customers. Capitalized product development costs and projected
revenues are reviewed quarterly to determine if any impairment in value has
occurred that would require an adjustment in the carrying value or change in
expected useful lives under the guidelines established under Statement of
Financial Accounting Standard ("SFAS") No. 86, "ACCOUNTING FOR THE COSTS OF
COMPUTER SOFTWARE TO BE SOLD, LEASED OR OTHERWISE MARKETED". Capitalized
software amortization expense is included in cost of license revenue. The
amortization period for the software costs capitalized is the economic life of
the related products, typically three to four years. Refer to
Note 2--Accounting Changes and Note 3--Impairment of Assets.
OTHER LONG-LIVED ASSETS--In accordance with SFAS No. 121, "ACCOUNTING FOR
THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED
OF", 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. If such assets are identified to be impaired, the impairment
to be recognized is the amount by which the carrying value of the asset exceeds
the fair value of the asset. Refer to Note 3--Impairment of Assets.
ADVERTISING EXPENSE--The cost of advertising is expensed as incurred. The
Company incurred $1,196,000, $1,409,000 and $1,329,000 in advertising costs
during the years ended December 31, 1999, 1998 and 1997, respectively.
ROYALTIES TO THIRD PARTIES--The Company has agreements with third parties
requiring the payment of royalties for sales of third party products or
inclusion of such products as a component of the Company's
40
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 1-- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS
INFORMATION (CONTINUED)
products. Royalties are charged to cost of license revenue and the Company does
not consider any royalty expense related to individual agreements to be
material.
STOCK-BASED COMPENSATION--The Company grants stock options for a fixed
number of shares to employees with an exercise price equal to the fair value of
the shares at the date of grant. The Company accounts for stock option grants in
accordance with Accounting Principles Board ("APB") Opinion No. 25, "ACCOUNTING
FOR STOCK ISSUED TO EMPLOYEES". Accordingly, no compensation expense is
recognized for the stock option grants. The Company has also made available an
Employee Stock Purchase Plan for eligible employees. Such eligible employees are
entitled semi-annually to purchase common stock, by means of limited payroll
deductions, at a 10% discount from the fair market value of the common stock as
of specific dates. In 1997, the Company adopted the disclosure only provisions
of SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION." Refer to Note
15--Stock Option Plans and Warrants.
INCOME TAXES--The Company uses the liability method of accounting for income
taxes. Provision is made in the Company's financial statements for current
income taxes payable and deferred income taxes arising primarily from temporary
differences in accounting for capitalized software costs, undistributed earnings
of international subsidiaries, depreciation expense, deferred income and state
income taxes. Refer to Note 12--Taxes Based on Income.
EFFECT OF FOREIGN CURRENCY--The Company translates the assets and
liabilities of its foreign subsidiaries at the rate of exchange in effect at the
end of the period. Revenues and expenses are translated using an average of
exchange rates in effect during the period. Translation adjustments are recorded
as a separate component of shareholders' equity in the consolidated balance
sheets. Transaction gains and losses, other than on intercompany accounts deemed
to be of a long-term nature, are included in net income in the period in which
they occur. 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.
DERIVATIVE INSTRUMENTS--The Company may enter into forward exchange
contracts to hedge certain anticipated repayments of its intercompany debt with
its foreign subsidiaries. The forward exchange contracts do not qualify as a
hedge for financial reporting purposes and, accordingly, unrealized gains or
losses based on the current forward foreign exchange rates are reflected
directly in income. Refer to Note 5--Financial Instruments.
EARNINGS PER SHARE--The Company discloses Basic and Diluted Earnings Per
Share in accordance with SFAS No. 128, "EARNINGS PER SHARE." Basic Earnings Per
Share is computed by dividing net income by the weighted-average number of
common shares outstanding for the period. Diluted Earnings Per Shares reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock, or resulted in
the issuance of common stock. Diluted Earnings Per Share is computed by using
the weighted-average number of common and common equivalent shares outstanding
during each period. Common equivalent shares are not included in the per share
calculations where their inclusion would be anti-dilutive. Refer to
Note 19--Earnings Per Share.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS--In June 1998, the Financial
Accounting Standards Board issued 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
41
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 1-- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS
INFORMATION (CONTINUED)
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.
NOTE 2--ACCOUNTING CHANGES
EARLY ADOPTION OF SOP 98-9--The Company adopted the provisions of SOP 98-9
in the fourth quarter of 1998 requiring VSOE for all undelivered elements of a
software arrangement. Accordingly, revenue on non-cancelable and pre-paid annual
lease agreements is recognized monthly over the term of the agreement since the
Company does not have the VSOE of fair value required under SOP 97-2 to allocate
the contract fee to the undelivered PCS elements of the arrangements. For 1998,
this resulted in a decrease in revenues that otherwise would have been
recognized in the fourth quarter of 1998 since only a portion of the revenues
related to annual lease agreements was recognized. The total amount of revenue
recorded for these agreements was unchanged; however, revenue was deferred into
subsequent periods, primarily over the first three quarters of 1999.
CHANGE IN ESTIMATE--Effective January 1, 1999, the Company 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. Refer to
Note 3--Impairment of Assets. 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.
NOTE 3--IMPAIRMENT OF ASSETS
In accordance with SFAS No. 86 and SFAS No. 121, 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. Accordingly, for the
years ended December 31, 1999 and 1998, the Company recognized non-cash, pre-tax
charges totaling $1,500,000 and $9,834,000, respectively, on various long-lived
assets, as described below. There were no such losses recognized during 1997.
CAPITALIZED SOFTWARE (NON-LINEAR TECHNOLOGY CODE FOR MSC.NASTRAN)--Prior to
the acquisition of MARC, the Company had entered into an agreement with a third
party for the commercialization of the third party's non-linear technology code.
The Company had capitalized $750,000 in payments to the third party under the
licensing agreement and was obligated to pay an additional $750,000. In
addition, the Company had agreed to make minimum royalty payments over the next
three years for approximately $1,300,000. The Company's interest in entering
this agreement was to acquire non-linear technology that could be integrated
into MSC.Nastran. However, as a result of the acquisition of MARC and its
non-linear technology, the Company decided not to pursue the development of the
third party's code. As one of the world's leading technology codes in the
non-linear finite element market, MARC had significant capabilities in
non-linear technology, which were similar to those of the third party. In
addition, the Company has full access to the MARC source code, which allows for
an easier and more complete integration of its non-linear capabilities into
MSC.Nastran. The Company negotiated with the third party to modify the
42
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 3--IMPAIRMENT OF ASSETS (CONTINUED)
agreement. Consequently, the Company intends to pay its full obligation for
licensing the code. In exchange, the third party has relieved the Company of its
minimum royalty obligations and has provided the source code modules for one of
its non-linear capabilities. However, since the Company has no current plans to
integrate these modules into MSC.Nastran, management does not believe that there
will be any future cash flow for these modules. Accordingly, a $1,500,000 charge
was recorded in cost of license revenue in the second quarter of 1999 to
write-off these capitalized software costs and to provide for the remaining
payments due under the licensing agreement.
CAPITALIZED SOFTWARE (MSC.PATRAN)--Since the acquisition of PDA
Engineering, Inc. ("PDA") in 1994, the Company attempted to correct many of the
shortcomings with MSC.Patran but found that a major rewrite and replacement of
the underlying database management system was necessary to correct inherent
flaws with the product's basic architecture. These flaws prevented both
performance enhancements and increases in the functionality of the product. This
initiative began in late 1996 and the result of these efforts was Version 8 of
MSC.Patran. This major rewrite included many changes to the underlying
architecture, complete replacement of the existing data base management system,
and other programming enhancements to improve performance, reliability, and
portability to new hardware platforms, specifically the NT operating system. The
release of Version 8 was staged over the second and third quarters of 1998 with
pre-releases to select customers for beta testing. This strategy was
orchestrated to assure customer acceptance at an early stage. MSC.Patran
customer responses to Version 8 were very positive with the transition from
earlier versions to Version 8 occurring very quickly during the later part of
1998. At December 31, 1998, MSC.Patran Version 8 was the primary source of
MSC.Patran revenue, with over 93% of total MSC.Patran revenue in the fourth
quarter of 1998 coming from Version 8. With this high level of acceptance in the
marketplace, management believed the future cash flows from prior versions would
be near zero for all prior versions of MSC.Patran. In addition, due to the
significant changes in the technological architecture of the product, future
cash flows of Version 8 could not be considered in measuring the net realizable
value of prior versions. Accordingly, a $4,096,000 charge was recorded in cost
of license revenue in the fourth quarter of 1998 to write-off the capitalized
software costs of all versions of MSC.Patran prior to Version 8.
OTHER CAPITALIZED SOFTWARE--The Company launched many new products in 1997
and 1998. The 1998 revenues from some of these products were below original
projections. As part of the change in the Company's leadership in December 1998
and the resulting restructuring plan (refer to Note 10--Restructuring Reserve),
the Company changed its focus and reduced its marketing efforts for certain
products. Accordingly, management revised its future revenue projections of
these products. These revenue decreases reduced the future cash flows of six
products below their net asset value. Therefore, the Company wrote off
$3,675,000 of capitalized software costs as a charge to cost of license revenue
in the fourth quarter of 1998, which represented the excess of the carrying
amount of these products over their future cash flows, and provided for $393,000
of related minimum royalty payments and software licenses for these products,
which was charged to royalty expense.
SILVERADO GOODWILL--As discussed in Note 4--Business Acquisitions,
$1,670,000 of excess purchase price was recorded as goodwill in connection with
the purchase of Silverado Software & Consulting, Inc. ("Silverado"). This
premium was based in part on Silverado's past performance but also on the
potential opportunity the Company's management saw in the ability to tap into
Silverado's established customer base to expand the Company's contract analysis
and consulting business. As part of the Company's
43
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 3--IMPAIRMENT OF ASSETS (CONTINUED)
restructuring plan in December 1998 (refer to Note 10--Restructuring Reserve),
the Company changed its focus to emphasize the expansion of the software
business and value-added integration services as opposed to the contract
analysis business. It was then determined that the revenue stream from the
contract analysis business would not be sufficient nor projected to be
sufficient to cover the costs associated with the operation. Management
estimated that Silverado would not produce sufficient revenue to cover the costs
associated with the production of the revenue. Therefore, during the fourth
quarter of 1998, the Company determined the fair value of the goodwill was zero
and recorded a charge included in restructuring and other impairment charges to
write-off the entire amount of goodwill associated with the acquisition of
Silverado.
NOTE 4--BUSINESS ACQUISITIONS AND DIVESTITURES
ACQUISITION OF MARC ANALYSIS RESEARCH CORPORATION--On June 18, 1999, the
Company acquired 100% of MARC pursuant to an Agreement and Plan of Merger dated
as of May 26, 1999 (the "Merger Agreement") among the Company, MARC and
significant shareholders of MARC. MARC is a software developer and supplier
whose products include MARC (a non-linear finite element analysis ("FEA")
program for engineering structural analysis), Mentat (a graphical user interface
for MARC), and MARC/ AutoForge (a simulation program for the bulk forging
industry).
The aggregate fair value of the consideration paid to shareholders and
holders of options of MARC resulted in a purchase price valued at approximately
$36,123,000. The Merger Agreement provided for a cash purchase price of
approximately $20,300,000 and the Stock Purchase Agreement provided for the
Company to issue a package of securities to two of the MARC shareholders,
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 subordinated notes payable and convertible subordinated debentures were
discounted to their respective estimated fair values based on the Company's
current borrowing rates. The warrants were valued at their estimated fair value
of $3,038,000 based on the Black-Scholes option-pricing model.
In allocating the purchase price to the acquired assets and assumed
liabilities, the Company has recorded a $8,719,000 deferred income tax liability
related to identified intangible assets, offset by $1,933,000 for deferred
income tax assets, and $2,360,000 for restructuring costs related to the
integration of MARC, primarily severance costs and costs related to facility
consolidations. Refer to Note 10--Restructuring Reserve.
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 independent 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: $3,433,000
to net tangible assets; $25,643,000 to identified intangible assets
44
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 4--BUSINESS ACQUISITIONS AND DIVESTITURES (CONTINUED)
(including $15,274,000 of developed technology, $6,322,000 to customer list,
$2,390,000 for trade name recognition, and $1,657,000 of assembled work force);
and $12,126,000 to goodwill. Goodwill and identified intangibles are being
amortized over 15 years.
The purchase price was determined through arms' length negotiations between
members of the Board of Directors of the Company and representatives of MARC.
The Company considered the revenues and results of operations of MARC in recent
periods, estimates of the business potential of MARC, MARC's software offerings
in the non-linear finite element analysis market segment, and other synergies of
the two companies (such as the ability to offer a full suite of FEA products and
leveraging technology and distribution channels). In connection with the
acquisition, the Company has established a retention bonus plan valued at
approximately $1,400,000 for employees of MARC who continue their employment
following the acquisition. The bonus amount is being charged to operations as it
is earned.
The following summarized unaudited pro forma consolidated results of
operations reflects the effect of the MARC acquisition as if it had occurred on
January 1, 1999 and 1998. The unaudited pro forma consolidated results of
operations presented below are not necessarily indicative of operating results
which would have been achieved had the acquisition been consummated as of
January 1, 1999 or 1998 and should not be construed as representative of future
operations.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
Revenue.............................................. $158,726,000 $144,680,000
Operating Expense.................................... $153,521,000 $157,774,000
Net Income (Loss).................................... $ 5,967,000 $(16,348,000)
Basic Earnings (Loss) Per Share...................... $ 0.43 $ (1.20)
Diluted Earnings (Loss) Per Share.................... $ 0.43 $ (1.20)
</TABLE>
ACQUISITION OF UNIVERSAL ANALYTICS INC.--On June 24, 1999, the Company
acquired UAI for approximately $8,400,000 in cash. UAI is a developer and
distributor of FEA software and engineering services for the engineering
community and to major manufacturers worldwide. The acquisition has been
accounted for as a purchase and, accordingly, the operating results of UAI have
been included in the Company's consolidated financial statements since the date
of acquisition. The excess of the aggregate purchase price over the fair market
value of net assets acquired was approximately $6,800,000. Goodwill and
identified intangibles are being amortized over ten years. The pro forma effect
of the UAI acquisition as if it had occurred on January 1, 1999 or 1998 is
immaterial to the consolidated financial statements presented herein.
ACQUISITION OF COMPUTERIZED STRUCTURAL ANALYSIS AND RESEARCH CORPORATION--On
November 4, 1999, the Company acquired CSAR for approximately $9,650,000 in cash
and five-year warrants to purchase 110,000 shares of the Company's common stock
at an exercise price of $10.00 per share. The warrants were recorded at their
estimated fair value of $258,000 based on the Black-Scholes option-pricing
model. The Company financed a portion of the purchase price through a $8,000,000
term loan. Refer to Note 5--Financial Instruments. CSAR is a developer and
distributor of FEA software and services for the engineering community and to
major manufacturers worldwide. The acquisition has been accounted for as a
purchase and, accordingly, the operating results of CSAR have been included in
the Company's
45
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 4--BUSINESS ACQUISITIONS AND DIVESTITURES (CONTINUED)
consolidated financial statements since the date of acquisition. The excess of
the aggregate purchase price over the fair market value of net assets acquired
was approximately $9,800,000. Goodwill and identified intangibles are being
amortized over five years. The pro forma effect of the CSAR acquisition as if it
had occurred on January 1, 1999 or 1998 is immaterial to the consolidated
financial statements presented herein.
ACQUISITION OF KNOWLEDGE REVOLUTION INC.--In late December 1998, the Company
acquired KR for approximately $19,200,000 in cash. KR is 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: $1,549,000 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
$1,786,000 to goodwill. Goodwill and identified intangibles are being amortized
over three to ten years. The pro forma effect of the KR acquisition as if it had
occurred on January 1, 1998 is immaterial to the consolidated financial
statements presented herein.
ACQUISITION OF SILVERADO SOFTWARE & CONSULTING, INC.--In September 1998, the
Company acquired all of the stock of Silverado for total consideration of
$2,809,000, consisting of the issuance of 222,200 shares of the Company's common
stock at $6.9375 per share, or $1,542,000, a promissory note of $331,000 due
March 2000, and cash of $936,000. Net assets acquired included cash and
securities available-for-sale of approximately $945,000. Silverado is a provider
of engineering services and custom software solutions for the design and
analysis of mechanical components, electronic packaging, and civil structures.
The acquisition has been accounted for as a purchase. The excess of the
aggregate purchase price over the fair market value of net assets acquired was
approximately $1,670,000, which was written off during 1998 due to its
impairment. Refer to Note 3--Impairment of Assets.
SALE OF INVESTMENT IN LMS INTERNATIONAL--In June 1999, the principal
shareholders of LMS International ("LMS") exercised a repurchase option for an
equity position that MSC had held in LMS. MSC realized a pre-tax gain of
$10,733,000. LMS is a privately held company based in Leuven, Belgium.
NOTE 5--FINANCIAL INSTRUMENTS
OFF-BALANCE-SHEET-RISK--The Company may enter into forward exchange
contracts to hedge certain anticipated repayments of its intercompany debt with
its foreign subsidiaries. The forward exchange contracts do not qualify as a
hedge for financial reporting purposes and, accordingly, unrealized gains or
losses, based on the current forward foreign exchange rates, are reflected
directly in income. At December 31, 1999, the Company had no such forward
exchange contracts. At December 31, 1998, the Company had two forward exchange
contracts maturing in January and February 1999 to exchange a total of 4,000,000
German Marks for United States Dollars in the amount of approximately
$2,500,000. The unrealized gains were immaterial at December 31, 1998.
46
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 5--FINANCIAL INSTRUMENTS (CONTINUED)
CONCENTRATIONS OF CREDIT RISK--Financial instruments that potentially
subject the Company to significant concentrations of credit risk consists
principally of trade accounts receivable. Concentrations of credit risk with
respect to trade accounts receivable are limited due to the number of entities
and the size of those entities comprising the Company's customer base.
SECURITIES AVAILABLE-FOR-SALE--The following is a summary of securities
available-for-sale:
<TABLE>
<CAPTION>
FAIR MARKET VALUE
DECEMBER 31,
----------------------
1999 1998
-------- -----------
<S> <C> <C>
Securities Available-for-Sale
Municipal Securities...................................... $ -- $15,782,000
Equity Securities......................................... 183,000 --
Other Debt Securities..................................... -- 699,000
-------- -----------
Total Securities Available-for-Sale..................... $183,000 $16,481,000
======== ===========
</TABLE>
At December 31, 1999 and 1998, all investment securities were classified as
available-for-sale. The amortized cost and fair market value of municipal and
debt securities at December 31, 1999 and 1998, by contractual maturity, are
shown below. Expected maturities will differ from contractual maturities because
the issuers of the securities may have the right to prepay obligations without
prepayment penalties. Equity securities have no contractual maturity.
<TABLE>
<CAPTION>
FAIR MARKET VALUE
DECEMBER 31,
----------------------
1999 1998
-------- -----------
<S> <C> <C>
Due in One Year or Less..................................... $ -- $10,257,000
Due After One Year Through Three Years...................... -- 4,075,000
Due After Three Years....................................... -- 2,149,000
-------- -----------
-- 16,481,000
Equity Securities........................................... 183,000 --
-------- -----------
Total Securities Available-for-Sale....................... $183,000 $16,481,000
======== ===========
</TABLE>
LINE OF CREDIT AND NOTE PAYABLE--As of December 31, 1998, the Company had a
balance outstanding on a line of credit with its previous principal bank of
$10,800,000. In May 1999, this amount was repaid. On August 11, 1999, the
Company entered into a new Loan and Security Agreement ("Loan Agreement") with
its new principal 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 term of the revolving
portion of the Loan Agreement expires May 31, 2001. As of December 31, 1999, the
amount available under the line of credit, based on the defined borrowing base,
was approximately $10,000,000. There was no balance outstanding on the line of
credit as of December 31, 1999 and there were no borrowings from the line of
credit during 1999.
47
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 5--FINANCIAL INSTRUMENTS (CONTINUED)
On November 4, 1999, the Company borrowed the $8,000,000 term loan in
connection with the acquisition of CSAR. The term of the loan is two years and
requires monthly principal payments of $267,000. As of December 31, 1999, the
balance on the loan was $7,733,000. Borrowings under the Loan Agreement carry an
interest rate equal to the Bank's prime lending rate or LIBOR plus 200 basis
points, adjustable on a monthly basis. Borrowings under the Loan Agreement are
secured by nearly all of Company's goods and equipment, inventory, contract
rights, and intellectual property rights. Borrowings also involve certain
restrictive covenants, including restrictions on dividends and investments. As
of December 31, 1999, the Company is in compliance with all covenants.
CONVERTIBLE SUBORDINATED DEBENTURES--The Company issued $56,608,000 of
convertible subordinated debentures in connection with the acquisition of PDA in
1994. In June 1999, in connection with the MARC acquisition, the Company issued
additional convertible subordinated debentures in the aggregate principal amount
of $2,000,000. The convertible subordinated debentures were recorded at their
estimated fair value at the time of issuance, net of a discount of $300,000.
Refer to Note 4--Business Acquisitions and Divestitures. The debentures bear
interest at 7 7/8% with interest payments due semi-annually on March 15th and
September 15th. The conversion feature permits the holder to convert the
debentures into shares of the Company's common stock at a conversion price of
$15.15 per share. The debentures mature August 18, 2004, but are redeemable at
the Company's option at any time after August 18, 1997 upon payment of a
premium. At December 31, 1999, the principal balance of the convertible
subordinated debentures was $58,556,000 and their carrying amount was
$58,287,000, net of an unamortized discount of $269,000. The unamortized
discount is being amortized to interest expense using the effective-interest
method over the term of the convertible subordinated debentures.
SUBORDINATED NOTES PAYABLE--In June 1999, in connection with the MARC
acquisition, the Company issued subordinated notes payable, at a discount, in
the aggregate principal amount of $14,236,000. The subordinated notes payable
were recorded at their estimated fair value at the time of issuance resulting in
a discount of $2,596,000. Refer to Note 4--Business Acquisitions and
Divestitures. The subordinated notes payable bear interest at 8% with interest
payments due semi-annually in January and July. $3,236,000 of the notes payable
are due in June 2001 and the remaining $11,000,000 is due by June 2009. At
December 31, 1999, the principal balance of the subordinated notes payable was
$14,236,000 and their carrying amount was $11,804,000, net of an unamortized
discount of $2,432,000. The unamortized discount is being amortized to interest
expense using the effective-interest method over the term of the subordinated
notes payable.
The maturities of the note payable, convertible subordinated debentures and
subordinated notes payable for the next five years are as follows:
<TABLE>
<CAPTION>
MATURITIES
-----------
<S> <C>
2000........................................................ $ 3,200,000
2001........................................................ 6,436,000
2002........................................................ 1,333,000
2003........................................................ --
2004........................................................ 58,556,000
-----------
$69,525,000
===========
</TABLE>
48
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 5--FINANCIAL INSTRUMENTS (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS--The following methods and assumptions
were used by the Company in estimating its fair value disclosures for financial
instruments:
CASH AND CASH EQUIVALENTS--The carrying amount reported in the
consolidated balance sheets for cash and cash equivalents approximates its
fair value.
SECURITIES AVAILABLE-FOR-SALE--The fair values for securities
available-for-sale are based on quoted market prices.
TRADE ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE--The carrying amounts
reported in the consolidated balance sheets for trade accounts receivable
and accounts payable approximate their fair value.
NOTE PAYABLE--The carrying amount reported in the consolidated balance
sheets for the note payable approximates its fair market value since the
interest rate on the note payable is adjusted on a monthly basis.
CONVERTIBLE SUBORDINATED DEBENTURES--The fair market value of the
convertible subordinated debentures outstanding is based on their quoted
trading price.
SUBORDINATED NOTES PAYABLE--The fair value of the subordinated notes
payable is based on the present value of its future cash flows using a
discount rate that approximates the Company's current borrowing rate.
The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1999 DECEMBER 31, 1998
--------------------------- ---------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Financial Instrument Assets:
Cash and Cash Equivalents................. $ 21,735,000 $ 21,735,000 $ 10,822,000 $ 10,822,000
Securities Available-for-Sale............. $ 183,000 $ 183,000 $ 16,481,000 $ 16,481,000
Trade Accounts Receivable, Net............ $ 37,995,000 $ 37,995,000 $ 39,674,000 $ 39,674,000
Financial Instrument Liabilities:
Accounts Payable.......................... $ (4,692,000) $ (4,692,000) $ (4,405,000) $ (4,405,000)
Line of Credit............................ $ -- $ -- $(10,800,000) $(10,800,000)
Note Payable Current Portion.............. $ (7,733,000) $ (7,733,000) $ -- $ --
Convertible Subordinated Debentures....... $(58,287,000) $(51,001,000) $(56,574,000) $(52,048,000)
Subordinated Notes Payable................ $(11,804,000) $(12,229,000) $ -- $ --
</TABLE>
49
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 6--TRADE ACCOUNTS RECEIVABLE
The following is the activity in the allowance for doubtful accounts
receivable for the periods indicated.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Beginning Balance........................................ $3,605,000 $1,691,000 $1,700,000
Additions Due to Acquisitions.......................... 158,000 -- --
Amounts Charged to Expense............................. 245,000 2,203,000 1,243,000
Write-Downs Against the Reserve........................ (826,000) (289,000) (1,252,000)
---------- ---------- ----------
Ending Balance........................................... $3,182,000 $3,605,000 $1,691,000
========== ========== ==========
</TABLE>
NOTE 7--PROPERTY AND EQUIPMENT
Property and equipment, at cost, consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1999 1998
----------- -----------
<S> <C> <C>
Computers and Other Equipment.............................. $26,018,000 $24,496,000
Leasehold Improvements..................................... 3,027,000 2,499,000
Furniture and Fixtures..................................... 2,970,000 2,393,000
----------- -----------
32,015,000 29,388,000
Less Accumulated Depreciation and Amortization............. (23,430,000) (20,493,000)
----------- -----------
Property and Equipment, Net.............................. $ 8,585,000 $ 8,895,000
=========== ===========
</TABLE>
Depreciation and amortization expense on property and equipment for the
years ended December 31, 1999, 1998 and 1997 was $4,672,000, $6,026,000 and
$5,751,000, respectively.
NOTE 8--CAPITALIZED SOFTWARE COSTS
The components of capitalized software costs, as they affected operating
income, are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1999 1998 1997
----------- ------------ ------------
<S> <C> <C> <C>
Capitalized Internal Software Development
Costs.......................................... $(8,255,000) $(11,600,000) $(12,545,000)
Amortization of Capitalized Software Costs....... 8,816,000 11,974,000 12,043,000
Impairment of Capitalized Software Costs......... 1,500,000 7,771,000 --
----------- ------------ ------------
$ 2,061,000 $ 8,145,000 $ (502,000)
=========== ============ ============
</TABLE>
In addition, the Company purchased certain software that was capitalized in
1999, 1998 and 1997 amounting to $1,088,000, $1,313,000 and $182,000,
respectively.
50
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 8--CAPITALIZED SOFTWARE COSTS (CONTINUED)
Capitalized software costs consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
Capitalized Software Costs............................... $ 80,589,000 $ 70,470,000
Less Accumulated Amortization............................ (60,472,000) (49,436,000)
------------ ------------
Capitalized Software Costs, Net........................ $ 20,117,000 $ 21,034,000
============ ============
</TABLE>
NOTE 9--GOODWILL AND OTHER INTANGIBLE ASSETS
As of December 31, 1999 and 1998, goodwill was $36,746,000 and $10,756,000,
respectively, net of accumulated amortization of $9,480,000 and $6,618,000,
respectively. Goodwill arising from acquisitions is amortized on the
straight-line basis over five to fifteen years. Other intangible assets are
amortized on the straight-line basis over three to fifteen years and consist of
the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1999 1998
----------- -----------
<S> <C> <C>
Developed Technology....................................... $23,674,000 $ 8,400,000
Customer List.............................................. 6,322,000 --
Value-Added Reseller Distribution Channel.................. 5,200,000 5,200,000
Tradename Recognition...................................... 2,390,000 --
Assembled Work Force....................................... 2,047,000 390,000
Other...................................................... 3,554,000 2,680,000
----------- -----------
43,187,000 16,670,000
Less Accumulated Amortization.............................. (7,653,000) (3,430,000)
----------- -----------
Other Intangible Assets, Net............................. $35,534,000 $13,240,000
=========== ===========
</TABLE>
The carrying values of goodwill and other intangible assets are evaluated
periodically in relation to the operating performance and the future
undiscounted cash flows of the underlying business. Adjustments are made if the
sum of expected future net cash flows is less than book value. Refer to
Note 3--Impairment of Assets.
NOTE 10--RESTRUCTURING RESERVE
In December 1998, the Company accrued $695,000 of severance costs as part of
a restructuring plan that was completed in the first quarter of 1999. During
February 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 (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. The Company continually evaluates the
balance of the restructuring reserve based on the remaining estimated amounts to
be paid. As a result, during the second quarter of 1999, the Company decreased
the restructuring reserve by $400,000.
51
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 10--RESTRUCTURING RESERVE (CONTINUED)
During 1999, as part of the acquisitions of MARC, UAI and CSAR, the Company
recorded $2,730,000 of additional acquisition costs related to the integration
of these entities into the Company. In accordance with Emerging Issues Task
Force Issue No. 95-3, "RECOGNITION OF LIABILITIES IN CONNECTION WITH A PURCHASE
BUSINESS COMBINATION," these costs were included in the purchase price
allocations, resulting in additional goodwill. These charges primarily consisted
of severance costs of $1,171,000 and costs related to facility consolidations of
$1,559,000.
As of December 31, 1999, the restructuring liability was $2,875,000 for
severance costs and lease commitments. For 1999, cash outlays were $6,047,000 in
conjunction with the $8,922,000 of restructuring charges and acquisition costs
recorded in 1998 and 1999. The remaining cash outlays are anticipated to be
completed by the end of 2000, excluding certain lease commitments that may
continue into the year 2001.
The following is the activity in the restructuring reserve for the periods
indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
----------- -------- --------
<S> <C> <C> <C>
Balance at Beginning of Period...................... $ 695,000 $ -- $ --
Charges to Expense.............................. 5,897,000 695,000 --
Reversal of Restructuring Charges............... (400,000) -- --
Acquisition Costs Capitalized................... 2,730,000 -- --
Amounts Paid.................................... (6,047,000) -- --
----------- -------- --------
Balance at End of Period............................ $ 2,875,000 $695,000 $ --
=========== ======== ========
</TABLE>
52
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 11--OTHER CURRENT LIABILITIES
Other current liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1999 1998
----------- -----------
<S> <C> <C>
Sales Taxes Payable...................................... $ 3,144,000 $ 2,896,000
Income Taxes Payable..................................... 2,891,000 1,328,000
Interest Payable......................................... 2,092,000 1,332,000
Contribution to Profit Sharing Plan...................... 2,031,000 1,796,000
Commissions Payable...................................... 798,000 1,226,000
Royalties Payable........................................ 747,000 1,169,000
Other.................................................... 4,816,000 4,528,000
----------- -----------
Total Other Current Liabilities........................ $16,519,000 $14,275,000
=========== ===========
</TABLE>
NOTE 12--TAXES BASED ON INCOME
The provision (benefit) for taxes based on income (loss) consists of the
following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Current:
Federal........................................ $3,103,000 $1,994,000 $ 293,000
State.......................................... (134,000) 489,000 160,000
Foreign........................................ 3,229,000 2,786,000 4,459,000
---------- ---------- ----------
6,198,000 5,269,000 4,912,000
Deferred......................................... (2,260,000) (5,465,000) 182,000
---------- ---------- ----------
Provision (Benefit) for Income Taxes........... $3,938,000 $ (196,000) $5,094,000
========== ========== ==========
</TABLE>
The foreign tax provision for 1999, 1998 and 1997 includes withholding taxes
of $1,748,000, $2,075,000 and $2,546,000, respectively, assessed to the Company
by foreign authorities on foreign revenues remitted to the United States. For
the years ended December 31, 1999, 1998 and 1997, the Company's foreign
operations realized combined taxable income (loss), including intercompany
charges and before taxes, of $816,000, ($4,134,000) and $2,889,000,
respectively.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax
53
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 12--TAXES BASED ON INCOME (CONTINUED)
purposes. Significant components of the Company's deferred tax liabilities and
assets as of December 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1999 1998
----------- -----------
<S> <C> <C>
Deferred Tax Liabilities:
Intangible Assets........................................ $10,794,000 $ 1,035,000
Capitalized Software..................................... 8,060,000 8,406,000
Organization Costs....................................... 743,000 344,000
Other.................................................... 263,000 84,000
----------- -----------
Total Deferred Tax Liabilities......................... 19,860,000 9,869,000
----------- -----------
Deferred Tax Assets:
Deferred Revenue......................................... 7,265,000 3,794,000
Foreign Deferred Taxes................................... 3,175,000 1,788,000
Net Operating Losses..................................... 3,070,000 5,692,000
Undistributed Earnings of Foreign Subsidiaries........... 2,708,000 868,000
Business Credits......................................... 1,855,000 1,296,000
Restructuring Liability.................................. 1,491,000 458,000
Benefits and Compensation................................ 1,463,000 1,288,000
State Taxes.............................................. 843,000 180,000
Allowance for Doubtful Accounts.......................... 700,000 610,000
Other.................................................... 534,000 268,000
----------- -----------
Total Deferred Tax Assets.............................. 23,104,000 16,242,000
----------- -----------
Valuation Allowance:
Net Operating Losses............................... (2,211,000) (5,258,000)
Undistributed Earnings of Foreign Subsidiaries..... (2,708,000) --
----------- -----------
Total Valuation Allowance........................ (4,919,000) (5,258,000)
----------- -----------
Net Deferred Tax Assets................................ 18,185,000 10,984,000
----------- -----------
Net Deferred Tax Liabilities/(Assets).......... $ 1,675,000 $(1,115,000)
=========== ===========
</TABLE>
In connection with its 1999 acquisitions, MSC recorded a net deferred tax
liability of $5,050,000, which was recorded directly in the deferred tax
liability and thus is not reflected in the provision for taxes.
The balance sheet presentation of the net deferred tax liabilities/(assets)
is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1999 1998
----------- -----------
<S> <C> <C>
Long-Term Deferred Income Taxes, Net..................... $16,957,000 $ 6,961,000
Current Deferred Tax Charges............................. (15,282,000) (8,076,000)
----------- -----------
Net Deferred Tax Liabilities/(Assets).................. $ 1,675,000 $(1,115,000)
=========== ===========
</TABLE>
54
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 12--TAXES BASED ON INCOME (CONTINUED)
At December 31, 1999, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $16,523,000. The federal net
operating loss carryforwards expire at various dates through the year 2012. An
acquisition by the Company in 1993 constituted an ownership change for federal
income tax purposes and, as a result, the amount of net operating loss
carryforwards that may be utilized in any given year may be limited. For
financial reporting purposes, a valuation allowance of $2,211,000 and $5,528,000
at December 31, 1999 and 1998, respectively, has been recognized to offset the
deferred tax assets relating to net operating losses from acquisitions before
1996. During 1999, an additional valuation allowance of $2,708,000 was
established to offset the deferred tax assets attributable to the undistributed
earnings of foreign subsidiaries.
The net decrease in the valuation allowances of $339,000 is due to a
decrease of $3,047,000 attributable to the elimination of restrictions on
previously acquired net operating losses and an addition of $2,708,000
attributable to undistributed earnings of foreign subsidiaries.
The following table reconciles the provision (benefit) for income taxes
based on income (loss) before taxes to the statutory federal income tax rate of
35% for the years ended December 31, 1999, 1998 and 1997.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1999 1998 1997
---------- ----------- ----------
<S> <C> <C> <C>
Income Tax Provision (Benefit) at Statutory
Federal Income Tax Rate................................ $3,162,000 $(4,611,000) $5,243,000
Increase (Decrease) Related To:
Amortization of Goodwill............................... 1,684,000 1,112,000 527,000
Income of Foreign Sales Corporation.................... (1,598,000) (1,136,000) (1,056,000)
Acquired In-Process Technology......................... 1,423,000 2,100,000 --
State Income Taxes, Net of Federal Benefits............ 742,000 (156,000) 564,000
Federal and State Research and Development Tax
Credits.............................................. (659,000) (631,000) (526,000)
Foreign Losses Not Benefited........................... -- 3,331,000 --
Other, Net........................................... (816,000) (205,000) 342,000
---------- ----------- ----------
Provision (Benefit) for Income Taxes................. $3,938,000 $ (196,000) $5,094,000
========== =========== ==========
</TABLE>
NOTE 13--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.
55
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 13--SEGMENT INFORMATION (CONTINUED)
The following tables summarize consolidated financial information of the
Company's operations by geographic location:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Revenues:
The Americas(1).......................... $ 68,092,000 $ 58,409,000 $ 60,326,000
Europe................................... 45,672,000 39,875,000 37,514,000
Asia-Pacific............................. 35,471,000 27,113,000 34,964,000
------------ ------------ ------------
Total Revenue.......................... $149,235,000 $125,397,000 $132,804,000
============ ============ ============
</TABLE>
- ------------------------
(1) Substantially the United States
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
Identifiable Assets:
The Americas(1)........................................ $141,890,000 $102,255,000
Europe................................................. 27,638,000 26,353,000
Asia-Pacific........................................... 17,692,000 12,209,000
------------ ------------
Total Identifiable Assets............................ $187,220,000 $140,617,000
============ ============
</TABLE>
- ------------------------
(1) Substantially the United States
The net assets of the Company's foreign subsidiaries totaled $22,725,000 and
$21,052,000 as of December 31, 1999 and 1998, respectively, excluding
intercompany items. Long-lived assets included in these amounts were $5,709,000
and $4,413,000 as of December 31, 1999 and 1998, respectively. The taxable
income of the Company's foreign subsidiaries is reported in Note 12--Taxes Based
on Income.
NOTE 14--EMPLOYEE BENEFITS
The Company contributes an amount, integrated with Social Security, to a
defined contribution plan, covering substantially all North American full-time
employees who have completed a specified term of service with the Company. For
the years ended December 31, 1999, 1998 and 1997, contributions charged to
expense in connection with this plan were $1,934,000, $1,704,000 and $2,694,000,
respectively. The plan has a 401(k) feature to permit voluntary employee
contributions, which does not affect the Company's expenses.
In 1995, the Company adopted a non-qualified supplemental retirement plan.
The Company contributes an amount, integrated with Social Security and the
Company's defined contribution plan, covering certain key employees who have
completed a specified term of service with the Company. For the years ended
December 31, 1999, 1998 and 1997, contributions charged to expense in connection
with this plan were $49,000, $58,000 and $134,000, respectively.
56
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
The Company announced the termination of its post retirement health care
plan in the third quarter of 1998. The accrued obligation of the plan as of
December 31, 1998, totaling $1,157,000, was recorded as a reduction to selling,
general and administrative expense in the third quarter of 1998. The gross
remaining accumulated post retirement obligation was $0 and $112,000 at
December 31, 1999 and 1998, respectively. The liability at December 31, 1998
represented the Company's obligation to reimburse certain employees for their
health insurance premiums through June 1999. Total expense, excluding the gain
recognized on the termination of the plan, for the years ended December 31,
1999, 1998 and 1997 was $0, $54,000 and $334,000, respectively.
NOTE 15--STOCK OPTION PLANS AND WARRANTS
1991 PLAN--The MSC.Software Corporation 1991 Stock Option Plan ("the 1991
Plan"), as amended, consists of two parts: a "Key Employee Program" that allows
discretionary awards of non-transferable incentive stock options and
non-qualified stock options to officers and other key employees, and a
"Non-Employee Director Program" that provides for automatic annual grants of
non-transferable, non-qualified stock options to non-employee directors.
The "Key Employee Program" section of the 1991 Plan provides for the
granting of both incentive stock options and non-qualified options for the
purchase of up to 2,500,000 authorized but unissued shares of the Company's
common stock at the fair market value of such shares on the date the option is
granted, or for non-qualified options at such price as the Compensation
Committee may determine.
The "Non-Employee Director Program" section of the 1991 Plan provides for
automatic grants to members of the Company's Board of Directors who are not
officers or employees of the Company or its subsidiaries. A maximum of 500,000
shares of authorized but unissued shares of the Company's common stock may be
issued upon the exercise of options under the "Non-Employee Director Program."
All eligible directors will receive annual non-discretionary grants of
non-qualified stock options for the purchase of 3,000 shares of the Company's
common stock.
Options under the 1991 Plan are exercisable up to ten years from the date of
grant, subject to vesting provisions outlined at the grant date.
A summary of stock option activity for the 1991 Plan is as follows:
<TABLE>
<CAPTION>
OPTION PRICE WEIGHTED-AVERAGE
OPTIONS PER SHARE EXERCISE PRICE
--------- ---------------- ----------------
<S> <C> <C> <C>
Outstanding at December 31,
1997...................... 2,076,800 $ 6.50 to $15.88 $12.07
Granted................... 1,167,350 $ 5.38 to $11.25 $ 9.28
Exercised................. (64,950) $ 6.50 to $11.00 $ 8.78
Canceled.................. (629,750) $ 7.75 to $15.88 $13.27
---------
Outstanding at December 31,
1998...................... 2,549,450 $ 5.38 to $15.88 $10.58
Granted................... 255,350 $ 5.50 to $ 7.25 $ 6.08
Exercised................. -- $ -- to $ -- $ --
Canceled.................. (632,300) $ 5.94 to $15.38 $10.24
---------
Outstanding at December 31,
1999...................... 2,172,500 $ 5.38 to $15.88 $10.15
=========
</TABLE>
57
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 15--STOCK OPTION PLANS AND WARRANTS (CONTINUED)
The number of options exercisable under the 1991 Plan at December 31, 1999,
1998 and 1997 was 1,600,050, 1,386,150 and 1,743,300, respectively. At
December 31, 1999, 1998 and 1997, the per-share weighted-average exercise prices
of the stock options exercisable under the 1991 Plan were $11.01, $11.46 and
$12.23, respectively. Options to purchase 687,950, 711,000 and 848,600 shares
were available for future grant under the 1991 Plan as of December 31, 1999,
1998 and 1997, respectively. At December 31, 1999, the weighted-average
remaining contractual life for stock options outstanding under the 1991 Plan was
5.55 years.
1998 PLAN--The MSC.Software Corporation 1998 Stock Option Plan ("the 1998
Plan"), as amended, consists of two parts: a "Key Employee Program" that allows
discretionary awards of non-transferable incentive stock options and
non-qualified stock options to officers and other key employees, and a
"Non-Employee Director Program" that provides for automatic annual grants of
non-transferable, non-qualified stock options to non-employee directors.
The "Key Employee Program" section of the 1998 Plan provides for the
granting of both incentive stock options and non-qualified options for the
purchase of up to 2,440,000 authorized but unissued shares of the Company's
common stock at the fair market value of such shares on the date the option is
granted, or for non-qualified options at such price as the Compensation
Committee may determine.
The "Non-Employee Director Program" section of the 1998 Plan provides for
automatic grants to members of the Company's Board of Directors who are not
officers or employees of the Company or its subsidiaries. A maximum of 60,000
shares of authorized but unissued shares of the Company's common stock may be
issued upon the exercise of options under the "Non-Employee Director Program."
All eligible directors will receive annual non-discretionary grants of
non-qualified stock options for the purchase of 3,000 shares of the Company's
common stock. Options to be granted to non-employee directors under the 1998
Plan do not begin until 2000. Directors may receive only 3,000 shares of the
Company's common stock per year from either the 1991or 1998 plans.
Options under the 1998 Plan are exercisable up to ten years from the date of
grant, subject to transfer restrictions and vesting provisions outlined at the
grant date. The 1998 Plan provides that vesting may be accelerated in certain
events related to changes in control of the Company, unless prior to such change
in control the Compensation Committee determines otherwise. Similarly, the 1998
Plan provides that the Compensation Committee has discretion, subject to certain
limits, to modify the terms of outstanding options. No amendment or cancellation
and re-grant, subject to permitted adjustments, shall reduce the per share
exercise price to a price less than 100% of the fair market value of the
Company's common stock on the option date of the initial option.
58
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 15--STOCK OPTION PLANS AND WARRANTS (CONTINUED)
A summary of stock option activity for the 1998 Plan is as follows:
<TABLE>
<CAPTION>
OPTION PRICE WEIGHTED-AVERAGE
OPTIONS PER SHARE EXERCISE PRICE
--------- --------------- ----------------
<S> <C> <C> <C>
Outstanding at December 31, 1997........... -- $ -- to $ -- $ --
Granted.................................. 600,000 $ 5.38 to $9.00 $8.00
---------
Outstanding at December 31, 1998........... 600,000 $ 5.38 to $9.00 $8.00
Granted.................................. 1,376,850 $ 5.00 to $7.69 $5.76
Canceled................................. (161,000) $ 5.25 to $5.25 $5.25
---------
Outstanding at December 31, 1999........... 1,815,850 $ 5.00 to $9.00 $6.36
=========
</TABLE>
The number of options exercisable under the 1998 Plan at December 31, 1999
and 1998 were 181,250 and 0, respectively. At December 31, 1999, the per-share
weighted-average exercise price of the stock options exercisable under the 1998
Plan was $8.15. Options to purchase 684,150 and 400,000 shares were available
for future grant under the 1998 Plan as of December 31, 1999 and 1998,
respectively. At December 31, 1999, the weighted-average remaining contractual
life for stock options outstanding under the 1998 Plan was 9.07 years.
EMPLOYEE STOCK PURCHASE PLAN--In September 1996, the Company's Board of
Directors adopted the MSC.Software Corporation 1996 Employee Stock Purchase Plan
("the Employee Stock Purchase Plan"). The Employee Stock Purchase Plan was
approved by the Company's shareholders at the 1997 Annual Meeting of
Shareholders. Under the Employee Stock Purchase Plan, a maximum of 750,000
shares of the Company's common stock have been made available for purchase by
eligible employees electing to participate in the Employee Stock Purchase Plan.
The Employee Stock Purchase Plan is intended to provide participating eligible
employees an additional incentive to advance the best interests of the Company
through ownership of common stock. As of January 31, 2000, a total of 134
eligible employees elected to participate in the Employee Stock Purchase Plan
with total payroll deductions as of that date equal to $370,000. Purchases were
as follows for the periods indicated:
<TABLE>
<CAPTION>
PRICE TOAL
SHARES PER SHARE PURCHASES
-------- --------- ----------
<S> <C> <C> <C>
July 31, 1997................................. 89,986 $6.9750 $ 628,000
January 31, 1998.............................. 48,876 $8.3813 $ 410,000
July 31, 1998................................. 54,119 $7.1438 387,000
January 31, 1999.............................. 59,734 $5.8500 349,000
July 31, 1999................................. 71,177 $4.8938 348,000
------- ----------
323,892 $6.5516 $2,122,000
======= ==========
</TABLE>
There are 426,108 remaining shares eligible for purchase under the Employee
Stock Purchase Plan as of December 31, 1999. On January 31, 2000, purchases of
75,470 shares totaling $365,000 were exercised.
STOCK-BASED COMPENSATION--The Company has adopted the disclosure-only
provisions of SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION."
Accordingly, no compensation cost has been recognized in the results of
operations for the stock option grants. Had compensation cost for the Company's
stock option plans been determined based on the fair value at the grant date for
awards during the years ended
59
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 15--STOCK OPTION PLANS AND WARRANTS (CONTINUED)
December 31, 1999, 1998 and 1997 consistent with the provisions of SFAS
No. 123, the Company's Net Income (Loss), Basic Earnings (Loss) Per Share and
Diluted Earnings (Loss) Per Share would have been reduced to the pro forma
amounts as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1999 1998 1997
---------- ------------ ----------
<S> <C> <C> <C>
Net Income (Loss):
As Reported................................... $5,097,000 $(12,979,000) $9,887,000
Pro Forma..................................... $4,053,000 $(13,371,000) $8,194,000
Basic Earnings (Loss) Per Share:
As Reported................................... $ 0.37 $ (0.95) $ 0.73
Pro Forma..................................... $ 0.29 $ (0.98) $ 0.61
Diluted Earnings (Loss) Per Share:
As Reported................................... $ 0.37 $ (0.95) $ 0.73
Pro Forma..................................... $ 0.22 $ (0.98) $ 0.47
</TABLE>
NOTE: DILUTED EARNINGS (LOSS) PER SHARE ARE PRESENTED AS EQUAL TO OR LESS THAN
BASIC EARNINGS (LOSS) PER SHARE.
Using the Black-Scholes valuation model, the estimated per share
weighted-average fair value of stock options granted during the years ended
December 31, 1999, 1998 and 1997 was $2.95, $4.23 and $4.37, respectively.
The pro forma effect on the Company's Net Income (Loss) and Basic Earnings
(Loss) Per Share for 1999, 1998 and 1997 is not representative of the pro forma
effect in future years. The pro forma effect does not take into consideration
compensation expense related to grants made prior to 1996 or additional grants
in future years, which are anticipated. The fair value of each option is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions used for the periods indicated:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Dividend Yield............................................ 0.0% 0.0% 0.0%
Expected Volatility....................................... 49.7% 46.1% 41.9%
Risk-Free Interest Rate................................... 6.25% 7.00% 7.00%
</TABLE>
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options. The Company's employee stock options have
characteristics significantly different from those of traded options, such as
vesting restrictions and extremely limited transferability. In addition, the
assumptions used in option valuation models are highly subjective, particularly
the expected stock price volatility of the underlying stock. Because changes in
these subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not provide a reliable
single measure of the fair value of its employee stock options.
WARRANTS--On March 9, 1998, the Company entered into a joint-development and
marketing arrangement with Kubota Solid Technology Corporation ("KSTC"). This
arrangement allowed KSTC to purchase warrants with an aggregate exercise price
of up to $3,000,000 to purchase shares of the Company's common stock. As of
December 31, 1999, all warrants were purchased under the arrangement. The
60
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 15--STOCK OPTION PLANS AND WARRANTS (CONTINUED)
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 provided KSTC with marketing rights to a specific technology
being developed.
The Company recorded service revenue related to the development effort and
marketing rights provided under the arrangement and issued warrants to KSTC. The
following table shows the service revenue recorded and warrants issued for the
periods indicated.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER
31,
---------------------
1999 1998
--------- ---------
<S> <C> <C>
Service Revenue Recorded................................ $924,000 $944,000
Value of Warrants Issued................................ $576,000 $556,000
Shares of Common Stock.................................. 217,864 185,843
Average Exercise Price.................................. $ 6.8850 $ 8.0713
</TABLE>
The warrants were recorded at fair value based on the Black-Scholes
valuation method using the following assumptions: dividend yield of 0.0%;
expected volatility between 42.6% and 49.7%; and risk-free interest rates
between 5.5% and 7.0%. The warrants issued have exercise prices ranging between
$5.8125 per share and $11.375 per share. 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, in connection with the acquisition of MARC, 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. The warrants had an estimated
fair value of $3,038,000 based on the Black-Scholes valuation method using the
following assumptions: dividend yield of 0.0%, expected volatility of 48.4%, and
a risk-free interest rate of 7.0%. On November 4, 1999, in connection with the
acquisition of CSAR, the Company issued five-year warrants to purchase 110,000
shares of the Company's common stock at an exercise price of $10.00 per share.
The warrants had an estimated fair value of $258,000 based on the Black-Scholes
valuation method using the following assumptions: dividend yield of 0.0%,
expected volatility of 47.9%, and a risk-free interest rate of 5.5%.
61
<PAGE>
MSC SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 16--COMMITMENTS AND CONTINGENCIES
The Company leases facilities and equipment under various lease agreements,
which range from one to twelve years, which require the following minimum annual
rental commitments:
<TABLE>
<CAPTION>
OPERATING LEASES
YEARS ENDING DECEMBER 31,
-------------------------
<S> <C>
2000 $ 4,090,000
2001 4,895,000
2002 4,540,000
2003 4,253,000
2004 4,106,000
Thereafter 17,942,000
------------
$ 39,826,000
============
</TABLE>
For the years ended December 31, 1999, 1998 and 1997, the combined annual
rental cost for various facilities and equipment under operating leases
approximated $7,690,000, $6,900,000 and $5,575,000, respectively. In most cases,
management expects that, in the normal course of business, leases will be
renewed or replaced by others.
NOTE 17--ACCUMULATED OTHER COMPREHENSIVE INCOME
The components of other comprehensive income (loss) are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Balance at Beginning of Period......... $(3,219,000) $(4,482,000) $(2,625,000)
Currency Translation Adjustment...... (2,204,000) 1,252,000 (1,857,000)
Unrealized Investment Gain........... (3,000) 11,000 --
----------- ----------- -----------
Balance at End of Period............... $(5,426,000) $(3,219,000) $(4,482,000)
=========== =========== ===========
</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. The amount of tax associated with the unrealized gains and
losses was immaterial.
NOTE 18--SHAREHOLDERS' EQUITY
In October 1998, the Company adopted a Stockholder Rights Plan ("the Plan").
As part of the Plan, a special type of dividend was declared on the common stock
of the Company distributing these rights to all stockholders of record on
October 16, 1998. These rights, which do not have any shareholder rights,
including voting or dividend rights, will expire on October 5, 2008, unless
earlier redeemed by the Company prior to expiration at a price of $.01 per
right. The rights automatically transfer with a transfer of common stock until
the time they become exercisable, which happens when certain specified events
occur. If the rights become exercisable, they entitle the holders thereof to
purchase stock of the Company at a price of $35.00, subject to certain other
provisions of the Plan.
62
<PAGE>
MSC SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 18--SHAREHOLDERS' EQUITY (CONTINUED)
The debentures issued by the Company have a feature that allows the holder
to convert the debentures to common stock of the Company at a conversion price
of $15.15 per share.
As of December 31, 1999, shares of common stock reserved for issuance were
as follows:
<TABLE>
<CAPTION>
<S> <C>
Stockholder Rights Plan..................................... 13,841,600
Convertible Subordinated Debentures......................... 3,865,100
Common Stock Warrants....................................... 1,913,700
Employee Stock Option Plans:
1991 Plan................................................. 2,860,500
1998 Plan................................................. 2,500,000
Employee Stock Purchase Plan................................ 426,100
----------
Total Shares Reserved for Issuance as of December 31,
1999.................................................. 25,407,000
==========
</TABLE>
NOTE 19--EARNINGS PER SHARE
The following table sets forth the computation of Basic and Diluted Earnings
(Loss) Per Share:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------
1999 1998 1997
----------- ------------ -----------
<S> <C> <C> <C>
NUMERATOR:
Numerator for Basic Earnings (Loss) Per Share - Net
Income (Loss)......................................... $ 5,097,000 $(12,979,000) $ 9,887,000
Effect of Dilutive Securities--Interest on 7 7/8%
Convertible Subordinated Debentures, Net of Tax....... --(1) --(1) --(1)
----------- ------------ -----------
Numerator for Diluted Earnings (Loss) Per Share......... $ 5,097,000 $(12,979,000) $ 9,887,000
=========== ============ ===========
DENOMINATOR:
Denominator for Basic Earnings (Loss) Per Share -
Weighted-Average Shares Outstanding................... 13,800,000 13,655,000 13,514,000
Effect of Dilutive Securities:
Employee Stock Options................................ 96,000 --(1) 114,000
Common Stock Warrants................................. 9,000 --(1) --(1)
7 7/8% Convertible Subordinated Debentures............ --(1) --(1) --(1)
----------- ------------ -----------
Dilutive Potential Common Shares.................... 105,000 -- 114,000
----------- ------------ -----------
Denominator for Diluted Earnings (Loss) Per Share -
Adjusted Weighted-Average Shares and Assumed
Conversions, if Applicable............................ 13,905,000 13,655,000 13,628,000
=========== ============ ===========
BASIC EARNINGS (LOSS) PER SHARE........................... $ 0.37 $ (0.95) $ 0.73
=========== ============ ===========
DILUTED EARNINGS (LOSS) PER SHARE......................... $ 0.37 $ (0.95) $ 0.73
=========== ============ ===========
</TABLE>
- --------------------------
(1) Anti-dilutive options and debentures are excluded from the calculation of
Diluted Earnings (Loss) Per Share for the periods indicated.
63
<PAGE>
MSC SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 19--EARNINGS PER SHARE (CONTINUED)
For additional disclosures regarding the convertible subordinated
debentures, employee stock options and common stock warrants, refer to
Note 5--Financial Instruments and Note 15--Stock Option Plans and Warrants.
The following table shows the common stock equivalents that were outstanding
as of December 31, 1999, 1998 and 1997, but were not included in the computation
of Diluted Earnings (Loss) Per Share because the options' or warrants' exercise
price was greater than the average market price of the common shares and,
therefore, the effect would be anti-dilutive:
<TABLE>
<CAPTION>
NUMBER OF OPTION PRICE
SHARES PER SHARE
--------- ------------------
<S> <C> <C>
Anti-Dilutive Stock Options:
As of December 31, 1999.............................. 2,527,200 $ 6.313 to $15.875
As of December 31, 1998.............................. 2,524,000 $ 8.625 to $15.875
As of December 31, 1997.............................. 1,592,000 $10.500 to $15.875
Anti-Dilutive Common Stock Warrants:
As of December 31, 1999.............................. 1,728,300 $ 6.688 to $11.375
As of December 31, 1998.............................. 185,800 $ 6.188 to $11.375
As of December 31, 1997.............................. -- $ -- to $ --
Anti-Dilutive Convertible Subordinated Debentures:
As of December 31, 1999.............................. 3,865,100.. $ 15.150
As of December 31, 1998.............................. 3,734,300.. $ 15.150
As of December 31, 1997.............................. 3,734,300 $ 15.150
</TABLE>
64
<PAGE>
MSC.SOFTWARE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NOTE 20--QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is selected unaudited quarterly financial data for the years
ended December 31, 1999 and 1998.
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1999(1) 1999(2) 1999 1999(3)
----------- ----------- ------------- ------------
<S> <C> <C> <C> <C>
Revenues....................................... $30,653,000 $33,442,000 $38,925,000 $46,215,000
Operating Expenses............................. $36,992,000 $36,895,000 $35,393,000 $37,319,000
Operating Income (Loss)........................ $(6,339,000) $(3,453,000) $ 3,532,000 $ 8,896,000
Other Expense (Income), Net.................... $ 1,514,000 $(9,938,000) $ 1,748,000 $ 277,000
Income (Loss) Before Provision (Benefit) for
Income Taxes.................................. $(7,853,000) $ 6,485,000 $ 1,784,000 $ 8,619,000
Provision (Benefit) for Income Taxes........... $(2,434,000) $ 3,205,000 $ 571,000 $ 2,596,000
Net Income (Loss).............................. $(5,419,000) $ 3,280,000 $ 1,213,000 $ 6,023,000
Basic Earnings (Loss) Per Share................ $ (0.39) $ 0.24 $ 0.09 $ 0.44
Diluted Earnings (Loss) Per Share.............. $ (0.39) $ 0.23 $ 0.09 $ 0.38
Basic Weighted-Average Shares.................. 13,770,000 13,770,000 13,818,000 13,842,000
Diluted Weighted-Average Shares................ 13,770,000 17,643,000 13,885,000 18,159,000
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1998 1998 1998 1998(4)
----------- ----------- ------------- ------------
<S> <C> <C> <C> <C>
Revenues............................................... $37,770,000 $29,679,000 $28,775,000 $ 29,173,000
Operating Expenses..................................... $29,391,000 $28,977,000 $27,351,000 $ 49,719,000
Operating Income (Loss)................................ $ 8,379,000 $ 702,000 $ 1,424,000 $(20,546,000)
Other Expense (Income), Net............................ $ 855,000 $ 721,000 $ 395,000 $ 1,163,000
Income (Loss) Before Provision (Benefit) for Income
Taxes................................................ $ 7,524,000 $ (19,000) $ 1,029,000 $(21,709,000)
Provision (Benefit) for Income Taxes................... $ 2,558,000 $ (6,000) $ 350,000 $ (3,098,000)
Net Income (Loss)...................................... $ 4,966,000 $ (13,000) $ 679,000 $(18,611,000)
Basic Earnings (Loss) Per Share........................ $ 0.36 $ 0.00 $ 0.05 $ (1.36)
Diluted Earnings (Loss) Per Share...................... $ 0.33 $ 0.00 $ 0.05 $ (1.36)
Basic Weighted-Average Shares.......................... 13,636,000 13,678,000 13,596,000 13,711,000
Diluted Weighted-Average Shares........................ 17,539,000 13,678,000 17,353,000 13,711,000
</TABLE>
- --------------------------
(1) Reflects restructuring charges of $5,897,000.
(2) Reflects an in-process research and development charge of $4,067,000 related
to the acquisition of MARC, impairment charges of $1,500,000 in cost of
license revenue, reversal of restructuring charges of $400,000, and a gain
on sale of equity investment of $10,773,000.
(3) Reflects an $800,000 reversal of bad debt expense in operating expense from
the collection of older accounts receivable balances and a gain of
$1,200,000 in other expense (income) related to foreign exchange
adjustments.
(4) Reflects a reduction in revenue of $9,398,000 related to the change in how
the Company recognizes revenue, an in-process research and development
charge of $6,000,000 related to the acquisition of KR, impairment charges of
$8,164,000 in cost of license revenue, and restructuring and other
impairment charges of $2,365,000.
NOTE: DILUTED EARNINGS (LOSS) PER SHARES ARE PRESENTED AS EQUAL TO OR LESS THAN
BASIC EARNINGS (LOSS) PER SHARE.
65
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
MSC.Software Corporation
We have audited the accompanying consolidated balance sheets of MSC.Software
Corporation as of December 31, 1999 and 1998, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
three years in the period ended December 31, 1999. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of MSC.Software
Corporation at December 31, 1999 and 1998, and the consolidated results of its
operations and its cash flows for each of three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.
/s/ Ernst & Young LLP
Los Angeles, California
February 23, 2000
66
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to General Instructions G(3) to Form 10-K, the information required
by this item is incorporated by reference to such information contained in the
Company's definitive Proxy Statement for the Annual Meeting of Shareholders to
be held on May 10, 2000, filed with the Securities and Exchange Commission
pursuant to Regulation 14-A. In addition, the information set forth under Item 1
of this Annual Report in Form 10-K under the caption "Executive Officers of the
Registrant" is also incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
Pursuant to General Instructions G(3) to Form 10-K, the information required
by this item is incorporated by reference to such information contained in the
Company's definitive Proxy Statement for the Annual Meeting of Shareholders to
be held on May 10, 2000, filed with the Securities and Exchange Commission
pursuant to Regulation 14-A.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Pursuant to General Instructions G(3) to Form 10-K, the information required
by this item is incorporated by reference to such information contained in the
Company's definitive Proxy Statement for the Annual Meeting of Shareholders to
be held on May 10, 2000, filed with the Securities and Exchange Commission
pursuant to Regulation 14-A.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On June 18, 1999, MSC acquired 100% of MARC pursuant to an Agreement and
Plan of Merger dated as of May 26, 1999 (the "Merger Agreement") among MSC, MSC
Holdings Co. II, a wholly-owned subsidiary of MSC (the "Merger Sub"), MARC and
the following Significant Shareholders: Dendron Technology B.V., a Dutch
corporation ("Dendron"); Fronos Technology B.V., a Dutch corporation ("Fronos");
and Nearchos Irinarchos. Dendron and Fronos are each owned by Mr. Irinarchos.
The transaction had a two-step structure whereby MSC purchased approximately 42%
of MARC's outstanding common stock from Dendron and Fronos pursuant to a Stock
Purchase Agreement dated as of May 26, 1999 among Dendron, Fronos and MSC (the
"Stock Purchase Agreement"), and immediately thereafter, pursuant to the Merger
Agreement, the Merger Sub merged with and into MARC, with MARC being the
surviving corporation and a wholly-owned subsidiary of MSC.
The aggregate fair value of the consideration paid to shareholders and
holders of options of MARC resulted in a purchase price valued at approximately
$36,100,000. The Merger Agreement provided for a cash purchase price of
approximately $20,300,000 and the Stock Purchase Agreement provided for MSC to
issue a package of securities to Dendron and Fronos, including $11,000,000
principal amount of 8% subordinated notes due in 10 years, approximately
$3,236,000 principal amount of 8% subordinated notes due in two years,
$2,000,000 principal amount of MSC's 7 7/8% convertible subordinated debentures
due August 18, 2004, and five-year warrants to purchase 1,400,000 shares of
MSC's common stock at an exercise price of $10.00 per share. Mr. Irinarchos
beneficially owns approximately 9.9% of MSC's voting securities as a result of
his ownership of these securities.
The purchase price was determined through arms' length negotiations between
members of the Board of Directors of MSC and representatives of MARC. MSC
considered the revenues and results of operations of MARC in recent periods,
estimates of the business potential of MARC, MARC's software offerings in the
non-linear finite element analysis market segment, and other synergies of the
two companies (such as the ability to offer a full suite of FEA products and
leveraging technology and distribution channels).
67
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
ITEM 14(A)1. FINANCIAL STATEMENTS
The following consolidated financial statements of MSC.Software Corporation
and subsidiaries, as included in its Annual Report, are included in Item 8.
Consolidated Balance Sheets--December 31, 1999 and 1998
Consolidated Statements of Operations for each of the three years in the
period ended
December 31, 1999
Consolidated Statements of Cash Flows for each of the three years in the
period ended
December 31, 1999
Consolidated Statements of Shareholders' Equity for each of the three
years in the period ended
December 31, 1999
Notes to Consolidated Financial Statements
Report of Ernst & Young LLP, Independent Auditors
ITEM 14(A)2. FINANCIAL STATEMENT SCHEDULES
All schedules have been omitted because the information either has been
shown in the consolidated financial statements or notes thereto, or is not
applicable or required under the instructions.
ITEM 14(A)3. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ---------------------
<C> <S>
2.1 Agreement and Plan of Merger dated as of May 26, 1999 by and
among The MacNeal-Schwendler Corporation, MSC Holdings Co.
II, MARC Analysis Research Corporation, Dendron Technology
B.V., Fronos Technology B.V. and Nearchos Irinarchos (filed
as Exhibit 2.1 to a Current Report on Form 8-K filed July 1,
1999, and incorporated herein by reference).
2.2 Stock Purchase Agreement dated as of May 26, 1999 among The
MacNeal-Schwendler Corporation, Dendron Technology B.V. and
Fronos Technology B.V. (filed as Exhibit 2.2 to a Current
Report on Form 8-K filed July 1, 1999, and incorporated
herein by reference).
2.3 Agreement and Plan of Merger dated as of December 22, 1998
by and among The MacNeal-Schwendler Corporation, MSC
Holdings Co., Knowledge Revolution and Paul Baszucki, as
shareholder representative (filed as Exhibit 2.1 to a
Current Report on Form 8-K filed January 4, 1999, and
incorporated herein by reference).
3.1 Certificate of Incorporation of MSC.Software Corporation, as
amended (filed as Exhibit 3.1 of MSC.Software Corporation's
Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1999, and incorporated herein by reference).
3.2 Restated Bylaws of MSC.Software Corporation (filed as
Exhibit 3.2 to MSC.Software Corporation's Annual Report on
Form 10-K filed for the fiscal year ended January 31, 1996,
and incorporated herein by reference).
</TABLE>
68
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ---------------------
<C> <S>
3.3 Certificate of Designations of Junior Participating
Preferred Stock (filed as Exhibit 2.2 to The
MacNeal-Schwendler Corporation's Registration Statement on
Form 8-A filed October 13, 1998, and incorporated herein by
reference).
4.1 The MacNeal-Schwendler Corporation Indenture dated as of
June 17, 1999 with Chase Manhattan Bank & Trust Company N.A.
as Trustee (filed as Exhibit 4.1 to a Current Report on Form
8-K filed July 1, 1999, and incorporated herein by
reference).
4.2 The MacNeal-Schwendler Corporation Warrant Agreement dated
as of June 18, 1999 with The MacNeal-Schwendler Corporation
acting in the capacity of Warrant Agent (filed as Exhibit
4.2 to a Current Report on Form 8-K filed July 1, 1999, and
incorporated herein by reference).
4.3 Rights Agreement dated as of October 5, 1998 between The
MacNeal-Schwendler Corporation and ChaseMellon Shareholder
Services, L.L.C., as Rights Agent, including the Form of
Right Certificate (Exhibit A), the Summary of Rights to
Purchase Junior Participating Preferred Stock (Exhibit B)
and the Form of Certificate of Designations of Junior
Participating Preferred Stock (Exhibit C) (filed as Exhibit
2.1 to The MacNeal-Schwendler Corporation's Registration
Statement on Form 8-A filed October 13, 1998 and
incorporated herein by reference).
4.4 Indenture, dated as of August 18, 1994, between MSC.Software
Corporation and Chemical Trust Company of California, as
trustee (filed as part of MSC.Software Corporation's
Registration Statement on Form S-3 (No. 33-83174), and
incorporated herein by reference).
4.5 First Supplemental Indenture, dated September 22, 1994,
between MSC.Software Corporation and Chemical Trust Company
of California, as trustee (filed as Exhibit 4.2 of
MSC.Software Corporation's Quarterly Report on Form 10-Q for
the quarterly period ended October 31, 1994, and
incorporated herein by reference).
4.6 Second Supplemental Indenture, dated December 14, 1994,
between MSC.Software Corporation and Chemical Trust Company
of California, as trustee (filed as Exhibit 4.3 of
MSC.Software Corporation's Quarterly Report on Form 10-Q for
the quarterly period ended October 31, 1994, and
incorporated herein by reference).
10.1** Agreement of Lease, dated August 25, 1999, between
MSC.Software Corporation and Imperial Promenade Associates,
LLC, a Delaware limited liability company.
10.2* 1998 Incentive Stock Option Plan for Key Employees, as
amended (filed as Annex A to The MacNeal-Schwendler
Corporation's Annual Proxy Statement for the Annual Meeting
of Shareholders held on June 23, 1999, and incorporated
herein by reference).
10.3* Employment Agreement Between MSC.Software Corporation and
Frank Perna, Jr. (filed as Exhibit 3.1 of MSC.Software
Corporation's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1999, and incorporated
herein by reference).
10.4 Loan and Security Agreement Between MSC.Software Corporation
and Comerica Bank-California (filed as Exhibit 3.1 of
MSC.Software Corporation's Quarterly Report on Form 10-Q for
the quarterly period ended June 30, 1999, and incorporated
herein by reference).
10.5 Second Amendment to Loan and Security Agreement Between
MSC.Software Corporation and Comerica Bank-California.
(filed as Exhibit 10.1 of MSC.Software Corporation's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1999, and incorporated herein by reference).
</TABLE>
69
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ---------------------
<C> <S>
10.6 Registration Rights Agreement dated June 18, 1999 among The
MacNeal-Schwendler Corporation, Dendron Technology B.V. and
Fronos Technology B.V. (filed as Exhibit 4.3 to a Current
Report on Form 8-K filed July 1, 1999 and incorporated
herein by reference).
10.7 Form of Agreement for use of MSC.Nastran, as modified to
September 1991 (filed as Exhibit 10.1 to MSC.Software
Corporation's Annual Report on Form 10-K filed for the
fiscal year ended January 31, 1992, and incorporated herein
by reference).
10.8 Agreement dated October 22, 1982, between MSC.Software
Corporation and NASA (filed as Exhibit 10.2 to MSC.Software
Corporation's Registration Statement on Form S-1, File No.
2-82719, and incorporated herein by reference).
10.9 Agreement of Lease, dated July 31, 1980, between
MSC.Software Corporation and Frank De Pietro (filed as
Exhibit 10.3 to MSC.Software Corporation's Registration
Statement on Form S-1, File No. 2-82719, and incorporated
herein by reference).
10.10 Form of Indemnification Agreement between MSC.Software
Corporation and directors, officers and agents thereof
(filed as Exhibit 10.5 to MSC.Software Corporation's Annual
Report on Form 10-K filed for the year ended January 31,
1989, and incorporated herein by reference).
10.11(a) Form of Severance Agreement between MSC.Software Corporation
and executive officers thereof (filed as Exhibit 10.6(a) to
The MacNeal-Schwendler Corporation's Transition Report on
Form 10-K filed for the fiscal year ended December 31, 1998,
and incorporated herein by reference).
10.11(b) Form of Severance Agreement between MSC.Software Corporation
and key employees (filed as Exhibit 10.6(a) to The
MacNeal-Schwendler Corporation's Transition Report on Form
10-K filed for the fiscal year ended December 31, 1998, and
incorporated herein by reference).
10.12* Amendment 1991-1 to 1983 Incentive Stock Option Plan for Key
Employees (filed as Annex A to MSC.Software Corporation's
Annual Proxy Statement for the Annual Meeting of
Shareholders held on June 12, 1991, and incorporated herein
by reference).
10.13* Amendment 1992-1 to 1983 Incentive Stock Option Plan for Key
Employees (filed as part of the Annual Proxy Statement for
MSC.Software Corporation's Annual Meeting of Shareholders
held on June 10, 1992, and incorporated herein by
reference).
10.14* 1991 Stock Option Plan (filed as Annex A to MSC.Software
Corporation's Annual Proxy Statement for the Annual Meeting
of Shareholders held on June 10, 1992, and incorporated
herein by reference).
10.15* 1991 Stock Option Plan Amendment (filed as part of MSC's
definitive Proxy Statement for the Annual Meeting of
Shareholders on June 14, 1995, and incorporated herein by
reference).
10.16 Separation Agreement with Thomas Curry (filed as Exhibit
10.12 to The MacNeal-Schwendler Corporation's Transition
Report on Form 10-K filed for the fiscal year ended December
31, 1998, and incorporated herein by reference).
10.17 Termination and General Release Agreement with Thomas Curry
(filed as Exhibit 10.13 to The MacNeal-Schwendler
Corporation's Transition Report on Form 10-K filed for the
fiscal year ended December 31, 1998, and incorporated herein
by reference).
</TABLE>
70
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ---------------------
<C> <S>
10.18 Termination and General Release Agreement with George
Riordan (filed as Exhibit 10.14 to The MacNeal-Schwendler
Corporation's Transition Report on Form 10-K filed for the
fiscal year ended December 31, 1998, and incorporated herein
by reference).
10.19 Form of Director Change in Control Agreement (filed as
Exhibit 10.15 to The MacNeal-Schwendler Corporation's
Transition Report on Form 10-K filed for the fiscal year
ended December 31, 1998, and incorporated herein by
reference).
21** Material Subsidiaries of the Registrant.
23** Consent of Ernst & Young LLP, Independent Auditors.
27.1** Restated Financial Data Schedule for the year ended December
31, 1998.
27.2** Financial Data Schedule for the year ended December 31,
1999.
</TABLE>
- ------------------------
* Denotes compensatory plan.
** Indicates filed herewith.
ITEM 14(B). REPORTS ON FORM 8-K
None.
71
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
MSC.SOFTWARE CORPORATION
(REGISTRANT)
Dated: March 22, 2000 By: /s/ FRANK PERNA, JR.
------------------------------------------
Frank Perna, Jr.
CHAIRMAN OF THE BOARD AND
CHIEF EXECUTIVE OFFICER
</TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<C> <S> <C>
/s/ FRANK PERNA, JR.
------------------------------------------- Chairman of the Board and March 22, 2000
Frank Perna, Jr. Chief Executive Officer
/s/ LOUIS A. GRECO Chief Financial Officer
------------------------------------------- (Principal Financial and March 22, 2000
Louis A. Greco Accounting Officer)
/s/ LARRY S. BARELS
------------------------------------------- Director March 22, 2000
Larry S. Barels
/s/ DONALD GLICKMAN
------------------------------------------- Director March 22, 2000
Donald Glickman
/s/ WILLIAM F. GRUN
------------------------------------------- Director March 22, 2000
William F. Grun
/s/ GEORGE N. RIORDAN
------------------------------------------- Director March 22, 2000
George N. Riordan
</TABLE>
72
<PAGE>
EXHIBIT 10.1
OFFICE LEASE
IMPERIAL PROMENADE ASSOCIATES, LLC
LANDLORD,
AND
MSC.SOFTWARE CORPORATION,
TENANT
<PAGE>
OFFICE LEASE
THIS LEASE ("Lease") is made between IMPERIAL PROMENADE ASSOCIATES,
LLC ("Landlord"), and the Tenant described in Item 1 of the Basic Lease
Provisions.
LEASE OF PREMISES
Landlord hereby leases to Tenant and Tenant hereby hires from Landlord,
subject to all of the terms and conditions set forth herein, those certain
premises (the "Premises") described in Item 3 of the Basic Lease Provisions and
as shown in the drawings attached hereto as Exhibit "A-I". The Premises are
located in that certain office building (the "Building") shown on Exhibit "A-2".
The Building is located on that certain land (the "Land") described on Exhibit
"A-3" attached hereto, which is also improved with landscaping, parking
facilities and other improvements and appurtenances. The Land, together with all
such improvements and appurtenances and the Building, are, subject to Paragraph
18, collectively referred to herein as the "Project". However, Landlord reserves
the right to make such changes, additions and/or deletions to the Land, the
Building and the Project as it shall determine from time to time.
BASIC LEASE PROVISIONS
1. Tenant: MSC.SOFTWARE CORPORATION, a Delaware corporation ("Tenant")
2. Building: Tower West, Twin Towers
Address: _____________ MacArthur Plaza (to be determined by Landlord)
South Coast Metro, California
3. Description of Premises: Floor(s): 2 - 6 and portion of 1 Suites:
100, 200, 300, 400, 500, 600
Rentable Area: Approximately 125,043 square feet (see Exhibit "A-4")
4. Tenant's Proportionate Share of Operating Costs: 30.7%
5. Basic Annual Rent (see Paragraphs 2 and 20) shall be twelve (12)
times the following monthly amounts:
<TABLE>
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Partial Lease Month: $ 6,210.47 per day ($1.49/rentable sq. ft./mo NNN)
Months 1-5 $ 0.00 (but see Paragraph 20(a))
Months 6-65: $ 186,314.07 ($1.49/rentable sq. ft/mo NNN)
Months 66-125: $__________ *
Months 126-149: $__________ **
</TABLE>
* Commencing on the first day of the sixty-sixth (66th) month of the term,
Basic Annual Rent shall be increased by the percentage increase, if any, in
the Consumer Price Index, Urban Wage Earners and Clerical Workers (Los
Angeles-Anaheim-Riverside region; "Sal Items"; Reference Base Year
1982-1984=100), as published by the United States Department of Labor, Bureau
of Labor Statistics or its successor (the "Index"), as follows: The Index for
the second month preceding the first day of the sixty-sixth (66th) month of
the term shall be compared with the Index for the second month preceding the
Commencement Date, and the Basic Annual Rent then in effect shall be
increased by the lesser of (i) the amount of the percentage increase, if any,
between them, or (ii) ten percent (10%); PROVIDED HOWEVER, in no event shall
the Basic Annual Rent be reduced by reason of such computation. If the Index
ceases to be published, is published less frequently or is altered in any
material respect, then Landlord shall adopt, at its reasonable discretion, a
substitute index or substitute procedure which reasonably reflects and
monitors changes in consumer prices.
** Commencing on the first day of the one hundred twenty-sixth (126th) month
of the term, Basic Annual Rent shall be increased by the percentage increase,
if any, in the Index, as follows: The Index for the second month preceding
the first day of the one hundred twenty-sixth (126th) month of the term shall
be compared with the effect shall be increased by the lesser of (i) the
amount of the percentage increase, if any, between them, or (ii) ten percent
(10%); PROVIDED HOWEVER, in no event shall the Basic Annual Rent be reduced
by reason of such computation. If the Index ceases to be published, is
published less frequently or is altered in any material respect, then
Landlord shall adopt, at its reasonable discretion, a substitute index or
substitute procedure which reasonably reflects and monitors changes in
consumer prices.
6. Initial Monthly Installment of Basic Annual Rent Payable upon
Execution: $ 186,314.07
($1.49 per square foot of Rentable Area)
7. Estimated Final Monthly Installment of Basic Annual Rent payable upon
execution: $0.00
8. Security Deposit: $0.00
9. Term: Twelve (12) years and five (5) months
10. Target Commencement Date: January 5, 2001
<PAGE>
11. Broker[s]: Equis of California
12. Permitted Use: General office, computer generated software
production, computerized printing of software manuals and shipping
of software products and storage, subject to and in accordance with
applicable Laws and any permits and approvals relating to such uses
to be obtained by Tenant at Tenant's expense.
13. Number of Parking Spaces (see Paragraph 18): three (3) spaces per 1,000
square feet of Premises, with ten percent (10%) of such spaces,
reserved for the exclusive use of Tenant, to be located at an area
proximate to the Building as designated by Landlord.
14. Addresses for Notices:
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To: Tenant To: Landlord Imperial Promenade Associates, LLC
3 Imperial Promenade, Suite 410
South Coast Metro, California 92704
</TABLE>
Prior to occupancy of the Premises:
MSC.Software Corporation
815 Colorado Blvd.
Los Angeles, CA 90041
After occupancy of the Premises:
MSC.Software Corporation
_____________MacArthur Place [the Premises]
South Coast Metro, California 92704
15. All payments payable under this Lease shall be sent to Landlord at the
address specified in Item 14 or to such other address as Landlord may
designate.
16. Guarantor: None
17. Date of this Lease: June 28, 1999
18. Options: Extend Term - see Paragraph 20(c)
Expand Premises - see Paragraph 20(d)
IN WITNESS WHEREOF, the parties hereto have executed this Lease,
consisting of the foregoing Basic Lease Provisions, the provisions of the
Standard Lease Provisions (the "Standard Lease Provisions") (consisting of
Paragraphs 1 through 20 which follow) and Exhibits "A-i" through "AA" and "B"
through "G", inclusive, all of which are incorporated herein by this reference.
In the event of any conflict between the provisions of the Basic Lease
Provisions and the provisions of the Standard Lease Provisions, the Standard
Lease Provisions shall control.
<TABLE>
LANDLORD TENANT
<S> <C>
IMPERIAL PROMENADE ASSOCIATES, LLC, MSC SOFTWARE CORPORATION,
a Delaware limited liability company a Delaware Corporation
By: /S/ CURTIS R. OLSON By: /S/ FRANK PERNA, JR.
----------------------------------- ------------------------------
Curtis R. Olson, Sole Member Its: CEO
--------------------------
Date September 7, 1999
-------------------------------- Date: August 31, 1999
----------------------------
By: /S/ LOUIS A. GRECO
------------------------------
Its: CFO
--------------------------
Date: AUGUST 31, 1999
----------------------------
</TABLE>
<PAGE>
<TABLE>
TABLE OF CONTENTS
PAGE
<S> <C>
1. TERM.......................................................................................1
2. BASIC ANNUAL RENT..........................................................................1
3. ADDITIONAL RENT............................................................................1
4. IMPROVEMENTS AND ALTERATIONS...............................................................4
5. REPAIRS....................................................................................4
6. USE OF PREMISES............................................................................5
7. UTILITIES AND SERVICES.....................................................................6
8. NONLIABILITY AND INDEMNIFICATION OF LANDLORD; INSURANCE....................................6
9. FIRE OR CASUALTY...........................................................................8
10. EMINENT DOMAIN.............................................................................9
11. ASSIGNMENT AND SUBLETTING..................................................................9
12. DEFAULT...................................................................................11
13. ACCESS; CONSTRUCTION......................................................................13
14. BANKRUPTCY................................................................................13
15. INTENTIONALLY LEFT BLANK..................................................................13
16. SUBORDINATION; ATTORNMENT; ESTOPPEL CERTIFICATES..........................................13
17. SALE BY LANDLORD; NONRECOURSE LIABILITY...................................................14
18. PARKING; COMMON FACILITIES................................................................15
19. MISCELLANEOUS.............................................................................15
(a) Attorneys' Fees..................................................................15
(b) Waiver...........................................................................15
(c) Notices..........................................................................15
(d) Labor............................................................................16
(e) Security.........................................................................16
(f) Storage..........................................................................16
(g) Holding Over.....................................................................16
(h) Condition of Premises............................................................16
(i) Landlord Warranty................................................................16
(j) Quiet Possession.................................................................16
(k) Matters of Record................................................................16
(l) Project Financing................................................................17
(m) Successors and Assigns...........................................................17
(n) Brokers..........................................................................17
(o) Name.............................................................................17
(p) Examination of Lease, Confidentiality.......................................... .17
(q) Time.............................................................................17
(r) Defined Terms and Marginal Headings..............................................17
(s) Conflict of Laws: Prior Agreements: Separability.................................17
(t) Authority........................................................................17
(u) Common Areas.....................................................................18
(v) Joint and Several Liability......................................................18
(w) Rental Allocation................................................................18
(x) Rules and Regulations............................................................18
(y) Financial Statements.............................................................18
20. ADDENDA...................................................................................18
(a) Rental Abatement.................................................................18
(b) Landlord Delay...................................................................18
(c) Options to Extend Term...........................................................18
(d) Expansion Option.................................................................19
(e) Nondisturbance Agreement.........................................................20
(f) INTENTIONALLY LEFT BLANK.........................................................20
(g) Definition - Nondiscriminatory...................................................20
(h) INTENTIONALLY LEFT BLANK.........................................................20
(i) Nonliability and Indemnification of Landlord.....................................20
</TABLE>
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(j) Americans with Disabilities Act..................................................20
(k) Transportation Management........................................................20
(l) Operating Costs Cap..............................................................20
(m) Moving-Related Allowance.........................................................20
(n) Signage..........................................................................20
(o) Exclusivity......................................................................21
(p) Environmental Release............................................................21
21. CONSTRUCTION OF BUILDING..................................................................21
</TABLE>
TABLE OF EXHIBITS
Exhibit "A-1' Floor Plan[s]
Exhibit "A-2" Plot Plan of Building and the Project
Exhibit "A-3" Legal Description of the Project
Exhibit "A-4" Rentable Area
Exhibit "B" Work Letter
Schedule "1" Preliminary Plans
Exhibit "C" Requirements for Alterations
Exhibit "D" Standards for Utilities and Services
Exhibit "E" Building Rules and Regulations
Exhibit "F" Form Estoppel Certificate
Exhibit "G" Tenant's Initial Certificate
Exhibit "H" Outline Specifications
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STANDARD LEASE PROVISIONS
1. TERM
(a) Unless earlier terminated in accordance with the provisions hereof
the initial term of this Lease shall be the period shown in Item 9 of the Basic
Lease Provisions; provided, however, in the event the Commencement Date (defined
below) occurs on a date other than the first (1st) day of a calendar month,
there shall be added to the term the partial month (the "Partial Lease Month")
from the Commencement Date to the first (1st) day of the calendar month
following the Commencement Date. As used herein, "term" shall refer to the
initial term described in Item 9 of the Basic Lease Provisions and, provided the
same is duly exercised and commences, the Extension Term described in
Subparagraph 20(c).
(b) Subject to the provisions of this Paragraph 1, the term shall
commence on the date (the "Commencement Date") which is the earlier of the
date Landlord delivers the Premises to Tenant or the date Tenant takes
possession or commences use of the Premises for any business purpose
(including moving in). Landlord shall be deemed to have delivered the
Premises to Tenant or the date determined by Landlord's Space Planner
(defined in the Work Letter described below) to be the date of substantial
completion of the Tenant Work (defined in the Work Letter). Notwithstanding
the foregoing, in the event that Landlord is delayed in delivering the
Premises by reason of any act or omission of Tenant, including, without
limitation, those specified in the Work Letter (the "Work Letter") attached
hereto as Exhibit "B" (a "Tenant Delay"), the term shall commence (unless
Tenant takes possession or commences use of the Premises prior thereto) on
the date the Premises would have been delivered by Landlord had the Tenant
Delay(s) not occurred. This Lease shall be a binding contractual obligation
effective upon execution hereof by Landlord and Tenant, notwithstanding the
later commencement of the term of this Lease.
(c) Landlord may deliver the Premises to Tenant on or after the
Target Commencement Date described in Item 10 of the Basic Lease Provisions.
Landlord shall use reasonable efforts to give Tenant at least fifteen (15)
days' notice of the date upon which, in Landlord's opinion, the Commencement
Date shall occur: provided, however, that in the event the Commencement Date
is delayed or otherwise does not occur on the date specified, this Lease
shall not be void or voidable, nor shall Landlord be liable to Tenant for any
loss or damage resulting therefrom.
2. BASIC ANNUAL RENT
(a) Tenant agrees to pay during the Partial Lease Month and each
Lease Year (defined below) of the term of this Lease as Basic Annual Rent
("Basic Annual Rent") for the Premises the sums shown for such periods in
Item 5 of the Basic Lease Provisions. For purposes of this Lease, a "Lease
Year" shall be each twelve (12) calendar month period commencing on (i) the
Commencement Date (or anniversary thereof) if the Commencement Date occurs on
the first (1st) day of a month, or otherwise (ii) the first (1st) day of the
calendar month following the Commencement Date (or anniversary thereof) if
the Commencement Date occurs other than on the first (1st) day of a month.
(b) Except as expressly provided to the contrary in Subparagraph
20(a) below, Basic Annual Rent shall be payable in equal consecutive monthly
installments, in advance, without deduction or offset, commencing on the
Commencement Date and continuing on the first (1st) day of each calendar
month thereafter. The first (1st) full monthly installment of Basic Annual
Rent, described in Item 6 of the Basic Lease Provisions, shall be payable
upon Tenant's execution of this Lease. If the Commencement Date is a day
other than the first (1st) day of a calendar month, then the Rent (defined
below) for the Partial Lease Month (the "Partial Lease Month Rent) shall be
calculated on the per diem basis shown therefor in Item 5 of the Basic Lease
Provisions for the number of days of such month from and including the
Commencement Date. The Partial Lease Month Rent shall be payable by Tenant
prior to the date that Tenant takes possession or commences use of the
Premises for any business purpose (including moving in). Basic Annual Rent,
all forms of additional rent payable hereunder by Tenant and all other
amounts, fees, payments or changes payable hereunder by Tenant shall (i) each
constitute rent payable hereunder (and shall sometimes collectively be
referred to herein as "Rent"), (ii) be payable to Landlord when due without
any prior demand therefor in lawful money of the United States and. except as
may be expressly provided to the contrary herein, without any offset or
deduction whatsoever, and (iii) be payable to Landlord at the address of
Landlord described in Item 14 of the Basic Lease Provisions or to such other
person or to such other place as Landlord may from time to time designate in
writing to Landlord.
(c) The parties agree that for all purposes hereunder the Premises
shall be stipulated to contain the number of square feet of Rentable Area
(defined in Exhibit "A-4") described in Item 3 of the Basic Lease Provisions.
Prior to the Commencement Date, Landlord's Space Planner shall verify the
exact number of square feet of Rentable Area in the Premises, utilizing the
BOMA Standard as defined in Exhibit "A-4" attached to this Lease. In the
event there is any variation from the number of square feet specified in Item
3 of the Basic Lease Provisions, Landlord and Tenant shall execute an
amendment to this Lease for the purpose of making appropriate adjustments to
the Basic Annual Rent, the Security Deposit, Tenant's Proportionate Share
(defined below) and such other provisions hereof as shall be appropriate
under the circumstances.
3. ADDITIONAL RENT
(a) Subject to the provisions of this Lease, Tenant shall pay to
Landlord, monthly, as additional rent an amount equal to Tenant's
Proportionate Share of Operating Costs (defined below).
(b) "Tenant's Proportionate Share" is, subject to the provisions of
this Paragraph 3, the percentage number described in Item 4 of the Basic
Lease Provisions. Tenant's Proportionate Share represents a fraction, the
numerator of which is the number of square feet of Rentable Area in the
Premises, as determined by Landlord or pursuant to Subparagraph 2(c) above,
and the denominator of which is the number of square feet of Rentable Area in
the Project, as determined by Landlord.
(c) "Operating Costs" means all costs, expenses and obligations
incurred or payable by Landlord in connection with the operation, ownership,
repair, management or maintenance of the Project during or allocable to the term
of this Lease, including, without limitation, the following:
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(i) All real property taxes, assessments, license fees,
excises, levies, charges or impositions and other similar governmental ad
valorem or other charges levied on or attributable to the Project or its
ownership, operation or transfer, and all taxes, charges, assessments or
similar impositions imposed in lieu of the same (collectively, "Real Estate
Taxes"). "Real Estate Taxes" shall also include all taxes, assessments,
license fees, excises, levies, charges or similar impositions imposed by any
governmental agency, district, authority or political subdivision (A) on any
interest of Landlord, any mortgagee of Landlord or any interest of Tenant in
the Project, the Premises or in this Lease, or on the occupancy or use of
space in the Project or the Premises; (B) on the gross or net rentals or
income from the Project, the Rent received hereunder, or on Landlord's
"right" or "rights" to any of the foregoing or on Landlord's business of
leasing the Premises, the Building or the Project, including, without
limitation, any gross income tax or excise tax levied by any federal, state
or local governmental entity with respect to the receipt of Rent or with
respect to the possession, leasing, operation, management, maintenance,
alteration, repair, use or occupancy of the Project, or portions thereof; (C)
measured by the gross square footage of the Project, the Premises, or any
portion thereof or by the number of actual, estimated or potential occupants
of the Project, the number of vehicular trips generated by or associated with
the Project, or the number of parking spaces contained within the Project, or
for any transportation, arts, housing or environmental plan, fund or system
instituted within or for any geographic area in which the Building is
located, or any similar measure; (D) on the construction, removal or
alteration of improvements in the Project; (E) for the provision of
amenities, services or rights of use, whether or not exclusive, public,
quasi-public or otherwise made available on a shared use basis, including
amenities, services or rights of use such as fire protection, police
protection, street, sidewalk, lighting, sewer or road maintenance, refuse
removal or janitorial services or for any other service, without regard to
whether such services were formerly provided by governmental or quasi
governmental agencies to property owners or occupants at no cost or at
minimal cost; and (F) related to any transportation plan, fund or system
instituted within the geographic area of the Project or otherwise applicable
to the Premises, the Project, or any portion thereof "Real Estate Taxes"
shall not include any income, capital stock, estate or inheritance tax
imposed by the State of California or the federal, county or city
governments; and
(ii) The cost of utilities (including taxes and other charges
incurred in connection therewith), fuel, supplies, equipment, tools,
materials, service contracts, janitorial services, waste and refuse disposal,
gardening and landscaping, insurance (including, but not limited to, public
liability, fire, property damage, flood, rental loss
[for a period of two years], boiler machinery, contractual indemnification,
earthquake and All Risk coverage insurance for up to the full replacement
cost of the Project and such other insurance as is customarily carried by
operators of other first-class buildings in the County of Orange) to the
extent carried by Landlord in its discretion (and the deductible portion of
any insured loss otherwise covered by such insurance), the cost of
compensation, including employment, welfare and social security taxes, paid
vacation days, disability, pension, medical and other fringe benefits of all
persons (including independent contractors) who perform services to the
extent of such performance or exclusively connected with the operation,
maintenance or repair of the Project, personal property taxes on and
maintenance and repair of equipment and other personal property used in
connection with the operation, maintenance or repair of the Project, such
auditors' fees, consultant fees and legal fees as are incurred in connection
with the operation, maintenance or repair of the Project, costs incurred for
administration and management of the Project, whether by Landlord or by an
independent contractor, administrative expenses, management fees, management
office operational expenses, rental expenses for or a reasonable allowance
for depreciation of personal property used in the operation, maintenance or
repair of the Project, license, permit and inspection fees, association fees
applicable to the Project (including without limitation the Project's share
of any such fee assessed in connection with the Specific Development Plan as
described in Subparagraph 21(b) below, all costs and expenses required by any
governmental or quasi-governmental authority or by applicable law, for any
reason, including capital improvements, whether capitalized or not the cost
of any capital improvements made to the Project by Landlord that improve life
safety systems or reduce operating expenses (such costs to be amortized over
such reasonable periods as Landlord shall determine with a return on capital
at a rate equal to the prime rate plus two (2) percent [the "prime rate" as used
herein shall mean the prime rate or base rate of interest then being charged by
the banking or financial institution commonly utilized by Landlord]
, the cost of air conditioning, heating, ventilating, plumbing, elevator
maintenance and repair, sign maintenance, and Common Area (defined in
Paragraph 18) repair, resurfacing, operation and maintenance, the cost of
providing Security services, and any other cost or expense incurred or
payable by Landlord in connection with the operation, repair, management or
maintenance of the Project.
(d) Operating Costs for any calendar year during which actual
occupancy of the Project is less than ninety-five percent (95%) of the
Rentable Area of the Project shall be appropriately adjusted to reflect
ninety-five percent (95%) occupancy of the existing Rentable Area of the
Project during such period. In determining Operating Costs, if any services
or utilities are separately charged to tenants of the Project or others,
Operating Costs shall be adjusted by Landlord to reflect the amount of
expense which would have been incurred for such services or utilities on a
full-time basis for normal Project operating hours. In the event (i) the
Commencement Date shall be a date other than January 1, (ii) the date fixed
for the expiration of the term shall be a date other than December 31, (iii)
of any early termination of this Lease, or (iv) of any increase or decrease
in the size of the Premises, then in each such event, an appropriate
adjustment in the application of this Paragraph 3 shall, subject to the
provisions of this Lease, be made to reflect such event on a basis determined
by Landlord to be consistent with the principles underlying the provisions of
this Paragraph 3.
(e) Prior to the commencement of each calendar year of the term
following the Commencement Date, Landlord shall have the right to give to
Tenant a written estimate of Tenant's Proportionate Share of the Operating
Costs for the Project for the ensuing year. Subject to Paragraph 20(l),
Tenant shall pay such estimated amount to Landlord in equal monthly
installments, in advance on the first (1st) day of each month during such
year. Subject to the provisions of this Lease, Landlord shall endeavor to
furnish to Tenant within 120 days after the end of each calendar year, a
statement indicating in reasonable detail the Operating Costs for such
period, and the parties shall, within thirty (30) days thereafter, make any
payment or allowance necessary to adjust Tenant's estimated payments to
Tenant's actual share of such Operating Costs as indicated by such annual
statement. Any payment due Landlord shall be payable by Tenant on demand from
Landlord. Any amount due Tenant shall be credited against installments next
becoming due under this Subparagraph 3(e).
(f) Tenant shall pay ten (10) days before delinquency, all taxes and
assessments (i) levied against any personal property or trade fixtures of
Tenant In or about the Premises, (ii) based upon the gross or net Rent
payable hereunder, and (iii) based upon this Lease or any document to which
Tenant is a party creating or transferring an interest in this Lease or an
estate in all or any portion of the Premises. If any such taxes or
assessments are levied against Landlord or Landlord's property or if the
assessed value of the Project is increased by the inclusion therein of a
value placed upon such
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personal property or trade fixtures, Tenant shall, upon demand, reimburse
Landlord for the taxes and assessments so levied against Landlord, or such
taxes, levies and assessments resulting from such increase in assessed value.
(g) Any delay or failure of Landlord in (I) delivering any estimate
or statement described in this Paragraph 3, or (ii) computing or billing
Tenant's Proportionate Share of Operating Costs shall not constitute a waiver
of its right to require an increase in Rent, or in any way impair, the
continuing obligations of Tenant under this Paragraph 3. Without limiting the
generality of the foregoing, Landlord may at any time during me term hereof
recalculate and correct me amount of Tenant's Proportionate Share of
Operating Costs, and Tenant shall pay to Landlord any amount due on demand by
Landlord; provided however, Tenant shall only be responsible for paying mat
portion of the corrected amount of Tenant's Proportionate Share of Operating
Costs accruing within one (1) year of the date of Landlord's accounting. In
the event of any dispute as to any Rent due under this Paragraph 3, Tenant
shall have the right after reasonable notice and at reasonable times to
inspect Landlord's accounting records at the accounting office of Landlord's
management company. If after such inspection, Tenant still disputes such
additional rental, upon Tenants written request therefore, a certification as
to the proper amount of Operating Costs and the amount due to or payable by
Tenant shall be made by Landlord's independent certified public accountant.
Such certification shall be final and conclusive as to all parties. In the
event of a discrepancy in Tenants favor, Landlord agrees to make the
adjustments in Tenant's favor and, at Landlord's option, (i) promptly pay any
such amount due to Tenant, or (ii) credit any such amount due to Tenant
against Tenant's next installment of Additional Rent In the event of a
discrepancy in Landlord's favor, Tenant shall pay such amount due to Landlord
with the next installment of Additional Rent. Tenant agrees to pay the cost
of such certification and the investigation with respect thereto, unless it
is determined that Landlord's original statement was in error in Landlord's
favor by more than two percent (2%). Tenant waives the right to dispute any
matter relating to the calculation of Operating Costs or other forms of Rent
under this Paragraph 3 if any claim or dispute is not asserted by Tenant in
writing to Landlord within one (1) year of delivery to Tenant of the original
billing statement with respect thereto.
(h) Subject to the provisions of this Paragraph 3, the rights and
obligations of Landlord and Tenant with respect to payments to be made
hereunder in regard to Operating Costs incurred or allocable to periods prior
to the expiration or sooner termination of this Lease shall survive such
expiration or termination.
(i) Notwithstanding the foregoing, for purposes of this Lease,
Operating Expenses shall not include:
(1) to the extent that any portion of Operating Expenses are
attributable to any other property (other than the Building and Project) or
any other business of Landlord (other than the business of maintaining,
managing and operating the Building and Project), then such expenses, costs
and amounts shall be equitably allocated in the Landlord's reasonable
discretion between the Building, the Project, and such other property or
business, and only the portion thereof attributable to the Building and
Project, as reasonably determined by Landlord, shall be included herein as
Operating Expenses.
(2) costs for which Landlord is reimbursed by any tenant or
occupant of the Project, or by any equipment warranties or by insurance by
its carrier or any tenant's carrier or by anyone else (including costs
reimbursed by reason of judgments or settlements);
(3) amounts paid as ground rental or as rental for the Building
by Landlord;
(4) costs of capital improvement or replacements except to the
extent specifically permitted in this PARAGRAPH 3; provided that even such
permitted costs shall be Operating Expenses in any given year only to the
extent of straight line amortization over the useful life of the improvement;
(5) electrical power costs for which any tenant directly
contracts with the local public service company or any costs paid by tenants to
Landlord for separately metered or special services such as after hours HVAC and
excess usage by other tenants;
(6) electric power and all other utility and other costs and
expenses associated with any retail space in the Building;
(7) costs of leasing commissions, attorneys' fees and other
costs and expenses incurred in connection with negotiations or disputes with
present or prospective tenants or other occupants of the Project;
(8) costs, including permit, license and inspection costs,
incurred with respect to the installation of tenant improvements made for new
tenants in the Building or incurred in renovating or otherwise improving,
decorating, painting or redecorating vacant space for tenants or other
occupants of the Building;
(9) costs incurred to comply with laws relating to the
investigation, removal, cleanup or remediation of Hazardous Material (as
defined in PARAGRAPH 6(f) hereof); provided, that Tenant may be obligated to
indemnify Landlord from and against any such costs in certain circumstances
pursuant to and in accordance with PARAGRAPH 6ff) HEREOF;
(10) costs and expenses incurred in connection with the
replacement (but not repair) of structural elements of the Building;
(11) costs of interest on debt or amortization and other charges,
costs and expenses payable under any loan secured by the Project;
(12) fines and penalties;
(13) costs incurred by Landlord in the repairs. capital
additions, alterations or replacements made or incurred to rectify or correct
defects in the initial design and construction of the Project;
(14) Landlord's general overhead and general and administrative
expenses;
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(15) costs and expenses of items paid to the Landlord or to
subsidiaries or affiliates of the Landlord to the extent the same exceeds the
costs of such services rendered by qualified, unaffiliated third parties on a
competitive basis;
(16) any management fee in excess of 3% of gross revenues derived
from the Project;
(17) premiums for earthquake insurance in excess of such premiums
paid for comparable buildings as the Building in the greater John Wayne
Airport area; and
(18) costs or assessments levied on Landlord by the City of Santa
Ana or associations due to Landlord's failure to comply with the requirements
of the City of Santa Ana or applicable CC&Rs with respect to the initial
construction of the Premises.
4. IMPROVEMENTS AND ALTERATIONS
(a) Landlord's sole construction obligation under this Lease with
respect to the Premises is set forth in the Work Letter attached hereto as
Exhibit "B"
(b) Tenant shall not make any alterations, additions or improvements
to the Premises (collectively, "Alterations") without (i) the prior written
consent of Landlord not to be unreasonably withheld or delayed, and (ii)
compliance with such nondiscriminatory requirements concerning such
Alterations as may be imposed by Landlord from time to time. Notwithstanding
the foregoing, Tenant shall be permitted to repaint and or re-carpet the
Premises without obtaining Landlord's prior written consent. Without limiting
the foregoing, Landlord may require, at a minimum, compliance with the
requirements set forth in Exhibit "C" attached hereto. All Alterations shall
be made by Tenant, at Tenants sole cost and expense, and shall be diligently
prosecuted to completion. The cost of any modifications of Project
improvements outside or inside of the Premises required by any governmental
agency as a condition or the result of Tenants Alterations shall be borne by
Tenant. Any contractor or person making such Alterations shall first be
approved in writing by Landlord. Upon the expiration or earlier termination
of this Lease, Landlord may elect to have Tenant either (i) surrender with
the Premises any or all of such Alterations as Landlord shall determine
(except trade fixtures not attached to the Premises), in which case, such
Alterations shall become the property of Landlord, or (ii) promptly remove
any or all of such Alterations designated by Landlord to be removed, in which
case, Tenant shall repair and restore the Premises to its original condition
as of the date of substantial completion of the Tenant Work, reasonable wear
and tear excepted. Notwithstanding the foregoing, Tenant shall have the
right, at any time it requests Landlord's prior written consent to an
Alteration, to further request that Landlord elect whether the Alterations
for which consent is requested be allowed to remain or be required to be
removed upon the expiration or earlier termination of this Lease. Unless
Landlord responds in writing to Tenant at the time of granting such consent
that any such Alterations may remain upon the Premises upon the expiration or
earlier termination of this Lease, then Tenant shall be required to remove
such Alterations in accordance herewith. Tenant shall have the right to
install a passive video surveillance system in the Premises and an antennae
on the roof of the Building solely for Tenants use, provided that (1) such
installations shall be at the sole cost and expense of Tenant and otherwise
in compliance with this Paragraph 4, (2) Tenant shall comply with the
requirements of any and all applicable laws, rules, CC&Rs, and governmental
agencies regarding such installations, (3) the location, specifications and
other physical aspects of such installations shall be pre-approved by
Landlord in writing, such approval to not be unreasonably withheld, and (4)
Tenant shall be responsible, at Tenants expense, for the maintenance and
repair of such items (including without limitation any repairs to other
portions of the Building or Project damaged arising out of the installation
or maintenance of such items), and (5) at Landlord's discretion, Tenant shall
remove such installations upon the expiration or earlier termination of the
Lease at Tenants sole expense and repair any damage caused thereby.
(c) Tenant shall keep the Premises, the Building and the Project
free from any and all liens arising out of any work performed, materials
furnished, or obligations incurred by or for Tenant. In the event that Tenant
shall not, within ten (10) days following the imposition of any such lien,
cause the same to be released of record by payment or posting of a bond in a
form and issued by a surety acceptable to Landlord, Landlord shall have the
right, but not the obligation, to cause such lien to be released by such
means as it shall deem proper (including payment of or defense against the
claim giving rise to such lien); in such case, Tenant shall reimburse
Landlord for all amounts so paid by Landlord in connection therewith,
together with all of Landlord's costs and expenses, with interest thereon at
the Default Rate (defined below). Such rights of Landlord shall be in
addition to all other remedies provided herein or by law.
5. REPAIRS
(a) Landlord shall use commercially reasonable efforts to keep the
Common Areas of the Building and the Project in a clean and neat condition
similar to other first class office buildings in the area of the Project.
Subject to Subparagraph 5(b) below, Landlord shall make all necessary
repairs, within a reasonable period following receipt of notice of the need
therefor from Tenant, to the foundation, root exterior walls, exterior doors
and windows of the Building, and to public corridors and other public areas
of the Project not constituting a portion of any tenant's premises and shall
use commercially reasonable efforts to keep all Building standard equipment
and systems used by Tenant in common with other tenants in good condition and
repair, reasonable wear and tear excepted. Notwithstanding the foregoing,
Tenant shall be solely responsible for the repair and maintenance of and all
damage to, the Building or the Project resulting from the design and
operation of all improvements which are not Building Standard Installations
(described in the Work Letter) in or serving the Premises installed at the
request of Tenant (regardless of whether installed by Landlord, its agents or
contractors or third-party contractors). Except as provided in Paragraph 9,
there shall be no abatement of Rent, and Landlord shall not be liable for any
injury to, or damage suffered by Tenant, including, without limitation,
interference with Tenants business arising from the making of any repairs,
alterations or improvements in or to any portion of the Premises, the
Building or the Project. Tenant waives the right to make repairs at
Landlord's expense under Sections 1941 and 1942 of the California Civil Code,
and under all other similar laws, statutes or ordinances now or hereafter in
effect.
(b) Tenant, at its expense, (i) shall keep the Premises and all
fixtures contained therein in a safe, dean and neat condition, and (ii) shall
bear the cost of maintenance and repair, by contractors selected by Tenant
and reasonably approved by Landlord, of all facilities which do not
constitute the Outline Specifications as set forth in Exhibit "H" attached
hereto located in the Premises, including, without limitation, lavatory,
shower, toilet, wash basin and kitchen facilities, and
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Premises specific heating and air conditioning Systems (including all
plumbing connected to said facilities or systems installed by or on behalf of
Tenant or existing in the Premises at the time of Landlord's delivery of the
Premises to Tenant). Tenant shall make all repairs to the Premises not
required to be made by Landlord under Subparagraph 5(a) above with
replacements of any materials to be made by use of materials of equal or
better quality. Tenant shall do all decorating, remodeling, alteration and
painting required by Tenant during the term of this Lease. Tenant shall pay
for the cost of any repairs to the Premises, the Building or the Project made
necessary by any negligence or willful misconduct of Tenant or any of its
assignees, subtenants, employees or their respective agents, representatives,
contractors, or other persons permitted in or invited to the Premises or the
Project by Tenant
(c) Upon the expiration or earlier termination of this Lease, Tenant
shall surrender the Premises in a safe, clean and neat condition; ordinary
wear and tear excepted. Tenant shall remove from the Premises all trade
fixtures (which are not required to be surrendered with the Premises pursuant
to the provisions of Subparagraph 4(b) hereof), furnishings and other
personal property of Tenant shall repair all damage caused by such removal,
and shall restore the Premises to its original condition, reasonable wear and
tear excepted. In addition to all other rights Landlord may have, in the
event Tenant does not so remove any such fixtures, furnishings or personal
property, Tenant shall be deemed to have abandoned the same, in which case,
Landlord may store the same, at Tenant's sole cost and expense, appropriate
the same for itself, and/or sell the same in its discretion.
6. USE OF PREMISES
a) Tenant shall use the Premises only for the purposes set forth in
Item 12 of the Basic Lease Provisions and shall not use the Premises or
permit the Premises to be used for any other purpose.
(b) Tenant shall not at any time use or occupy the Premises, or
permit any act or omission in or about the Premises in violation of any law,
statute, ordinance or any governmental rule, regulation or order
(collectively, "Law"), and Tenant shall, upon written notice from Landlord,
discontinue any use of the Premises which is a violation of Law. If any Law
shall, by reason of the nature of Tenant's specific use or occupancy of the
Premises, impose any duty upon Tenant or Landlord with respect to (i)
modification, operation or other maintenance of the Premises, the Building or
the Project, or (ii) the use, alteration or occupancy thereof, Tenant shall
comply in lull at its expense with such Law.
(c) Tenant shall not at any time use or occupy the Premises in
violation of the certificates of occupancy issued for the Building or the
Premises, and in the event that any department of the State of California or
the city or county in which the Project is located shall at any time contend
or declare that the Premises am used or occupied in violation of such
certificate or certificates of occupancy, any Law or any recorded covenants,
conditions and restrictions affecting the Project, Tenant shall, upon five
(5) days' notice from Landlord or any such governmental agency, immediately
discontinue such use of the Premises (and otherwise immediately remedy such
violation). The failure by Tenant to discontinue such use shall be considered
a default under this Lease, and Landlord shall have the right to exercise any
and all rights and remedies provided herein or by Law. Tenant shall be solely
responsible for making its own independent investigation with the City of
Santa Ana and other applicable governmental agencies to determine that the
nature of the business to be conducted by Tenant in the Premises is in
compliance with all Laws and permissible uses under any certificate of
occupancy issued for the Building or the Premises and that Tenant is not
relying upon any independent representation or guaranty by Landlord, written
or verbal, that such business will constitute a lawful or permissible use
under any certificate of occupancy issued for the Building or the Premises,
or otherwise permitted by Law.
(d) Tenant shall not do or permit to be done anything, which may
invalidate or increase the cost of any All Risk, property damage, liability
or other insurance policy covering the Building, the Project and/or property
located therein and shall comply with all rules, orders, regulations and
requirements of the Pacific Fire Rating Bureau or any other organization
performing a similar function. In addition to all other remedies of Landlord,
Landlord may require Tenant, promptly upon demand, to reimburse Landlord for
the full amount of any additional premiums charged for such policy or
policies by reason of Tenant's failure to comply with the provisions of this
Paragraph 6.
(e) Tenant shall not in any way interfere with the rights or quiet
enjoyment of other tenants or occupants of the Premises, the building or the
Project. Tenant shall not use or allow the Premises to be used for any
improper, immoral, unlawful or objectionable purpose, nor shall Tenant cause,
maintain, or permit any nuisance in, on or about the Premises, the Building
or the Project. Tenant shall not place a load upon any portion of the
Premises exceeding the structural floor load (per square foot of area), as
set forth in Exhibit "H,TM which such area was designated (and is permitted
by Law) to carry or otherwise use any Building system in excess of its
capacity or in any other manner which may damage such system or the Building.
Business machines and mechanical equipment shall be placed and maintained by
Tenant, at Tenants sole cost and expense, in locations and in settings
sufficient in Landlord's reasonable judgment to absorb and prevent vibration,
noise and annoyance. Tenant shall not commit or suffer to be committed any
waste in, on, upon or about the Premises, the Building or the Project.
(f) As used herein, the term "Hazardous Material" means any
hazardous or toxic substance, material or waste which is or becomes regulated
by any local governmental authority, the Slate of California or the United
States Government, including, without limitation, (i) any material or
substance which is defined or listed as a `hazardous waste," "extremely
hazardous waste," "restricted hazardous waste," "hazardous substance" or
"hazardous material" under any federal, state or local law, statute,
ordinance or any governmental rule, regulation or order governing or in any
way relating to the release, use, generation, handling, leakage, dumping,
discharge or disposal of any of the above (collectively, "Hazardous Material
Laws") (ii) petroleum or any petroleum derivative, (iii) any flammable
explosive or radioactive material, (iv) any polychlorinated biphenyl, and (v)
asbestos or any asbestos containing material or derivative. Tenant hereby
agrees that (i) Tenant and each of its Affiliates (defined below), assignees,
subtenants, and their respective agents, servants, employees, representatives
and contractors shall not bring onto the Premises or the Project any
Hazardous Material (other than customary amounts of Hazardous Materials used
for office supplies and cleaning materials brought into the Premises by
Tenant in the normal course of its tenancy and in full compliance with all
Hazardous Material Laws), (ii) Tenant shall immediately notify Landlord in
writing in the event Tenant becomes aware of or suspects that there has been
any release of any Hazardous Materials in, on or about the Premises or the
Project, or that any person has stored or otherwise brought onto the Project,
or any portion thereof, any Hazardous Material (other than customary amounts
of office supplies and cleaning materials). Tenant agrees to indemnify,
defend (with counsel selected by Landlord), protect and hold Landlord and
each of its Affiliates harmless from and against any and all claims, actions,
administrative proceedings (including informal
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proceedings), judgments, damages, punitive damages, penalties, fines, costs,
liabilities, interest or losses, including reasonable attorneys' fees and
expenses, consultant fees, and expert fees, together with all other costs and
expenses of any kind or nature that arise during or after the term of this
Lease directly or indirectly from or in connection with the presence,
handling, storage, release or discharge of any Hazardous Material in or into
the air, soil, surface water or groundwater at on, about, under or within the
Premises or the Project, or any portion thereof generated, released,
discharged or otherwise brought onto, under, or about the Project by Tenant
or any Affiliate thereof. Each of the covenants and agreements of Tenant set
forth in this Subparagraph 6(f) shall survive the expiration or earlier
termination of this Lease. Landlord agrees to use reasonable efforts to
generally include the terms and provisions of this Subparagraph 6(f) in
leases with other tenants of the Building; provided however, in no event
shall the failure to include the provisions of this Subparagraph 6(f) in any
other lease of the Building constitute Landlord's default hereunder.
7. UTILITIES AND SERVICES
(a) Provided that Tenant is not in default beyond any applicable
grace and cure period hereunder, Landlord shall furnish, or cause to be
furnished to the Premises, the utility service and other services described
in Exhibit "D" attached hereto, subject to the conditions and in accordance
with the standards set forth therein and in this Lease.
(b) Tenant agrees to cooperate fully at all times with Landlord and
to comply with all regulations and requirements, which Landlord may from time
to time, prescribe for the use of the utilities and services described herein
and in Exhibit "D". Landlord shall not be liable to Tenant for the failure of
any other tenant, or its assignees. subtenants, employees, or their
respective invitees, licensees, agents or other representatives to comply
with such regulations and requirements.
(c) Landlord reserves the right at all times to separately meter
electrical service provided to all or any portion of the Premises, and in
such event Tenant shall directly pay such electric service bills to the
utility provider and such costs shall not be part of Operating Costs. If
Tenant requires utility service or other services in quantities greater than,
at times other than or of a type or quality different than that generally
furnished by Landlord pursuant to Exhibit "D" Tenant shall pay to Landlord,
upon receipt of a written statement therefor, Landlord's charge for such
additional or different utility service or services; provided, however, it in
Landlord's judgment, such excess or different service cannot be furnished
unless additional risers, conduits, feeders, switchboards and/or other
facilities are installed in the Building, or otherwise are not then being
provided to other tenants in the Project (at the rate or level requested by
Tenant), the provision of such additional or different services shall be
subject to Landlord's nondiscriminatory requirements and conditions;
provided, further, however, that in no case shall Landlord have any
obligation to provide such additional or different utility or other services
if (i) the same is not generally available in first class office buildings in
the area of the Project, (ii) in the case where additional risers, conduits,
feeders, switchboards and/or other appurtenances would be required to be
installed in the Building to provide such service, (A) the installation,
maintenance or use of such facilities is not permitted under applicable
Project financing documents, Law or insurance regulations, could result in
permanent damage or injury to the Building or Building systems, could create
a dangerous or hazardous condition or disturb or interfere with the use,
occupancy or quiet enjoyment of other tenants or otherwise adversely affect
the income stream, financeability, reputation or value of the Project, (B)
Tenant shall not commit in advance to bear the cost (and to provide security
satisfactory to Landlord for performance of such obligation) of installation,
use, maintenance, repair and removal of such facilities, or (C) Landlord
determines in good faith that installation, operation, maintenance and/or
removal of such facilities is otherwise infeasible under the circumstances.
Subject to the foregoing, Landlord shall, upon reasonable prior notice by
Tenant, furnish to the Premises additional elevator, heating, air
conditioning and/or cleaning services upon such terms and conditions as shall
be reasonably determined by Landlord, including payment of Landlord's
Building-standard charge therefor. In the case of any additional utilities or
services to be provided hereunder, Landlord may require a switch and metering
system to be installed so as to measure the amount of such additional
utilities or services. The cost of installation, maintenance and repair of
such system shall be paid by Tenant upon demand.
(d) Landlord shall not be liable for, and Tenant shall not be
entitled to, any damages, abatement or reduction of Rent, or other liability
by reason of any failure to furnish any services or utilities described
herein or in Exhibit "D" for any reason, including, without limitation, when
caused by accident, breakage, repairs, Alterations or other improvements to
the Project, strikes, lockouts or other labor disturbances or labor disputes
of any character, governmental regulation, moratorium or other governmental
action, inability to obtain electricity, water or fuel, or any other cause
beyond Landlord's reasonable control; provided, however, that if Tenant's use
and occupancy of the Premises is materially disrupted by reason of the
failure of such services, then Landlord shall abate Tenant's Rent in
proportion to the disruption, but only if and to the extent that Landlord
actually receives rental loss insurance proceeds therefor. Landlord shall be
entitled to cooperate with the energy conservation efforts of governmental
agencies or utility suppliers. No such failure, stoppage or interruption of
any such utility or service shall be construed as an eviction of Tenant, nor
shall the same relieve Tenant from any obligation to perform any covenant or
agreement under this Lease. In the event of any failure, stoppage or
interruption thereof Landlord shall use reasonable efforts to attempt to
restore all services promptly. No representation is made by Landlord with
respect to the adequacy or fitness of the Building's ventilating, air
conditioning or other systems to maintain temperatures as may be required for
the operation of any computer, data processing or other special equipment of
Tenant or for any other purpose.
(e) Landlord reserves the right from time to time to make reasonable
and nondiscriminatory modifications to the above standards (including,
without limitation, those described in Exhibit "D") for utilities and
services; provided such modifications do not materially disrupt Tenants
operations at the Premises.
8. NONLIABILITY AND INDEMNIFICATION OF LANDLORD; INSURANCE
(a) Landlord shall not be liable to Tenant and Tenant hereby waives
all claims against Landlord, its partners, officers, trustees, affiliates,
directors, employees, contractors, agents and representatives (collectively,
"Affiliates") for any injury or damage to any person or property occurring or
incurred in connection with or in any way relating to the Premises, the
Building or the Project from any cause, including, without limitation, by
reason of the active or passive negligence of Landlord or its Affiliates, but
subject to Paragraph 20(i) below. Without limiting the foregoing, neither
Landlord nor any of its Affiliates shall be liable for and there shall be no
abatement of Rent for (i) any damage to Tenant's property stored with or
entrusted to Affiliates of Landlord, (ii) loss of or damage to any property
by theft or any other wrongful or illegal act, or (iii) any injury or damage
to persons or property resulting from fire, explosion, falling plaster,
steam, gas, electricity, water or rain which may leak from any part of the
Building or the Project or from the pipes, appliances, appurtenances or
plumbing works therein or from the root street or sub-surface or from any
other place or resulting from dampness or any other cause
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whatsoever or from the acts or omissions of other tenants, occupants or other
visitors to the Building or the Project, or from any other cause whatsoever,
(iv) any diminution or shutting off of light, air or view by any structure
which may be erected on lands adjacent to the Building, whether within or
outside of the Project, or (v) any latent or other defect in the Premises,
the Building or the Project. In addition and without limitation to the other
provisions of Subparagraphs (a) and (b) of this Paragraph 8, Tenant agrees
that in no case shall Landlord ever be responsible or liable on any theory
for any injury to Tenant's business, loss of profits, loss of income or any
other form of consequential damage. Tenant shall give prompt notice to
Landlord in the event of (A) the occurrence of a fire or accident in the
Premises or in the Building, or (B) the discovery of any defect therein or in
the fixtures or equipment thereof. The foregoing limitation on liability
shall not apply to any third party claim for personal injury or damage to
property made against the Tenant, which arises from the sole negligent acts
or omissions of Landlord or its Affiliates accruing prior to the Commencement
Date.
(b) Tenant shall indemnity, defend (with legal counsel selected by
Landlord), protect and hold Landlord harmless from and against any and all
claims, suits, judgments, losses, costs, obligations, damages, expenses,
interest and liabilities, including, without limitation, reasonable
attorneys' fees, for any injury or damage to any person or property
whatsoever arising out of or in connection with this Lease, the Premises or
Tenants activities in the Project, including, without limitation, when such
injury or damage has been caused in whole or in part by the act, negligence,
fault or omission of Tenant, its agents, servants, contractors, employees,
representatives, licensees or invitees, but subject to Paragraph 20(i)below.
Without limiting the foregoing, Tenant shall reimburse Landlord for all
expenses, damages and fines incurred or suffered by Landlord by reason of any
breach, violation or non-performance by Tenant, its agents, servants or
employees, of any covenant or provision of this Lease, or by reason of damage
to persons or property caused by moving property of or for Tenant in or out
of the Building, or by the installation or removal of furniture or other
property, or by reason of carelessness, negligence or improper conduct of
Tenant or its agents, employees or servants in the use or occupancy of the
Premises. The provisions of this Subparagraph 8(b) shall survive the
expiration or earlier termination of this Lease.
(c) Tenant hereby agrees to maintain in full force and effect at all
times during the term of this Lease, at its sole cost and expense, for the
protection of Tenant and Landlord, as their interests may appear, policies of
insurance issued by a responsible carrier or carriers, qualified to do
business in the State of California, with a financial class rating of not
less than X and a policy holder rating of not less than A in the most recent
Bests Key Rating Guide and otherwise acceptable to Landlord, which afford the
following coverages:
(i) Comprehensive general liability insurance (or commercial
general liability Insurance) or such successor comparable form of coverage,
including blanket contractual liability, broad form property damage,
independent contract's coverage, personal injury, completed operations,
product liability, cross liability and severability of interest clauses, and
fire damage, written on an *occurrence" basis with coverage of not less than
Five Million Dollars ($5,000,000.00) combined single limit per occurrence for
both bodily injury (including death) and property damage;
(ii) All Risk Insurance, including, without limitation,
insurance covering loss or damage resulting or arising from sprinkler
leakage, in an amount sufficient to cover the full cost of replacement of all
improvements to the Premises (other than Building Standard Installations) and
all of Tenant's fixtures and other personal property. The proceeds of such
insurance shall be devoted exclusively to the replacement of the same unless
this Lease shall cease and terminate pursuant to the provisions of Paragraph
9 hereof; and
(iii) Workers Compensation and Employers Liability Insurance
(as required by law).
(d) Tenant may, with the prior written consent of Landlord, elect to
have reasonable deductibles (not to exceed Ten Thousand Dollars ($10,000.00))
under the policy required pursuant to Subparagraph 8(c)(ii).
(e) Tenant shall deliver to Landlord at least thirty (30) days prior
to the time such insurance is first required to be carried by Tenant, and
thereafter at least thirty (30) days prior to expiration of each such policy,
certificates of insurance evidencing the coverage required hereunder with
limits not less than those specified above. Such policies of insurance shall
be written as primary policies, not contributing with, and not in excess of
coverage which Landlord may carry. The certificate of insurance with respect
to the coverage described in Subparagraph 8(c)(i) above shall specifically
reflect insurance of Tenant's obligations under Subparagraph 8(b) above. Such
certificates shall name Landlord as an additional insured and shall expressly
provide that the interest of the same therein shall not be affected by any
breach by Tenant of any policy provision for which such certificates evidence
coverage. Further, all certificates shall expressly provide that not less
than thirty (30) days' prior written notice shall be given Landlord in the
event of material alteration to or cancellation of the coverages evidenced by
such certificates. If on account of the failure of Tenant to comply with the
provisions of this Paragraph 8, Landlord is adjudged a insurer by its
insurance carrier, then, in addition to all other remedies available to
Landlord, any loss or damage Landlord shall sustain by reason thereof shall
be borne by Tenant and shall be immediately paid by Tenant upon receipt of a
bill therefor and evidence of such loss.
(f) Upon demand, Tenant shall provide Landlord, at Tenants sole cost
and expense, with such increased amount of existing insurance and such other
insurance with such limits as Landlord may require and such other hazard
insurance as the nature and condition of the Premises may require. in the
opinion of Landlord, to afford Landlord adequate protection for such risks.
However, in all cases such adjustments shall be based upon the requirements
of an institutional lender of Landlord or otherwise reasonable and consistent
with the requirements of other first class office projects in the County of
Orange.
(g) Landlord makes no representation that the insurance coverage
specified to be carried by Tenant pursuant to this Paragraph S is adequate to
protect Tenant against Tenant's undertaking under the terms of this Lease or
otherwise, and in the event Tenant believes that any such insurance coverage
called for under this Lease is insufficient Tenant shall provide, at its own
cost and expense, such additional insurance as Tenant deems adequate.
(h) Notwithstanding any provision of this Paragraph 8 to the
contrary, Landlord hereby waives any and all rights of recovery against
Tenant for or arising out of damage to, or destruction of; the Premises, the
Building or the Project from causes then included under standard fire and All
Risk insurance policies or endorsements; provided, however, that such waiver
of subrogation shall be limited exclusively to insurance proceeds actually
received by Landlord for such damage or destruction. Tenant hereby waives any
and all rights of recovery against Landlord for or arising out of damage to,
or
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destruction of any property of Tenant, from causes then included under
standard fire and All Risk insurance policies or endorsements. Tenant
represents that its present insurance policies now in force permit such
waiver. If at any time during the term of this Lease (i) either party shall
give less than five (5) days' prior written notice to the other party
certifying that any insurance carrier which has issued any such policy shall
refuse to consent to the aforesaid waiver of subrogation, or (ii) such
insurance carrier shall consent to such waiver only upon the payment of an
additional premium (and such additional premium is not paid by the other
party hereto), or (iii) such insurance carrier shall revoke a consent
previously given or shall cancel or threaten to cancel any policy previously
issued and then in force and effect, because of such waiver of subrogation,
then, in any of such events, the waiver of subrogation contained herein shall
thereupon be of no further force or effect as to the loss, damage or
destruction covered by such policy. It however, at any time thereafter, a
consent to such waiver of subrogation shall be obtained without an additional
premium from any existing or substitute insurance carrier, the waiver
hereinabove provided for shall again become effective. Nothing contained
herein shall abrogate or limit Tenant's waiver and indemnity contained in
Subparagraphs 8(a) and 8(b).
(i) Tenant shall not keep, use, sell or offer for sale in or upon
the Premises any article, which may be prohibited by any insurance policy
periodically in force covering the Premises, the Building or the Project. If
any of Landlord's insurance policies shall be cancelled or cancellation shall
be threatened or the coverage thereunder reduced or threatened to be reduced
in any way because of a non-permitted use of the Premises, or any part
thereof by Tenant or any assignee, subtenant, licensee or invitee of Tenant
and, if Tenant fails to remedy the condition giving rise to such
cancellation, threatened cancellation, reduction of coverage, or threatened
reduction of coverage, within such time period as Landlord determines is
reasonably sufficient to prevent cancellation of coverage as set forth in
said notice, or if such coverage has been cancelled within forty eight (48)
hours after notice thereof Landlord may, at its option, either terminate this
Lease or enter upon the Premises and attempt to remedy such condition, and
Tenant shall promptly pay the cost thereof to Landlord as additional Rent.
Landlord shall not be liable for any damage or injury caused to any property
of Tenant or of others located on the Premises resulting from such entry. If
Landlord is unable, or elects not to remedy such condition, then Landlord
shall have all of the remedies provided for in this Lease in the event of a
default by Tenant
(j) Tenant shall not do or permit to be done any act or things upon
or about the Premises or the Building, which will (i) result in the assertion
of any defense by the insurer to any claim under, (ii) invalidate, or (iii)
be in conflict with, the insurance policies of Landlord or Tenant covering
the Building, the Premises or fixtures and property therein, or which would
increase the rate of fire insurance applicable to the Building to an amount
higher than it otherwise would be; and Tenant shall neither do nor permit to
be done any act or thing upon or about the Premises or the Building which
shall or might subject Landlord to any liability or responsibility for injury
to any person or persons or to property, provided that nothing in this
Paragraph 8 shall prevent or limit Tenants use of the Premises for the
purposes stated in Paragraph 6 hereof.
(k) It as a result of any act or omission by or on the part of
Tenant or violation of this Lease, whether or not Landlord has consented to
the same, the rate of "All Risk" or other type of insurance maintained by
Landlord on the Building and fixtures and property therein, shall be
increased to an amount higher than it otherwise would be, Tenant shall
reimburse Landlord for all increases of Landlord's fire insurance premiums so
caused, such reimbursement to be Additional Rent payable within five (5) days
after demand therefor by Landlord.
(l) Landlord shall provide any or all of the following types of
insurance, with commercially reasonable deductibles as determined by Landlord
and in amounts and coverages as may be determined by Landlord in its
discretion: "all risk" property insurance subject to standard exclusions,
covering the Building or Project, and such other risks as Landlord or its
mortgagees may from time to time deem appropriate; and commercial general
liability coverage. Landlord shall not be required to carry insurance of any
kind on Tenants alterations, trade fixtures, furnishings, equipment interior
plate glass, signs and all other items of personal property and alterations,
and shall not be obligated to repair or replace that property should damage
occur. All proceeds of insurance maintained by Landlord upon the Building and
the Project shall be the property of Landlord, whether or not Landlord is
obligated to or elects to make any repairs.
9. FIRE OR CASUALTY
(a) Subject to the provisions of this Paragraph 9, in the event the
Premises, or access thereto, is wholly or partially destroyed by fire or other
casualty, Landlord shall (to the extent permitted by Law and covenants,
conditions and restrictions then applicable to the Project) rebuild, repair or
restore the Premises and access thereto to substantially the same condition as
existing immediately prior to such destruction, and this Lease shall continue in
full force and effect. Notwithstanding the foregoing, (i) Landlord's obligation
to rebuild, repair or restore the Premises shall not apply to any personal
property or other items installed or contained in the Premises which are not
installed as part of the initial tenant improvements, and (ii) Landlord shall
have no obligation whatsoever to rebuild, repair or restore the Premises with
respect to any damage or destruction occurring during the last twelve (12)
months of the term of this Lease or the Extension Term.
(b) Landlord may elect to terminate this Lease in any of the following
cases of damage or destruction to the Premises or the Building: (i) where the
cost of rebuilding, repairing and restoring the Building (collectively,
"Restoration"), would, regardless of the lack of damage to the Premises or
access thereto, in the opinion of Landlord, exceed twenty percent (20%) of the
then replacement cost of the Building; (ii) where, in the case of any damage or
destruction to any portion of the Building by uninsured casualty, the cost of
Restoration of the Building, in the opinion of Landlord, exceeds One Million
Dollars ($1,000,000.00); or (iii) where, in the case of any damage or
destruction to the Premises or access thereto by uninsured casualty, the cost of
Restoration of the Premises or access thereto, in the opinion of Landlord,
exceeds twenty percent (20%) of the replacement cost of the Premises. Any such
termination shall be made by thirty (30) days' prior written notice to Tenant
given within sixty (60) days of the date of such damage or destruction.
(c) Subject to the later terms hereof Tenant shall have the right to
terminate this Lease following the destruction of the Premises (or damage to
the Premises so extensive as to reasonably prevent Tenants substantial use
and enjoyment of the Premises) if any of the following occurs: (i) the
Premises cannot, with reasonable diligence, be repaired by Landlord within
three hundred sixty (360) days after the date of the damage or destruction,
as determined by Landlord's architect Completion Period"); (ii) the Premises
cannot safely be repaired because of the presence of hazardous factors,
including Hazardous Materials. earthquake faults, radiation, chemical waste
and other similar dangers: or (iii) the damage or destruction occurs during
the last twelve (12) months of the Term and cannot, with reasonable
diligence, be repaired by Landlord within ninety (90) days after the date of
the damage or destruction, as determined by Landlord's architect. If Tenant
elects to terminate this Lease pursuant hereto, Tenant shall give Landlord
written notice of its election to terminate within
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fifteen (15) days after the date of the determination by Landlord's
architect, and this Lease shall terminate thirty (30) days after the date of
such notice. Notwithstanding the foregoing, (1) in the event Landlord's
architect makes a determination that the Premises can be repaired within the
Completion Period as set forth in clause (i) above, and thereafter Landlord's
architect makes a determination that the damage or destruction will not,
despite Landlord's reasonable diligence, be repaired within the Completion
Period, Landlord shall give Tenant written notice of such determination
together with Landlord's architect's estimated date that the damage or
destruction will be repaired, and if such estimated completion date is more
than an aggregate of sixty (60) days from the expiration of the Completion
Period plus delays outside of the reasonable control of Landlord, Tenant
shall have a period of fifteen (15) days after receipt of said notice to
elect to terminate this Lease and this Lease will terminate within thirty
(30) days after the date of said notice, or (2) if the Premises are not
repaired within eighteen (18) months after the damage or destruction
(including delays outside of the reasonable control of Landlord), then Tenant
shall have a period of ten (10) days after said time period to elect to
terminate this Lease by providing written notice to Landlord of such election
and this Lease will terminate within thirty (30) days after Tenants notice.
Notwithstanding the foregoing, Tenant shall not have the right to terminate
hereunder if a Tenant Default has occurred and is continuing at the time of
such damage or destruction, or at the time of exercising such right to
terminate, or the damage or destruction was caused, in whole or in part, from
the fault or neglect of Tenant, its agents, contractors, assignees,
subtenants, employees, licensees or invitees.
(d) If this Lease is not terminated by Landlord or Tenant pursuant
to subparagraphs (a), (b) or (c) hereof and as the result of any damage or
destruction, the Premises, or a portion thereof are rendered untenantable,
the Basic Annual Rent shall abate ratably during the period of Restoration
(based upon the extent to which such damage and Restoration materially
interfere with Tenants business in the Premises) unless such damage or
destruction shall have resulted from the fault or neglect of Tenant, its
agents, servants, contractors, representatives, employees, licensees or
invitees. This Lease shall be considered an express agreement governing any
case of damage to or destruction of the Premises, the Building or the
Project. Tenant hereby waives the provisions of California Civil Code
Sections 1932(2) and 1933(4) and the provisions of any successor or other law
of like import.
10. EMINENT DOMAIN
In the event the whole of the Premises, the Building or the Project
shall be taken under the power of eminent domain, or sold to prevent the
exercise thereof (collectively, a "`Taking"), this Lease shall automatically
terminate as of the date of such Taking. In the event of a Taking of such
portion of the Project, the Building or the Premises as shall, in the opinion
of Landlord, substantially interfere with Landlord's operation thereof
Landlord may terminate this Lease upon thirty (30) days' written notice to
Tenant given at any time within sixty (60) days following the date of such
Taking. For purposes of this Lease, the date of Taking shall be the earlier
of the date of transfer of title resulting from such Taking or the date of
transfer of possession resulting from such Taking. In the event that a
portion of the Premises is so taken and this Lease is not terminated,
Landlord shall, with reasonable diligence, proceed to restore (to the extent
permitted by Law and covenants. conditions and restrictions then applicable
to the Project) the Premises (other than Tenant's personal property and
fixtures, and tenant improvements not constituting Building Standard
Installations) to a complete, functioning unit In such case, the Basic Annual
Rent shall be reduced proportionately based on the portion of the Premises so
taken. If all or any portion of the Premises is the subject of a temporary
Taking, this Lease shall remain in full force and effect, and Tenant shall
continue to perform each of its obligations under this Lease; in such case,
Tenant shall be entitled to receive the entire award allocable to the
temporary Taking of the Premises. Except as provided herein, Tenant shall not
assert any claim against Landlord or the condemning authority for, and hereby
assigns to Landlord, any compensation in connection with any such Taking, and
Landlord shall be entitled to receive the entire amount of any award
therefor, without deduction for any estate or interest of Tenant, Nothing
contained in this Paragraph 10 shall be deemed to give Landlord any interest
in, or prevent Tenant from seeking any award against the condemning authority
for the Taking of personal property or fixtures of Tenant, or for relocation
or business interruption expenses recoverable by Tenant from the condemning
authority. In addition, in the event of a Taking of the whole or any part of
the Premises only, Tenant shall have the right to seek an award for up to
fifty, percent (50%) of Tenant's leasehold interest in this Lease, provided
that in no event shall any such claim by Tenant diminish any award payable to
Landlord. This Paragraph 10 shall be Tenant's sole and exclusive remedy in
the event of a Taking. Each party hereby waives the provisions of Sections
1265.130 and 1265.150 of the California Code of Civil Procedure and the
provisions of any successor or other law of like import.
11. ASSIGNMENT AND SUBLETTING
(a) Tenant shall not directly or indirectly, voluntarily or
involuntarily, by operation of law or otherwise, assign, sublet, mortgage,
hypothecate or otherwise encumber all or any portion of its interest in this
Lease or in the Premises or grant any license in or suffer any person other
than Tenant or its employees to use or occupy the Premises, or any part
thereof without obtaining the prior written consent of Landlord, which
consent shall, subject to Subparagraphs 11(d), (e), (0' and (g) below, not be
unreasonably withheld. Any such attempted assignment, subletting, license,
mortgage, hypothecation. other encumbrance or other use or occupancy without
the consent of Landlord shall be null and void and of no effect. For purposes
of application of Subparagraphs 11(b), (c), (d), (e), (0. and (g) below, any
mortgage, hypothecation or encumbrance of all or any portion of Tenant's
interest in this Lease or in the Premises and any grant of a license or
sufferance of any person other than Tenant or its employees to use or occupy
the Premises, or any part thereof shall be deemed to be an "assignment" of
this Lease. In addition, as used in this Paragraph 11, the term "`Tenant"
shall also mean any entity that has guaranteed Tenants obligations under this
Lease, and the restrictions applicable to Tenant contained herein shall also
be applicable to such guarantor.
(b) No permitted assignment or subletting shall relieve Tenant of
its obligation to pay the Rent and to perform all of the other obligations to
be performed by Tenant hereunder. The acceptance of Rent by Landlord from any
other person shall not be deemed to be a waiver by Landlord of any provision
of this Lease or to be a consent to any subletting or assignment. Consent by
Landlord to one (1) subletting or assignment shall not be deemed to
constitute a consent to any other or subsequent attempted subletting or
assignment.
(c) If Tenant desires at any time to assign this Lease or to sublet
the Premises, or any portion thereof it shall first notify Landlord of its
desire to do so and shall submit in writing to Landlord (i) the name of the
proposed assignee or subtenant; (ii) the nature of the proposed assignee's or
subtenants business to be carried on in the Premises; (iii) the terms and
provisions of the proposed assignment or sublease, which shall be expressly
subject to the provisions of this Lease;
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(iv) in the case of a sublease, the portion of the Premises proposed to be
sublet; and (v) such financial and other information as Landlord may
reasonably request concerning the proposed assignee or subtenant.
(d) INTENTIONALLY LEFT BLANK
(e) Tenant acknowledges that it shall be reasonable for Landlord to
withhold its consent to a proposed assignment or sublease if (i) the use to
be made of the Premises by the proposed assignee or subtenant is (A) not
generally consistent with the character and nature of other tenants in the
Building or the Project or would result in a heavier burden (in comparison to
that resulting from Tenant's use of such portion of the Premises) on the
Building, the Project, the systems, the structures or the Common Areas
thereof, (B) in conflict with any TM exclusive" or similar use or signage
rights of another Project tenant, or (C) prohibited by any provision of this
Lease, including, without limitation, the rules and regulations then in
effect; (ii) the character, moral stability, reputation or financial
responsibility of the proposed assignee or subtenant are not reasonably
satisfactory to Landlord; (iii) in the case of a proposed mortgage,
hypothecation or other encumbrance of Tenant's leasehold estate, (A) the
proposed assignee or subtenant requests relief from any provision of this
Paragraph 11 or this Lease, including, without limitation, in the case of an
assignment of this Lease, those provisions requiring assumption of this Lease
by each assignee, (B) the proposed mortgage, hypothecation or encumbrance is
of less than the entire leasehold estate, or (C) the proposed assignee or
subtenant cannot reasonably demonstrate to Landlord that such mortgage,
hypothecation or encumbrance will not impair or adversely affect any of
Landlord's rights hereunder; (iv) in the case of a sublease, the portion of
the Premises proposed to be sublet is not a single, self contained unit of
space with access to restrooms and exits in conformance with applicable Law
or otherwise cannot be the subject of a valid certificate of occupancy; or
(v) the proposed assignee or subtenant is an existing tenant or subtenant in
the Project and Tenant is offering such assignment or sublease at a rental
rate less than that being offered by Landlord for similar space within the
Project.
(f) The voluntary or other surrender of this Lease by Tenant or a
mutual cancellation hereof shall not constitute a merger, and shall, at the
option of Landlord, either terminate all or any existing subleases or
subtenancies or shall operate as an assignment to Landlord of such subleases
or subtenancies. Notwithstanding anything to the contrary contained in this
Paragraph 11 or Paragraph 20(n): (i) an assignment of this Lease or sublease
of all or a portion of the Premises to (A) an affiliate of Tenant, (B) an
entity which Tenant is merged with, consolidated into, or reconstituted as,
or (C) an entity which acquires all or substantially all of the assets or
stock of Tenant shall not be deemed an assignment or transfer under this
Paragraph 11, provided that (1) Tenant notifies Landlord of any such
transaction and promptly supplies Landlord with supporting documents or
Information requested by Landlord regarding such transaction or such
affiliate or successor, (2) such transaction is not a subterfuge by Tenant to
avoid its economic obligations under this Lease or to reduce its net worth or
ability to pay obligations generally, and (3) Tenant shall warrant to
Landlord that the parties to the transaction were not attempting to avoid the
specific assignment and subleasing restrictions of Tenant under this Lease,
including without limitation the application of subparagraphs (e) and (g) of
this Paragraph ii. For purposes of the foregoing, a person or entity will be
deemed to be an affiliate of any other person or entity who is controlling,
controlled by, or under common control with such person or entity, and
"control" shall mean the ownership, directly or indirectly, of at least
fifty-one percent (51%) of the voting securities of, or possession of the
right to vote, in the ordinary direction of its affairs, of at least
fifty-one percent (51%) of the voting interests in, any person or entity;
(ii) If Tenant is a publicly traded company, the shares of which are freely
traded on a generally recognized national stock exchange or over the counter,
the transfer of shares on such exchange or over the counter shall not be
deemed to be an assignment or transfer under this Paragraph ii; and (iii) a
sale of capital stock by Tenant in a public offering shall not be deemed an
assignment or transfer under this Paragraph 11. Each assignee, sublessee,
licensee, mortgagee or other transferee, other than Landlord, shall assume in
a writing satisfactory to Landlord, all applicable obligations of Tenant
under this Lease and except with respect to transactions not deemed
assignments or transfers as identified in subparts (I), (ii) and (iii) above,
shall be jointly and severally liable for the performance of all of the
applicable provisions hereof. Notwithstanding the foregoing and without
prejudice to Landlord's right to require a written assumption from each
assignee, any person or entity to whom this Lease is assigned, including,
without limitation, assignees pursuant to the provisions of the Bankruptcy
Code, 11 U.S.C ss.ss. 101 ET seq.. (the "Bankruptcy Code"), shall
automatically be deemed to have assumed all applicable obligations of Tenant
arising under this Lease. Tenant agrees to reimburse Landlord for Landlord's
reasonable costs and attorneys' fees incurred, in an amount not to exceed
$5,000.00, in connection with the processing, investigation and documentation
of any requested assignment or sublease subject to this Paragraph.
(g) If Landlord shall give its consent to any assignment of this
Lease or to any sublease of all or any portion of the Premises, Tenant shall
pay to Landlord as Additional Rent hereunder
(i) In the case of an assignment, an amount equal to fifty
percent (50%) of all sums and other consideration paid to the assignor Tenant
by the assignee for, or by reason of, such assignment, but deducting from
such sums and consideration, all legal fees and brokerage commissions
actually paid to lawyers and independent brokers in connection with such
transaction and any tenant improvement allowance granted to the assignee to
the extent actually devoted exclusively to the installation of leasehold
improvements in the Premises (such commissions and allowance being referred
to herein as "`Transaction Inducements"); and
(ii) In the case of a sublease, fifty, percent (50%) of all
sums, rents, additional charges, key money and other consideration payable
under the sublease by the subtenant to Tenant in excess of Rent accruing
during the term of the sublease with respect to the subleased portion of the
Premises (at the rate per square foot of Rentable Area payable by Tenant).
Tenant shall be entitled to deduct all Transaction Inducements related to
such sublease.
The obligation to make the payments described in this
Subparagraph 11(g) shall be a joint and several obligation of the Tenant and
the assignee or sublessee, as the case may be. The amounts payable under
Subparagraph 11(g) shall be paid to Landlord as and when payable by the
assignee or sublessee to Tenant Landlord agrees to accept payments directly
from any assignee or sublessee. Within fifteen (15) days after written
request therefor by Landlord, Tenant shall furnish evidence to Landlord of
the amount of consideration received or expected to be received from such
assignment or sublease.
(h) Notwithstanding any provision of this Lease to the contrary, in the
event this Lease is assigned to any person or entity pursuant to the provisions
of the Bankruptcy Code, any and all monies or other consideration payable or
otherwise to be delivered in connection with such assignment shall be paid or
delivered to Landlord, shall be and remain the exclusive property of Landlord
and shall not constitute the property of Tenant or Tenants estate within the
meaning of the
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Bankruptcy Code. All such money and other consideration not paid or delivered
to Landlord shall be held in trust for the benefit of Landlord and shall be
promptly paid or delivered to Landlord.
12. DEFAULT
(a) The occurrence of any of the following shall constitute a
material default and breach of This Lease by Tenant (a "Tenant Default):
(i) Any failure by Tenant to pay any installment of Basic
Annual Rent or to make any other payment required to be made by Tenant
hereunder when due, where such failure continues for five (5) days after
delivery of written notice of such failure by Landlord to Tenant: provided,
however, That any such notice shall be in lieu of and not in addition to, any
notice required under Sections 1161 !1 in.' of The California Code of Civil
Procedure;
(ii) The abandonment of The Premises by Tenant;
(iii) Any failure by Tenant to execute and deliver any
statement described in Paragraph 16 requested by Landlord, where such failure
continues for five (5) days after delivery of written notice of such failure
by Landlord to Tenant; provided, however, That any such notice shall be in
lieu of and not in addition to, any notice required under Sections 1161 ET
SEQ., of the California Code of Civil Procedure;
(iv) Any failure by Tenant to observe and perform any Other
provision of this Lease, including, without limitation, any provision of The
Exhibits attached hereto, as They may exist from time to time, to be observed
or performed by Tenant, where such failure continues for Thirty (30) days
(except where a different period of time is specified in This Lease, in which
case, such different time period shall apply) after delivery of written
notice of such failure by Landlord to Tenant; provided, however, That any
such notice shall be in lieu of and not in addition to, any notice required
under Sections 1161 ET SEQ., of the California Code of Civil Procedure. If
The nature of such default is such that the same cannot reasonably be cured
within such thirty (30) day period, Tenant shall not be deemed to be in
default if Tenant shall, commence such cure within such thirty (30) day
period, and thereafter diligently prosecute such cure to completion;
(v) The making or furnishing by Tenant of any warranty,
representation or statement to Landlord in connection with this Lease, or any
other agreement to which Tenant and Landlord are parties, which Tenant knows,
or has reason to know, is false or misleading in any material respect when
made or furnished;
(vi) Any transfer in violation of Paragraph 11 above;
(vii) Any instance whereby Tenant or any general partner of
Tenant shall cease doing business as a going concern, make an assignment for
the benefit of creditors, generally not pay its debts as they become due or
admit in writing its inability to pay its debts as They become due, file a
petition commencing a voluntary case under any chapter of the Bankruptcy
Code, be adjudicated an insolvent, file a petition seeking for itself any
reorganization, composition, readjustment, liquidation, dissolution or
similar arrangement under The Bankruptcy Code or any other present or future
similar statute, law, rule or regulation, or file an answer admitting The
material allegations of a petition filed against it in any such proceeding,
consent to The filing of such a petition or acquiesce in the appointment of a
trustee, receiver, custodian or other similar official for it or of all or
any substantial part of its assets or properties, or take any action looking
to its dissolution or liquidation;
(viii) Any instance whereby a case, proceeding or other action
shall be instituted against Tenant or any general partner of Tenant seeking
The entry of an order for relief against Tenant or any general partner
Thereof as debtor, to adjudicate Tenant or any general partner thereof as a
bankrupt or insolvent, or seeking reorganization, arrangement, readjustment,
liquidation, dissolution or similar relief against Tenant or any general
partner thereof under The Bankruptcy Code or any other present or future
similar statute, law, rule or regulation, which case, proceeding or other
action either results in such entry, adjudication or issuance or entry of any
other order or judgment having a similar effect, or remains undismissed for
sixty (60) days, or within sixty (60) days after the appointment (without
Tenants or such general partners consent) of any trustee, receiver, custodian
or other similar official for it or such general partner, or of all or any
substantial part of its or such general partners' assets and properties, such
appointment shall not be vacated;
(ix) The appointment of a receiver, trustee or custodian to
take possession of all or any substantial portion of the assets of Tenant, or
The formation of any committee of Tenants creditors, or any class thereof for
The purpose of monitoring or investigating the financial affairs of Tenant or
enforcing such creditors' rights.
(b) In the event of any such default by Tenant, then in addition to
any other remedies available to Landlord at law or in equity, Landlord shall
have the immediate option to terminate this Lease and all rights of Tenant
hereunder by giving written notice of such termination. In the event That
Landlord shall elect to so terminate this Lease, then Landlord may recover
from Tenant:
(i) The worth at The time of award of any unpaid Rent which had
been earned at The time of such termination; plus
(ii) The worth at The time of award of the amount by which the
unpaid Rent which would have been earned after termination until the time of
award exceeds the amount of such rental loss Tenant proves reasonably could
have been avoided: plus
(iii) The worth at The time of award of the amount by which
The unpaid Rent for the balance of The term after the time of award exceeds The
amount of such rental loss That Tenant proves reasonably could be avoided;
(iv) Any other amount necessary to compensate Landlord for all
detriment proximately caused by Tenant's failure to perform its obligations
under this Lease or which in The ordinary course would be likely to result
therefrom; and
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(v) At Landlord's election, such other amounts in addition to
or in lieu of the foregoing as may be permitted from time to time by
applicable California Law.
(c) As used in Subparagraphs 1 2(b)(i) and 1 2(b)(ii) above, the
"worth at the time of award" is computed by allowing interest at the rate
specified in Subparagraph 12(i) below. As used in Subparagraph 12(b)(iii)
above, the `worth at the time of award" is computed by discounting such
amount at the discount rate of the Federal Reserve Bank of San Francisco at
the time of award plus one percent (1%).
(d) In the event of any such default by Tenant, Landlord shall also
have the right, with or without terminating this Lease, to enter the Premises
and remove all persons and property from the Premises; such property may be
removed and stored in a public warehouse or elsewhere at the cost and risk of
and for the account of Tenant
(e) In the event of the abandonment of the Premises by Tenant or in
the event that Landlord shall elect to reenter as provided in Subparagraph
12(d) or shall take possession of the Premises pursuant to legal proceedings,
or pursuant to any notice provided by Law, then if Landlord does not elect to
terminate this Lease as provided in this Paragraph 12, Landlord may from time
to time, without terminating this Lease, either recover all rentals as they
become due or relet the Premises, or any pan thereof for such term or terms
and at such rental or rentals and upon such other terms and conditions as
Landlord, in its sole and absolute discretion, may deem advisable, with the
right to make alterations and repairs to the Premises.
(f) In the event that Landlord shall elect to relet, Then rentals
received by Landlord from such reletting shall be applied: first, to the
payment of any indebtedness (other than Rent) due hereunder from Tenant to
Landlord; second, to the payment of any cost of such reletting (including
brokerage commissions); third, to the payment of the cost of any alterations
and repairs to the Premises; fourth, to the payment of Rent due and unpaid
hereunder; and the residue, if any. shall be held by Landlord and applied in
payment of future Rent as the same may become due and payable hereunder.
Should reletting, during any month to which such Rent is applied, result in
the actual payment of rentals at less than the Rent payable during that month
by Tenant hereunder, then Tenant shall pay such deficiency to Landlord
immediately upon demand thereof by Landlord. Such deficiency shall be
calculated and paid monthly. Tenant shall also pay to Landlord as soon as
ascertained, any costs and expenses incurred by Landlord in such reletting or
in making such alterations and repairs not covered by the rentals received
from such reletting.
(g) No re-entry or taking of possession of the Premises by Landlord
pursuant to this Paragraph 12 shall be construed as an election to terminate
this Lease unless a written notice of such election shall be given to Tenant
or unless the termination thereof be decreed by a court of competent
jurisdiction. Notwithstanding any reletting without termination by Landlord,
Landlord may, at any time after such reletting, elect to terminate this Lease
for any such default. Upon the occurrence of a default by Tenant under
Subparagraph 12(a), if the Premises, or any portion thereof are sublet,
Landlord in addition and without prejudice to any other remedies herein
provided or provided by Law, may, at its option, collect directly from the
sublessee all rentals becoming due to the Tenant and apply such rentals
against other sums due hereunder to Landlord.
(h) In addition and without prejudice to any other right or remedy
of Landlord, if Tenant shall be in default under this Lease, Landlord may
cure the same at the cost and expense of Tenant immediately and without
notice in the case (A) of emergency, (B) where such default unreasonably
interferes with any other tenant in the Project, or (C) where such default
will result in the violation of Law or the cancellation of any insurance
policy maintained by Landlord. All costs incurred by Landlord in curing such
default(s), including, without limitation, attorneys' fees, shall be
reimbursable by Tenant as additional Rent hereunder upon demand, together
with interest thereon, from the date such costs were incurred by Landlord, at
the rate specified in Subparagraph 12(i) below.
(i) Tenant acknowledges and agrees that any late payment by Tenant
of Rent or any other amount payable by Tenant hereunder will result in damage
to Landlord, the exact amount of which will be extremely difficult to
ascertain. Such damage includes, without limitation, administrative expenses,
accounting and processing costs and late charges, which may be payable by
Landlord on mortgage financing or other obligations of Landlord relating to
the Project. As a result, Landlord and Tenant agree that in the event Tenant
is more than ten (10) days an paying any amount of Rent or any other payment
due under this Lease, then without the need for any further notice to Tenant,
Tenant shall pay Landlord a late charge equal to that penalty charged by any
mortgagee of the Project as a late charge or penalty not to exceed five
percent (5%) of the delinquent amount. Landlord and Tenant agree that such
late charge is a fair and reasonable estimate of the damage Landlord will
incur by reason of such delinquent payment. Following the occurrence of three
(3) instances of payment of Rent more than ten (10) days late in any twelve
(12) month period, Landlord may, without prejudice to any other rights or
remedies available to it, upon written notice to Tenant, (i) require that all
remaining monthly installments of Rent shall be payable three (3) months in
advance; and in addition or in the alternative at Landlord's election, (ii)
require that Tenant increase the amount of the Security Deposit (if any) by
an amount equal to one (1) month's Rent In addition, any amount due from
Tenant to Landlord hereunder which is not paid within thirty (30) days of the
date due shall bear interest at an annual rate (the "Default Rate") equal to
four percent (4%) in excess of the discount rate being charged by the Federal
Reserve Bank of San Francisco on advances to member banks pursuant to
Sections 13 and 13(a) of the Federal Reserve Act, as amended, as of the
twenty-fifth (25th) day of the month preceding the date hereof (or such
lesser amount as shall be the maximum rate then permitted by applicable use).
The payment of such interest by Tenant shall not constitute a waiver of any
default by Tenant hereunder.
(j) The performance by Landlord of any agreement, concession or
grant for "free rent," Rent abatement, a "credit fund" to be applied against
Rent otherwise payable hereunder or any grant or payment by Landlord to or
for the benefit of Tenant of any cash or other bonus, allowance or other
payment or inducement or any assumption of obligations by Landlord to or for
the benefit of Tenant given or granted to or for the benefit of Tenant as
consideration for execution and delivery of this Lease by Tenant (all such
agreements, concessions, grants, payments and assumptions are collectively
referred to herein as `Tenant Inducements") shall be continuously conditional
upon Tenants full and complete performance of its obligations under this
Lease during months 1-144 of the Lease term only, as this Lease may be
amended or extended. Effective immediately upon the occurrence of a Tenant
Default during months 1-144 of the Lease term only, (A) any provision of this
Lease providing for performance of a Tenant Inducement shall be automatically
deemed terminated and of no further force or effect, and (B) any Tenant
inducement previously granted, issued, paid or given to or for the benefit of
Tenant shall be immediately due and payable by Tenant to Landlord as Rent
hereunder Notwithstanding phrase (B) above
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at the end of each consecutive twenty four (24) month period, commencing from
me Commencement Date, so long as a Tenant Default shall not have occurred
during such 24 month period, for purposes of this paragraph, Tenant shall be
deemed to have earned one (1) month of me Fixturization Period or Deferred
Rent Period, as me case may be. If a Tenant Default occurs during months
1-144 of me Lease Term, men Tenant shall immediately pay Landlord, in
addition to all other remedies at law, in equity, or under this Lease, an
amount equal to the Tenant Inducement minus me Rent for such "earned" months.
At the expiration of the Lease, if mere is no Tenant Default, men Landlord
shall at its election either reimburse Tenant for amounts paid by Tenant to
Landlord pursuant to me preceding sentence for unearned Tenant Inducement, or
credit such amounts against any monies owed by Tenant to Landlord pursuant to
this Lease.
(k) Tenant hereby waives for Tenant and for all those claiming under
Tenant all rights now or hereafter existing to redeem by order or judgment of
any court or by any legal process or writ, Tenants right of occupancy of the
Premises after any termination of this Lease. Notwithstanding any provision
of this Lease to the contrary, the expiration or termination of this Lease
and or the termination of Tenants rights to possession of the Premises shall
not discharge, relieve or release Tenant from any obligation or liability
whatsoever under any indemnity provision of this Lease, including, without
limitation, the provisions of Paragraphs 6 and 8 hereof
(l) To the full extend permitted by law, Tenant hereby waives the
right to trial by jury in any action, proceeding or counterclaim brought by
Tenant on any mailer whatsoever arising out or of in any way connected with
this Lease, the relationship of Landlord and Tenant, Tenants use or occupancy
of the Premises and or any claim of injury or damage.
(m) Should a dispute arise between me parties regarding any mailer
described above or in Subparagraph 17(c) below, then except with respect to
actions for unlawful or forcible retainer either party may cause me dispute
to be submitted to Jams/Endispute or its successor ("JAMS") in the County in
which the building is situated for binding arbitration before a single
arbitrator. However, each party reserves the right to seek a provisional
remedy by judicial action. No arbitration election by either party pursuant
to this subsection shall be effective if made later than thirty (30) days
following service of a judicial summons and complaint by or upon such party
concerning the dispute. The arbitration shall be conducted in accordance with
the rules of practice and procedure of JAMS and otherwise pursuant to the
California Arbitration Act (Code of Civil Procedure Sections 1280 et seq.).
Notwithstanding the foregoing, the arbitrator is specifically directed to
limit discovery to that which is essential to the effective prosecution or
defense of the action. The arbitrator shall apportion the costs of the
arbitration, together with the attorneys' fees of the parties, in the manner
deemed equitable by the arbitrator, it being the intention of the parties
that the prevailing party ordinarily be entitled to recover its reasonable
costs and fees. Judgment upon any award rendered by the arbitrator may be
entered by any court having jurisdiction.
13. ACCESS; CONSTRUCTION
Landlord reserves the right to use the roof and exterior walls of
the Premises and the area beneath, adjacent to and above me Premises,
together with the right to install, use, maintain, repair, replace and
relocate equipment, machinery, meters, pipes, ducts, plumbing, conduits and
wiring (within the walls of the Premises) throughout the Premises, which
serve other portions of the Building or the Project in a manner and in
locations which do not unreasonably interfere with Tenant's use of the
Premises. In addition, Landlord shall have free access to any and all
mechanical installations of Landlord or Tenant, including, without
limitation, machine rooms, telephone rooms and electrical closets. Tenant
agrees that there shall be no construction of partitions or other
obstructions which interfere with or which threaten to interfere with
Landlord's free access thereto, or interfere with the moving of Landlord's
equipment to or from the enclosures containing said installations. Landlord
reserves and shall at any time and all times have the right to enter the
Premises upon reasonable prior notice (except in an emergency or following a
Tenant Default) and subject to Tenants reasonable security precautions, to
inspect the same, to supply janitorial service and any other service to be
provided by Landlord to Tenant hereunder, to exhibit the Premises to
prospective purchasers, lenders or tenants, to post notices of
nonresponsibility, to alter, improve, restore, rebuild or repair the
Premises, or any other portion of the Building, or to do any other act
permitted or contemplated to be done by Landlord hereunder, all without being
deemed guilty of an eviction of Tenant and without liability for abatement of
Rent or otherwise. For such purposes. Landlord may also erect scaffolding and
other necessary structures where reasonably required by the character of the
work to be performed. Landlord shall conduct all such inspections and/or
improvements, alterations and repairs so as to minimize, to the extent
reasonably practical and without additional expense to Landlord, any
interruption of or interference with the business of Tenant. Tenant hereby
waives any claim for damages for any injury or inconvenience to or
interference with Tenant's business, any loss of occupancy or quiet enjoyment
of the Premises, and any other loss occasioned thereby. For each of such
purposes, Landlord shall at all times have and retain a key with which to
unlock all of the doors in, upon and about the Premises (excluding Tenant's
vaults and safes, access to which shall be provided by Tenant upon Landlord's
reasonable request). Landlord shall have the right to use any and all means
which Landlord may deem proper in an emergency in order to obtain entry to
the Premises, or any portion thereof Any entry into the Premises obtained by
Landlord by any of such means shall not under any circumstances be construed
to be a forcible or unlawful entry into, or a detainer of, the Premises, or
any eviction of Tenant from the Premises, or any portion thereof No provision
of this Lease shall be construed as obligating Landlord to perform any
repairs, Alterations or decorations to the Premises or the Project except as
otherwise expressly agreed to be performed by Landlord pursuant to the
provisions of this Lease.
14. INTENTIONALLY LEFT BLANK
15. INTENTIONALLY LEFT BLANK
16. SUBORDINATION; ATTORNMENT; ESTOPPEL CERTIFICATES
(a) Tenant agrees that this Lease and the rights of Tenant hereunder
shall be subject and subordinate to any and all deeds of trust, security
interests, mortgages, master leases, ground leases or other security
documents and any and all modifications, renewals, extensions, consolidations
and replacements thereof (collectively, "5ecurity Documents") which now or
hereafter constitute a lien upon or affect the Project, the Building or the
Premises. Such subordination shall be effective without the necessity of the
execution by Tenant of any additional document for the purpose of evidencing
or effecting such subordination. In addition, Landlord shall have the right
to subordinate or cause to be subordinated any such Security Documents to
this Lease, and in such case, in the event of the termination or transfer of
Landlord's estate or interest in the Project by reason of any termination or
foreclosure of any such Security Documents, Tenant shall, notwithstanding
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such subordination, attom to and become the Tenant of the successor in
interest to Landlord. Furthermore, Tenant shall within fifteen (15) days of
demand therefor execute any instruments or other documents consistent with
Tenant's rights under this Lease which may be required by Landlord or the
holder of any Security Document and specifically Tenant shall execute,
acknowledge and deliver within fifteen (15) days of written demand therefor a
subordination of lease or subordination of deed of trust, in the form
reasonably required by the holder of the Security Document requesting the
document; the failure to do so by Tenant within such time period shall be a
material default hereunder. Notwithstanding any provision of this Lease to
the contrary, the subordination of this Lease and the rights of Tenant to any
Security Documents which are executed or entered into after the date of this
Lease (and Tenants duty hereunder to execute any documents evidencing such
subordination) shall be subject to the holder of such Security Document
agreeing pursuant to such holders standard form for such purpose (or
otherwise pursuant to any other form in common use by institutional lenders)
that Tenant's possession and this Lease shall not be disturbed by such holder
so long as no default hereunder shall occur, and Tenant shall attom to the
record owner of the Project.
(b) Tenant shall, upon not less than fifteen (15) days' prior notice
by Landlord, execute, acknowledge and deliver to Landlord a statement in
writing certifying to those customary and reasonable facts for which
certification has been requested by Landlord or any current or prospective
purchaser, holder of any Security Document, ground lessor or master lessor,
including, but without limitation, that (i) this Lease is unmodified and in
full force and effect (or if there have been modifications, that the same is
in full force and effect as modified and stating the modifications), (ii) the
dates to which the Basic Annual Rent, Rent and other charges hereunder have
been paid, if any, and (iii) whether or not to the best knowledge of Tenant,
Landlord is in default in the performance of any covenant, agreement or
condition contained in this Lease and, if so, specifying each such default of
which Tenant may have knowledge. The form of the statement attached hereto as
Exhibit "F" is hereby approved by Tenant for use pursuant to this
Subparagraph 16(c); however, at Landlord's option, Landlord shall have the
right to use other forms for such purpose. Tenant's failure to execute and
deliver such statement within such time shall, at the option of Landlord,
constitute a material default under this Lease and, in any event, shall be
conclusive upon Tenant that this Lease is in full force and effect without
modification except as may be represented by Landlord in any such certificate
prepared by Landlord and delivered to Tenant for execution. In addition,
Landlord is hereby irrevocably appointed and authorized as agent and
anomey4n-fact of Tenant to execute and deliver such statement in the event
that Tenant tails to execute and deliver such statement within fifteen (15)
days after notice from Landlord requesting execution and delivery thereof.
Any statement delivered pursuant to this Paragraph 16 may be relied upon by
any prospective purchaser of the fee of the Building or the Project or any
mortgagee, ground lessor or other like encumbrances thereof or any assignee
of any such encumbrance upon the Building or the Project. Under no
circumstances shall Tenant be obligated to sign any such statement which
requires or contains terms that would materially and adversely modify or
amend Tenant's rights or obligations under this Lease.
(c) In addition, and not in lieu of the foregoing, as a condition of
Landlord's obligation to deliver the Premises to Tenant hereunder, on or
before the date that Tenant takes possession or commences use of the Premises
for any business purpose (including moving in), Tenant shall execute and
deliver to Landlord a certificate substantially in the form of Exhibit "G"
attached hereto, indicating thereon any exceptions thereto which Tenant
claims to exist at that time.
(d) Landlord agrees to execute a certificate substantially in the
form of Exhibit "G" attached hereto, in favor of such party as Tenant may
reasonably request, indicating thereon any exceptions thereto which Landlord
to its actual knowledge claims to exist at that time.
17. SALE BY LANDLORD; NONRECOURSE LIABILITY
(a) In the event of a sale or conveyance by Landlord of the Building
or the Project, Landlord shall be released from any and all liability under
this Lease. If the Security Deposit has been made by Tenant prior to such
sale or conveyance, Landlord may transfer the Security Deposit to the
purchaser, and upon delivery to Tenant of notice thereof pursuant to the
provisions of Section 1950.7 of the California Civil Code, Landlord shall be
discharged from any further liability in reference thereto.
(b) Landlord and each of its officers, directors, Affiliates,
shareholders and constituent shareholders shall in no event or at any time be
personally liable for the payment or performance of any obligation required
or permitted of the Landlord under this Lease or under any document executed
in connection herewith. In the event of any actual or alleged failure, breach
or default by Landlord under this Lease or any such document, the sole
recourse of Tenant shall be against the interest of Landlord in the Project,
or in the event that Landlord has admitted in writing it is or is adjudicated
by a court of competent jurisdiction to be insolvent and a court of competent
jurisdiction has finally adjudicated Landlord's breach or default hereunder,
Tenant's recourse shall be extended to offset any damage resulting from such
breach or default against Tenant's obligation to pay Basic Annual Rent
hereunder. No attachment, execution, writ or other process shall be sought or
obtained, and no judicial proceeding shall be initiated by or on behalf of
Tenant, against Landlord (or any of Landlord's officers, directors,
Affiliates or constituent partners or shareholders) personally or Landlord's
assets (other than Landlord's interest in the Project) as a result of any
such failure, breach or default.
(c) Landlord shall not be in default of any obligation of Landlord
hereunder unless and until it has failed to perform such obligation within
thirty (30) days after receipt of written notice of such failure from Tenant,
provided, however, that if the nature of Landlord's obligation is such that
more than thirty (30) days are required for its performance, Landlord shall
not be in default if Landlord commences to cure such default within the
thirty (30) day period and thereafter diligently prosecutes the same to
completion. Tenant's sole remedy for breach of this Lease by Landlord shall
be pursuant to Subparagraph 12(m), an action for damages, injunction or
specific performance; Tenant shall have no right to terminate this Lease on
account of any breach or default by Landlord. Notwithstanding any provision
of this Lease, all liability of Landlord under this Lease or otherwise with
respect to any acts or omissions of Landlord or events which occur during the
term of this Lease and which in any way relate to Tenant's tenancy hereunder
or occupancy of the Premises shall terminate two (2) years following the
expiration or sooner termination of this Lease other than as to those claims,
if any, asserted in reasonable detail in a writing delivered by Tenant to
Landlord prior to the expiration of such two (2) year period.
(d) As a condition to the effectiveness of any notice of default
given by Tenant to Landlord, Tenant shall also concurrently give such notice
under the provisions of Subparagraph 17(c) to each beneficiary under a deed
of trust encumbering the Project of whom Tenant has received written notice
(such notice to specify the address of the beneficiary). In the event
Landlord shall fail to cure any breach or default within the time period
specified in Subparagraph 17(c) then prior
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to the pursuit of any remedy therefor by Tenant, such beneficiary(ies) shall
have one additional Thirty (30) day period within which to cure such default,
or if such default cannot reasonably be cured within such period, Then such
beneficiary(ies) shall have such additional time as shall be necessary to
cure such default, provided that within such Thirty (30) day period, any of
such beneficiary(ies) has commenced and is diligently pursuing The remedies
available to it which are necessary to cure such default (including, without
limitation, as appropriate, commencement of foreclosure proceedings).
18. PARKING; COMMON FACILITIES
(a) Tenant shall have the right to the nonexclusive use of The
number of parking spaces located in The parking facilities of The Project
specified in Item 13 of the Basic Lease Provisions, in the general location
designated on Exhibit "A-2" attached hereto, free of charge Throughout the
initial term of This Lease and any Extension, for The parking of motor
vehicles used by Tenant, its officers, employees, assignees, subtenants,
guests and invitees only. Landlord reserves The right, at any time upon
written notice to Tenant, to change The location of Tenant's parking spaces
within The parking facility originally designated for such use, if any, as
determined by Landlord in its reasonable discretion. The use of such spaces
shall be subject to the rules and regulations adopted by Landlord from time
to time for the use of such facilities. Landlord further reserves the right
to make such changes to the parking system as Landlord may deem necessary or
reasonable from time to time (i.e., Landlord may provide for one or a
combination of parking systems, including, without limitation, self parking,
and valet assist parking: provided however, in no event shall there be tandem
or double stall parking). Landlord may require execution of an agreement with
respect to The use of such parking facilities by Tenant and/or its officers
and employees in form satisfactory to Landlord as a condition of any such use
by Tenant, its officers and employees, provided such agreement is consistent
with Tenants rights under This Lease. A default by Tenant, its officers,
employees, assignees, subtenants, guests and invitees in compliance with such
rules and regulations not cured by Tenant as provided in Paragraph 12 above,
or the performance of such agreement(s) shall constitute a material default
by Tenant hereunder. Tenant shall not permit or allow any vehicles that
belong to or are controlled by Tenant or Tenants officers, employees,
suppliers, shippers, customers or invitees to be loaded, unloaded or parked
in areas other than Those designated by Landlord for such activities. If
Tenant permits or allows any of the prohibited activities described in This
Paragraph 18, Then Landlord shall have The right, without notice, in addition
to such other rights and remedies that it may have, to remove or tow away The
vehicle involved and charge The cost to Tenant, which cost shall be
immediately payable, upon demand by Landlord.
(b) Subject to Subparagraphs 18(a) and 18(c) hereof and The
remaining provisions of This Lease, Tenant shall have the non-exclusive
right, in common with others, to The use of The garage and such entrances,
lobbies, restrooms, elevators, ramps, drives, stairs, and similar access ways
and service ways and other common areas and facilities in and adjacent to The
Building and The Project as are designated from time to time by Landlord for
The general nonexclusive use of Landlord, Tenant and The other tenants of the
Project and Their respective employees, agents, representatives, licensees
and invitees ("Common Areas"). The use of such Common Areas shall be subject
to the rules and regulations contained herein and The provisions of any
covenants, conditions and restrictions affecting The Project. Landlord
reserves The right to make 5uch changes, alterations, additions, deletions,
improvements, repairs or replacements in or to The Building, The Project
(including the Premises) and the Common Areas as Landlord may deem necessary
or desirable, including, without limitation, constructing new buildings and
making changes in The location, size, shape and number of driveways,
entrances, parking spaces, parking areas, loading areas, landscaped areas and
walkways; provided, however, That There shall be no unreasonable permanent
obstruction of access to or use of the Premises resulting therefrom. In the
event that the Building or the Project is not completed on the date of
execution of This Lease, Landlord shall have the sole judgment and discretion
to determine The architecture, design, appearance, construction, workmanship,
materials and equipment with respect to construction of the Building and The
Project; provided such elements are consistent with The Outline
Specifications and the plans and specifications derived therefrom for The
Project set forth in Exhibit "H" attached hereto. Notwithstanding any
provision of This Lease to The contrary, The Common Areas shall not in any
event be deemed to be a portion of or included within the Premises leased to
Tenant, and the Premises shall not be deemed to be a portion of The Common
Areas.
(c) Landlord reserves The right (i) to change The configuration,
size and dimensions of The Project and its Common Areas. (ii) to add or sever
from its ownership any portion of the Project at any time, and (iii) to
exclude from The rights of use granted to Tenant any rights of passage over
or use of any portion of The Project. In no event shall Landlord's exercise
of the foregoing (1) change the dimensions of The Premises, (2) be
inconsistent with Exhibit "H" attached hereto, or (3) materially impair or
inhibit Tenant's rights of access and use of the parking areas to be used by
Tenant and The Building.
19. MISCELLANEOUS
(a) ATTORNEYS' FEES. In the event of any legal action or proceeding
brought by either party against The other arising out of this Lease, the
prevailing party shall be entitled to recover reasonable attorneys' fees and
costs incurred in such action. Such amounts shall be included in any judgment
rendered in any such action or proceeding. In The event Tenant shall become
insolvent, or any action is filed in any court or tribunal, administrative
agency or any other forum having jurisdiction, pursuant to any applicable
law, for a petition in bankruptcy or insolvency, or for reorganization of
Tenant, or for The appointment of a receiver, trustee or conservator of all
or portion of Tenant's property, Landlord shall be entitled to collect all
reasonable attorneys' fees and costs incurred in connection therewith as a
precondition to the curing of any Tenant Default as a result thereof.
(b) WAIVER. No waiver by Landlord or Tenant of any provision of this
Lease or of any breach by Tenant hereunder shall be deemed to be a waiver of
any other provision hereof or of any subsequent breach by Tenant or Landlord.
Landlord's consent to or approval of any act by Tenant requiring Landlord's
consent or approval under this Lease shall not be deemed to render
unnecessary the obtaining of Landlord's consent to or approval of any
subsequent act of Tenant. No act or Thing done by Landlord or Landlord's
agents during the term of This Lease shall be deemed an acceptance of a
surrender of the Premises, unless in writing signed by Landlord. The delivery
of The keys to any employee or agent of Landlord shall not operate as a
termination of the Lease or a surrender of the Premises. The acceptance of
any Rent by Landlord following a breach of this Lease by Tenant shall not
constitute a waiver by Landlord of such breach or any other breach unless
such waiver is expressly stated in a writing signed by Landlord.
(c) NOTICES. All notices which Landlord or Tenant may require, or
may desire, to serve on The other must be in writing and may be served by
personal service, or as an alternative to personal service, by mailing the
same by registered or certified mail, postage prepaid, addressed as set forth
in Item 14 of The Basic Lease Provisions, or addressed to such other address
or addresses as either Landlord or Tenant may from time to time designate to
The other in writing. However, any
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notice (including a summons and complaint) which Landlord may require or may
desire to serve on Tenant shall be deemed sufficiently served and given if
personally served or delivered by registered or certified mail, postage
prepaid, to Tenant at the Premises. In addition, any bill, statement, consent
or other communication which Landlord may desire or is required to give to
Tenant shall be deemed sufficiently given or rendered if in writing, hand
delivered to the Premises or sent to Tenant at the Premises by registered or
certified mail, postage prepaid.
(d) LABOR. Tenant shall not at any time prior to or during the term
hereof, either directly or indirectly, use any contractors, labor or
materials, the use of which would create any difficulty with other
contractors or labor engaged by Tenant, Landlord or by others in the
construction, maintenance or operation of the Premises, the Building or the
Project.
(e) SECURITY. Landlord shall be the sole determinant of the type and
amount of security services, if any, to be provided to the Project. In all
events, Landlord shall not be liable to Tenant, and Tenant hereby waives any
claim against Landlord, for, and expressly assumes the risk of (I) any
unauthorized or criminal entry of third parties into the Premises, the
Building or the Project, (ii) any injury to persons, or (iii) any loss or
damage of property in and about the Premises, the Building or the Project, by
or from any unauthorized or criminal acts of third parties, regardless of any
action, inaction, failure, breakdown, malfunction and/or insufficiency of the
security services provided by Landlord, or any actual or alleged passive or
active negligence of Landlord.
(f) STORAGE. Any storage space at any time demised to Tenant
hereunder shall be used exclusively for storage, subject to the other
provisions of this Lease. Notwithstanding any other provision of this Lease
to the contrary,(i) Landlord shall have no obligation to provide heating,
cleaning. water or air conditioning therefor, and (ii) Landlord shall be
obligated to provide to such storage space only such electricity as will, in
Landlord's judgment, be adequate to light said space as storage space.
(g) HOLDING OVER. Tenant shall have no right to holdover or retain
possession of any portion of the Premises after the expiration or sooner
termination of this Lease. If Tenant holds over after the expiration or
earlier termination of the term hereof, with the express consent of Landlord,
Tenant shall become and be only a month-to-month tenant, or without the
express consent of Landlord, Tenant shall become and be only a tenant at
sufferance. In either event, Tenant shall pay rent during such holdover equal
to the greater of the then prevailing market rate being charged by the
Landlord at the Project or (A) 120% in first three months, and (B) thereafter
one hundred fifty percent (150%), of the Basic Annual Rent payable by Tenant
immediately prior to such expiration or termination, and otherwise upon the
terms, covenants and conditions herein specified, so far as applicable.
Neither any provision hereof nor acceptance by Landlord of Rent after such
expiration or earlier termination shall be deemed a consent to a holdover
hereunder or result in a renewal of this Lease or an extension of the term.
Notwithstanding any provision to the contrary contained herein, (i) Landlord
expressly reserves the right to require Tenant to surrender possession of the
Premises upon the expiration of the term of this Lease or upon the earlier
termination hereof, the right to reenter the Premises, and the right to
assert any remedy at law or in equity to evict Tenant and/or collect damages
in connection with any such holding over, and (ii) Tenant shall indemnify,
defend and hold Landlord harmless from and against any and all claims,
demands, actions, losses, damages, obligations, costs and expenses,
including, without Limitation, attorneys' fees incurred or suffered by
Landlord by reason of Tenant's failure to surrender the Premises on the
expiration or earlier termination of this Lease in accordance with the
provisions of this Lease; provided however, Tenant shall not be required to
indemnify Landlord for any consequential damages arising from first three (3)
months of Tenants holdover of the Premises after the expiration or sooner
termination of this Lease if such holdover is with Landlord's express written
consent.
(h) CONDITION OF PREMISES. Except as set forth in Subparagraph 19(i)
next below, Tenant acknowledges that neither Landlord nor any agent of
Landlord has made any representation or warranty with respect to the
Premises, the Building or the Project or with respect to the suitability of
any part of the Project for the conduct of Tenant's business. Subject to the
provisions of Subparagraph 19(i) next below, Paragraph 21 below and the Work
Letter, the taking of possession of the Premises by Tenant shall conclusively
establish that the Premises, the Building and the Project were at such time
in good and sanitary order, condition and repair and that the Tenant Work had
been finally completed, without defect and otherwise in accordance with the
Tenant's Plans (described in the Work Letter).
(i) LANDLORD WARRANTY. Landlord covenants that, as of the Lease
Commencement Date, the Building, the Common Areas and the Premises, will have
been completed in accordance with the Outline Specifications, in a good and
workmanlike manner, in full compliance with applicable law, free from latent
or other defects. In the event of a breach of this covenant, Landlord shall
promptly, after receipt of notice from Tenant specifying the alleged breach,
correct and repair the defect (or other problem) at its sole cost and
expense. The cost thereof shall not be treated as an Operating Expense. The
foregoing covenant shall survive as a Landlord warranty for a period of one
(1) year following the Commencement Date. This covenant and warranty shall be
specifically enforceable by Tenant and the violation hereof shall be a
material default by Landlord under this Lease, Costs associated with general
operations, maintenance and repair of the Building, the Common Areas and/or
the Premises, which are associated with customary use, wear and/or tear,
shall not be covered by this Subparagraph.
(j) QUIET POSSESSION. Upon Tenant's paying the Rent reserved
hereunder and observing and performing all of the covenants, conditions and
provisions on Tenant's part to be observed and performed hereunder, Tenant
shall have quiet possession of the Premises for the term hereof without
hindrance or ejection by any person lawfully claiming under Landlord, subject
to the provisions of this Lease and to the provisions of any (i) covenants,
conditions and restrictions, or (ii) deed of trust to which this Lease is
subordinate or may be subordinated pursuant to the terms of this Lease.
(k) MATTERS OF RECORD. Except as otherwise provided herein, this
Lease and Tenant's rights hereunder are subject and subordinate to all
matters affecting Landlord's title to the Project recorded in the official
records of Orange County, California, prior to and subsequent to the date
hereof including, without limitation, all covenants, conditions and
restrictions ("CC&RS") and the provisions of all loan documents relating to
each loan secured by a mortgage or deed of trust encumbering the Project.
Tenant agrees for itself and all persons in possession or holding under it
that it will comply with and not violate any such covenants, conditions and
restrictions, loan documents, or other matters of record. Landlord reserves
the right, from time to time, to grant such easements, rights and dedications
as Landlord deems necessary or desirable, and to cause the recordation of
parcel maps and covenants, conditions and restrictions affecting the
Premises, the Building or the Project, as long as such easements, rights,
dedications, maps, and covenants, conditions and restrictions do not
materially interfere with the use of the Premises by Tenant. At Landlord's
request, Tenant shall join in the execution of
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any of the aforementioned documents. If a Declarant under CC&Rs requests
Landlord's consent to a modification to such CC&Rs and Landlord believes such
consent may adversely affect Tenant, then Landlord shall consult with Tenant
regarding such modification and if Tenant states that such modification shall
adversely affect Tenants business, then Landlord shall not consent to the
requested modification.
(l) PROJECT FINANCING. Notwithstanding anything to the contrary
contained in this Lease, Landlord shall have a period of one hundred twenty
(120) days following Tenants execution and delivery of this Lease to attempt
to secure financing for the construction of the Project, the tenant
improvements, all common and parking areas, and other ancillary improvements
in connection therewith. If Landlord is unable to obtain such financing, on
terms acceptable to Landlord in its sole and absolute discretion, (1) within
such one hundred twenty (120) day period, then Landlord shall thereafter have
the right, upon written notice to Tenant, to terminate this Lease or (2)
within one hundred eighty (180) days from execution of this Lease, then
Tenant shall thereafter have the right, upon written notice to Landlord, to
terminate this Lease, in which event Landlord shall (i) return to Tenant all
funds deposited by Tenant with Landlord and thereafter neither party shall
have any further rights or obligations under this Lease, and (ii) reimburse
Tenant for Tenant's reasonable out of pocket costs and expenses incurred in
connection with this Lease as of such date, including without limitation
reasonable attorneys' fees, in an amount not to exceed $25,000.00; provided
however, Landlord shall not be required to reimburse Tenant for such out of
pocket costs and expenses if Landlord's failure to secure such financing is
due, in whole or in substantial part, to the creditworthiness of Tenant.
Tenant acknowledges that as a material inducement to Landlord to execute this
Lease, (i) Tenant shall timely acknowledge and deliver to Landlord all such
documents and instruments as may be customarily required by any lender
providing financing to Landlord from time to time during the term hereof
including, without limitation, those documents and instruments which may be
required under Paragraph 16, and (ii) if any prospective lender to Landlord
shall request or require in connection with the placement of any financing to
Landlord or pursuant to the provisions of any Security Document any
modification of this Lease, Tenant shall not delay or withhold its agreement
to such proposed modification provided the same shall not modify the Basic
Annual Rent payable hereunder nor materially and adversely affect the
obligations or rights of Tenant hereunder. Tenant shall be responsible for
any and all liability, loss, cost, damage and expense, including, without
limitation, attorneys' fees, which Landlord shall incur in connection with
Tenant's failure or delay in executing, acknowledging and delivering such
documents and instruments or Tenants breach of any other covenant or
agreement embodied in this Lease that results in the delay, impairment or
cancellation of such financing.
(m) SUCCESSORS AND ASSIGNS. Except as otherwise provided in this
Lease, all of the covenants, conditions and provisions of this Lease shall be
binding upon and shall inure to the benefit of the parties hereto and their
respective heirs, personal representatives, successors and assigns. Tenant
shall attom to each purchaser, successor or assignee of Landlord in
accordance with Paragraph 16(a).
(n) BROKERS. Tenant warrants that it has had no dealings with any
real estate broker or agent in connection with the negotiation of this Lease,
excepting only the broker named in Item 11 of the Basic Lease Provisions and
that it knows of no other real estate broker or agent who is or might be
entitled to a commission in connection with this Lease. Landlord covenants
and agrees to pay all real estate commissions due in connection with this
Lease to the broker described in Item 11 of the Basic Lease Provisions.
(o) NAME. Tenant shall not, without the prior written consent of
Landlord (which consent shall not be unreasonably withheld), use the name,
insignia or logotype of the Building or the Project for any purpose, and in
no event shall Tenant acquire any rights in or to such names. Tenant shall
not use any picture of the Building or of the Project in its advertising,
stationery or in any other manner; however, Landlord agrees to Tenant's use
of a picture of the Building or Project in Tenants public reports. Landlord
expressly reserves the right at any time to change the name, number,
designation or logotype of the Building or the Project or the exterior or
interior signage thereon and therein without the consent of Tenant without in
any manner being liable to Tenant therefor.
(p) EXAMINATION OF LEASE, CONFIDENTIALITY. Submission of this
instrument for examination or signature by Tenant does not constitute a
reservation of or option for lease, and it is not effective as a lease or
otherwise until execution by and delivery to both Landlord and Tenant.
Landlord and Tenant agree that (i) the terms and provisions of this Lease are
confidential and constitute proprietary information of Landlord and Tenant,
and (ii) neither party shall disclose, nor shall it permit its partners,
officers, directors, shareholders, employees, brokers and attorneys to
disclose any term or provision of this Lease to any other person without
first obtaining the prior written consent of the other party, except as
otherwise legally required in public reports, or in connection with the
financing or takeover of Tenant. The foregoing covenant of confidentiality
shall not apply to the extent such information is being disseminated in
connection with the financing or sale of the Premises.
(q) TIME. Time is of the essence of this Lease and each and all of
its provisions.
(r) DEFINED TERMS AND MARGINAL HEADINGS. The words "Landlord" and
"Tenant" as used herein shall include the plural as well as the singular. If
more than one (1) person is named as Tenant, the obligations of such persons
are joint and several. The marginal headings and titles to the paragraphs of
this Lease are not a part of this Lease and shall have no effect upon the
construction or interpretation of any part hereof.
(s) CONFLICT OF LAWS: PRIOR AGREEMENTS: SEPARABILITY. This Lease
shall be governed by and construed pursuant to the laws of the State of
California. This Lease contains all of the agreements of the parties hereto
with respect to any matter covered or mentioned in this Lease. No prior
agreement, understanding or representation pertaining to any such matter
shall be effective for any purpose. No provision of this Lease may be amended
or added to except by an agreement in writing signed by the parties hereto or
their respective successors in interest. The illegality, invalidity or
unenforceability of any provision of this Lease shall in no way impair or
invalidate any other provision of this Lease, and such remaining provisions
shall remain in full force and effect.
(t) AUTHORITY. If either party is a corporation, each individual
executing this Lease on its behalf hereby covenants and warrants that it is a
duly authorized and existing corporation, that it has and is qualified to do
business in California, that the corporation has full right and authority to
enter into this Lease, and that each person signing on behalf of the
corporation is authorized to do so. If either party is a partnership or
trust, each individual executing this Lease on its behalf hereby covenants
and warrants that he is duly authorized to execute and deliver this Lease on
its behalf in accordance with the terms of such entity's partnership or trust
agreement. Tenant shall provide Landlord on demand with
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such evidence of such authority as Landlord shall reasonably request,
including, without limitation, resolutions, certificates and opinions of
counsel.
(u) COMMON AREAS. The rights of Tenant hereunder in and to the
Common Areas shall at all times be nonexclusive with the rights of Landlord
and other tenants of Landlord who use the same in common with Tenant, and ft
shall be the duty of Tenant to keep all of the Common Areas free and clear of
any obstructions created or permitted by Tenant or resulting from Tenant's
operations, and to use the Common Areas only for normal activities, parking
and ingress and egress by Tenant and its employees, agents, representatives,
licensees and invitees to and from the Premises, the Building or the Project
If, in the opinion of Landlord, unauthorized persons are using the Common
Areas by reason of the presence of Tenant in the Premises, Tenant upon demand
of Landlord, shall correct such situation by appropriate action or
proceedings against all such unauthorized persons. Nothing herein shall
affect the rights of Landlord at any time to remove any such unauthorized
persons from said areas or to prevent the use of any of said areas by
unauthorized persons.
(v) JOINT AND SEVERAL LIABILITY. If two (2) or more individuals,
corporations, partnerships or other business associations (or any combination
of two (2) or more thereof) shall sign this Lease as Tenant, the liability of
each such individual, corporation, partnership or other business association
to pay Rent and perform all other obligations hereunder shall be deemed to be
joint and several, and all notices, payments and agreements given or made by,
with or to any one of such individuals, corporations, partnerships or other
business associations shall be deemed to have been given or made by, with or
to all of them. in like manner, if Tenant shall be a partnership or other
business association, the members of which are, by virtue of statute or
federal law, subject to personal liability, then the liability of each such
member shall be joint and several.
(w) INTENTIONALLY OMITTED.
(x) RULES AND REGULATIONS. Tenant agrees to comply with all rules
and regulations of the Building and the Project imposed by Landlord as set
forth on Exhibit "El. attached hereto, as the same may be changed from time
to time in a reasonable nondiscriminatory manner upon reasonable notice to
Tenant. Landlord shall not be liable to Tenant for the failure of any other
tenant or any of its assignees, subtenants, or their respective agents,
employees, representatives, invitees or licensees to conform to such rules
and regulations. To the extent of inconsistency between the Rules and
Regulations with other provisions of this Lease, the provisions of this Lease
shall apply.
(y) FINANCIAL STATEMENTS. Upon Landlord's written request no more
than annually, Tenant shall promptly furnish Landlord, from time to time,
with the next current audited financial statements, if any, prepared in
Tenant's customary manner, certified by Tenant and an independent auditor to
be true and correct, reflecting Tenant's then current financial condition.
20. ADDENDA
The provisions of this Paragraph 20 shall supersede and override
any other provision of this Lease to the extent the same are inconsistent:
(a) RENTAL ABATEMENT As consideration for Tenant's performance of
all of its obligations under the Lease, Landlord hereby conditionally (i)
grants Tenant a rent free fixturization period during months one (1) and two
(2) of the Lease Term in the amount of $372,628.14 I.E. $186,314.07 per
month) ("Fixturization Period"), and (ii) excuses Tenant from the payment of
the monthly installment of Basic Annual Rent during Months three (3) through
five (5) of the term of this Lease in the amount of $558,942.21 (I.E.
$186,314.07 per month) ("Deferred Rent Period"), together with Tenant's
Proportionate Share of Operating Costs during such period, provided that
Tenant shall not be in an uncured material default in its obligations under
this Lease during months 1-144 of the Lease term only. Should Tenant at any
time during months 1-144 of the Lease term be in default under this Lease and
not cure such default within the cure periods provided in this Lease, then
the total sum of such Rent so conditionally excused shall become immediately
due and payable by Tenant to Landlord. If at the expiration of the 144th
month of the term, Tenant has not so defaulted, Landlord shall waive any
payment of all such Rent so conditionally excused.
(b) LANDLORD DELAY. If Landlord shall not have delivered possession
of the Premises to Tenant with the Tenant Work substantially completed by the
date which is ninety (90) days following the Target Commencement Date plus
periods attributable to Tenant Delays or prevention, delay, or stoppage
caused by strikes, lockouts, labor disputes, acts of God, unavailability of
services, labor or materials or reasonable substitutes for those items,
government actions, civil commotion, fire, inclement weather, or other
casualty or causes outside of the reasonable control of Landlord commonly
considered FORCE MAJEURE (collectively "Penalty-Free Period"), Landlord shall
thereafter (so long as no Tenant's Default exists under this Lease) credit to
Basic Annual Rent first due under this Lease an amount equal to Two Thousand
Dollars ($2,000.00) per day for each day that Landlord has failed to so
deliver possession of the Premises to Tenant from the expiration of the
Penalty-Free Period until the date upon which Landlord has so delivered the
Premises to Tenant. At Tenant's written request, landlord will advise Tenant
of any such FORCE MAJEURE delays.
(c) OPTIONS TO EXTEND TERM. Landlord hereby grants to Tenant two (2)
options (Individually referred to hereinafter as an "Option" and collectively
referred to hereinafter as the "Options") to extend the term of this Lease
for additional consecutive terms of five (5) years and zero (0) months (each
is called an "Extension"), on the same terms and conditions as set forth in
this Lease, except the Basic Annual Rent shall be the amount determined as
set forth below. Tenant shall have the opportunity to exercise the initial
Option with respect to only four (4) contiguous floors of the Premises. The
second Option shall be exercised only with respect to the Premises so leased
during the first Extension. Each Option shall be exercised only by written
notice delivered to Landlord at least two hundred seventy (270) days before
the expiration of the initial term of this Lease or the immediately preceding
Extension ("Exercise Date"), as the case may be. If Tenant fails to deliver
to Landlord written notice of the exercise of the Option within the time
period prescribed above, such Option and any succeeding Options shall lapse,
and there shall be no further right to extend the term of this Lease. Each
Option shall be exercisable by Tenant on the express conditions that (i) at
the time of the exercise of such Option, and thereafter at all times prior to
the commencement of such Extension, a Tenant's Default shall not have
occurred and be continuing under this Lease, and (ii) Tenant has not been ten
(10) or more days late in the payment of Rent more than a total of nine (9)
times
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during the term of this Lease. If Tenant property exercises an Option,
"term", as used herein and in this Lease, shall be deemed to include the
applicable Extension, unless specified otherwise herein.
The Basic Annual Rent during each Extension shall be increased,
as of the commencement of each Extension (each is called a "Rental Adjustment
Date") to ninety-five percent (95%) of the "Fair Market Value" of the
Premises, determined in the following manner: Not later than ninety (90) days
prior to any applicable Exercise Date, Tenant shall give written notice to
Landlord of its preliminary interest in the applicable Option, and thereafter
Landlord and Tenant shall meet in an effort to negotiate, in good faith, the
Fair Market Value of the Premises as of the applicable Rental Adjustment
Date. If Landlord and Tenant have not agreed upon the Fair Market Value of
the Premises at least eighty (80) days prior to the applicable Exercise Date,
the Fair Market Value shall be determined by the following appraisal method:
(i) If Landlord and Tenant are not able to agree upon the
Fair Market Value of the Premises within the time period described above,
then Landlord and Tenant shall attempt to agree in good faith upon a single
appraiser not later than seventy-five (75) days prior to the applicable
Exercise Date. If Landlord and Tenant are unable to agree upon a single
appraiser within such time period, then Landlord and Tenant shall each
appoint one appraiser not later than sixty-five (65) days prior to the
applicable Exercise Date, and Landlord and Tenant shall each give written
notice to the other of such appointment at the time of such appointment
Within ten (10) days thereafter, the two appointed appraisers shall appoint a
third appraiser. If either Landlord or Tenant fails to appoint its appraiser
and to give written notice thereof to the other party within the prescribed
time period, the single appraiser appointed shall determine the Fair Market
Value of the Premises. If both parties fail to appoint appraisers within the
prescribed time periods, then the first appraiser thereafter selected by a
party (such selection to be by written notice thereof to such appraiser and
the other party) shall determine the Fair Market Value of the Premises. Each
party shall bear the cost of its own appraiser and the parties shall share
equally the cost of the single or third appraiser if applicable. All
appraisers shall have at least two (5) years' experience in the appraisal of
commercial/industrial real property in the area in which the Premises am
located and shall be members of professional organizations such as MAI or its
equivalent.
(ii) For the purposes of such appraisal, the term "Fair
Market Value" shall mean the price that a ready and willing tenant would pay
and Landlord would accept, as of the applicable Rental Adjustment Date, as
monthly rent, for comparable space within comparable high-rise office
buildings in the greater John Wayne Airport area if such space, including all
incidental amenities, such as parking, were exposed for lease on the open
market for a reasonable period of time. If a single appraiser is chosen, then
such appraiser shall determine the Fair Market Value of the Premises.
Otherwise, the Fair Market Value of the Premises shall be the arithmetic
average of the two (2) of the three (3) appraisals which are closest in
amount, and the third appraisal shall be disregarded. Landlord and Tenant
shall instruct the appraiser(s) to complete their determination of the Fair
Market Value not later than thirty (30) days prior to the applicable Exercise
Date. If the Fair Market Value is not determined prior to the applicable
Exercise Date, then Tenant may elect not to exercise the applicable Extension
option, or Landlord may agree to extend the applicable Exercise Date for an
additional period of time, not to exceed thirty (30) days, so as to inalize
the determination of Fair Market Value.
(iii) In no event shall the Basic Annual Rent be reduced
below the Basic Annual Rent applicable to the Premises immediately prior to
the applicable Rental Adjustment Date.
Promptly following the commencement of each exercised Extension
Landlord shall at Landlord's expense, repaint and re-carpet the Premises
utilizing equivalent type, grade and quality materials as originally
installed.
(d) EXPANSION OPTION. Provided no Tenant's Default has occurred and
is continuing, if rentable space on Floors 7-9 of the Building (collectively,
the "Adjacent Space") shall become available for leasing by other than any
existing tenant(s), Landlord shall make said Adjacent Space available to
Tenant to lease, upon the terms and conditions hereinafter set forth ("Right
of First Offer'). When all or any portion of the Adjacent Space first becomes
available as set forth above, Landlord shall, prior to making the Adjacent
Space available to other third parties, deliver written notice of such
availability to Tenant ("Landlord's Notice"). For a period of fifteen (15)
days following Tenants receipt of Landlord's Notice, Tenant shall have the
first opportunity to lease the Adjacent Space upon the terms and conditions
set forth below, by delivering to Landlord within said fifteen (15) day
period written notice ("Election Notice") of its election to exercise its
Right of First Offer. If Tenant fails or elects not to exercise its Right of
First Offer granted pursuant to this paragraph with in said fifteen (15) day
period. the Right of First Offer shall automatically terminate without
further action of the panics, and Landlord shall thereafter be free to lease
the Adjacent Space to any third party upon such terms and conditions as
Landlord desires. If Tenant timely and properly exercises its Right of First
Offer as hereinabove provided, Tenant shall, within fifteen (15) days after
receipt from Landlord, enter into an amendment of this Lease with Landlord
upon Landlord's then current standard lease amendment form for the Building,
which amendment shall incorporate the Adjacent Space Into the Premises upon
the terms and conditions hereinafter set forth. If Tenant fails to execute
and deliver such amendment within said fifteen (15) day period, the Right of
First Offer shall automatically terminate without further action of the
parties, and Landlord shall thereafter be free to lease the Adjacent Space to
any third party upon such terms and conditions as Landlord desires.
Notwithstanding the foregoing, should Tenant initially fail to exercise the
Right of First Offer, Tenant shall thereafter be permitted to periodically
inquire as to whether Adjacent Space is leaseable". If Adjacent Space is
leaseable, Tenant shall be permitted to lease such Adjacent Space as provided
in this Subparagraph 20(d). For purposes of this Subparagraph 20(d),
unleaseable shall mean any Adjacent Space which is then vacant and for which
Landlord is not currently negotiating for lease to a third party.
Upon Tenant's timely and proper exercise of the Right of First
Offer, the Adjacent Space shall be incorporated into the Premises and shall
be leased to Tenant upon the same terms and conditions as are then in effect
under this Lease, for the remaining term as set forth in this Lease and at
the rate of Basic Annual Rent in effect, except that:
(i) If Tenant is leasing any portion of floor 7, then
Monthly installments of Basic Annual Rent due under this Lease shall be
increased to reflect such rent upon the Adjacent Space with respect to such
floor 7 at the rate then in effect under this Lease for floors 1-6 ; If
Tenant is leasing any portion of floor 8, then Monthly installments of Basic
Annual Rent due under this Lease shall be increased to reflect such rent upon
the Adjacent Space with respect to such floor 8 at a rate equal to the sum of
the rate then in effect under this Lease (for floors 1-6) plus nine cents
($0.09)/per month per square foot of such floor 8; If Tenant is leasing any
portion of floor 9 then
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Monthly installments of Basic annual Rent due under this Lease shall be
increased to reflect such rent upon the Adjacent Space with respect to such
floor 9 at a rate equal to the sum of the rate then in effect under this
Lease (for floors 1) plus nineteen cents ($0.19 per month per square foot of
such floor 9.
(ii) Tenant's Proportionate Share shall be increased to
reflect the Rentable Area of the Adjacent Space;
(iii) The parking spaces available for Tenant shall
be increased at the ratio of three (3) spaces per 1,000 square feet of
Adjacent Space.
(e) NONDISTURBANCE AGREEMENT Landlord shall use best efforts to
provide Tenant with a reasonable nondisturbance agreement from mortgagees of
Landlord, should they exist, to be delivered within a reasonable time period
after the closing of any such loan.
(f) INTENTIONALLY LEFT BLANK
(g) DEFINITION - NONDISCRIMINATORY. For purposes of Paragraphs 4(b)
and 7(c) of this Lease, the term "nondiscriminatory" refers to those rules
and requirements established from time to time by Landlord for general
application to and enforcement against all or substantially all tenants in
the Project, including, with respect to Paragraph 4(b), work site rules,
regulations regarding time of work, notice requirements and bonding
requirements.
(h) INTENTIONALLY LEFT BLANK
(i) NONLIABILITY AND INDEMNIFICATION OF LANDLORD. Notwithstanding
any provision set forth in Section 8(a), 6(b) or 19(e) of the Lease to the
contrary, Landlord shall not be exempted from liability under Section 8(a),
and Tenant shall not be required to indemnity Landlord under Paragraph 8(b),
if, but only if, Landlord's conduct, which gives rise to such claim, amounts
to gross negligence or willful misconduct.
(j) AMERICANS WITH DISABILITIES ACT Landlord agrees to be
responsible for and shall pay all remedial costs associated with, and shall
comply with, the Americans with Disabilities Act ("ADA"), as it relates to
the Common Areas of the Building only, based solely on requirements existing
or Imposed on Landlord as of the Commencement Date. Any changes,
modifications, rehabilitation or repair to the Common Area required by any
amendment to ADA or any regulations thereunder which are enacted or become
effective after the Commencement Date, shall be Landlord's responsibility,
but the cost thereof shall be an Operating Cost for purposes of this Lease.
Notwithstanding any other provision of the Lease, Landlord shall have no
duty, obligation or responsibility, nor shall Landlord be obligated to expend
any monies over and above the work specified in the Work Letter, to the
extent caused by a Tenant requested Change Order, to make the Premises comply
with any requirement of ADA or any other similar laws, including life-fire
safety codes, physical handicap codes and/or earthquake safety codes.
(k) TRANSPORTATION MANAGEMENT Tenant shall fully comply with all
present or future governmentally mandated programs intended to manage
parking, transportation or traffic in and around the Building, and in
connection therewith, Tenant shall take responsible action for the
transportation planning and management of all employees located at the
Premises by working directly with Landlord, any governmental transportation
management organization or any other transportation-related committees or
entities.
(l) OPERATING COSTS CAP. Notwithstanding anything to the contrary
contained in Paragraph 3 of this Lease, provided no Tenant's Default has
occurred and is continuing, annual increases in Tenants Proportionate Share
of Operating Costs (exclusive of taxes, insurance, repairs, capital
expenditures, and items outside of Landlord's reasonable control) shall not
exceed the lesser of (i) the percentage increase in the Index (as defined in
Item 5 of the Basic Lease Provisions) from the prior year, or (ii) four
percent (4%) per year. Tenant acknowledges and agrees that Tenant shall be
responsible for Tenant's Proportionate Share of all increases in taxes,
insurance, repairs, capital expenditures, and items outside of the reasonable
control of Landlord. In addition, Tenant shall not be liable for Tenant's
Proportionate Share of any increase in real property taxes arising solely due
to reassessment of all or any portion of the Project as a result of a sale,
exchange or other transfer of an interest in the Project.
(m) MOVING-RELATED ALLOWANCE. As an additional Tenant Inducement (as
that term is defined in Paragraph 120) of this Lease), Landlord shall provide
to Tenant an allowance in the amount of One Dollar ($1.00) per square foot of
Rentable Area of the Premises as of the Commencement Date to be used towards
moving, cabling, and other moving-related expenses, including without
limitation miscellaneous consultant expenses in connection therewith. Tenant
shall provide to Landlord, as a condition to receiving any payment under this
allowance, copies of paid invoices or other evidence satisfactory to Landlord
of all such paid expenses.
(n) SIGNAGE. As defined in Specific Development Plan No. SD43, as
amended pursuant to Ordinance NS-2390 ("Applicable Ordinance"), Tenant shall
have the right to two (2) Building Identification Signs at the top of the
Building (which shall be exclusive to Tenant and is hereby granted personally to
Tenant and not to any other assigning subtenant or transferor of Tenant), one
(1) identification sign on an Entryway Sign to the Building (if two (2) tenant
names are identified on an Entryway Sign, Tenant's name shall be located above
such other tenant's name), and if Landlord decides to erect any Ground
Identification Sign(s) within the Project and Landlord chooses to include any
tenant names on any such Ground Identification Sign(s), then Tenant shall have
the right to one (1) identification sign on a Ground Identification Sign. Each
Building Identification Sign, Entryway Sign and Ground Identification Sign shall
be in such location as designated by Landlord. Tenant shall have no right to
maintain identification signs in any other location in, on or about the Building
or Project and shall not display or erect any other signs, displays or other
advertising materials that are visible from the exterior of the Premises. The
size, design, color and other physical aspects of the permitted signs shall be
subject to Landlord's written approval prior to installation (not to be
unreasonably withheld or delayed), any covenants, conditions and restrictions
applicable to the Project, all applicable municipal or other governmental
permits and approvals, and any other signage criteria applicable to the Building
or Project and approved by the applicable governmental authorities including,
but not limited to, the Applicable Ordinance. The cost of all signs, including
the installation, maintenance and removal thereof shall be at Tenant's sole cost
and expense. If Tenant fails to maintain its signs, or if Tenant fails to
remove same upon
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termination of this Lease and repair any damage caused by such removal
(including, but not limited to, resurfacing the affected area, if required by
Landlord), Landlord may do so at Tenant's expense.
(o) EXCLUSIVITY. Provided no Tenant's Default has occurred and is
continuing and that Tenant has not sublet the entire Premises or assigned its
interest in this Lease pursuant to Paragraph 11 to other than an affiliated
company, Landlord agrees that Landlord shall not lease any other space within
the Building throughout the term of this Lease to another business or entity
whose business is in direct competition with the business of Tenant.
(p) ENVIRONMENTAL RELEASE. Landlord shall make available to Tenant
copies of any environmental assessment reports in Landlord's possession
relating to the Project as of the Commencement Date. Tenant shall have no
liability or responsibility with respect to any Hazardous Materials
disclosures contained therein.
21. CONSTRUCTION OF BUILDING
Tenant and Landlord understand and agree that the Building is to be
constructed by Landlord as part of the Project.
(a) The Building will be a 9-story building containing approximately
205,000 square feet of Rentable Area substantially as shown on the Site Plan
attached as Exhibit "A-2" of this Lease. Access to the main entrance to the
Building and the parking area from Columbine Avenue will be as shown on the
Site Plan. The ratio of usable to Rentable Area in the Building will be no
less than ninety percent (90%) for a full floor tenant.
(b) The Project consists of two 9-story office buildings over a
2-level parking garage. The Project is situated on approximately 5.9 acres.
The Project is a part of an approximately 6&acre Specific Development Plan
known as MacArthur Place. Parking of approximately 1,400 parking spaces for
the Project will be provided on two levels underneath the buildings as well
as the upper parking deck where the buildings are situated.
(c) The Project is subject to the Master Declaration of Covenants,
Conditions, Easements and Restrictions or MacArthur Place, as the same may be
amended from time to time. Landlord reserves the right, prior to or upon
completion of the Project, to record a Reciprocal Easement Access and
Maintenance Agreement or like instrument ("REA") against the Project for the
mutual benefit of all owners of property within the Project and their
tenants, and which will impose certain restrictions, covenants, easements and
obligations upon the Premises, Landlord and Tenant, in order to obtain such
benefit The REA will be reasonable in form and content, will not be
inconsistent with Tenant's rights under the Lease, and will contain those
features and provisions in similar instruments executed and recorded by
Landlord on similar properties. The REA will likely contain, without
limitation, the following:
(i) Reciprocal easements for vehicular and pedestrian
access, circulation and parking;
(ii) Covenants for the maintenance and repair (or
reimbursement for the costs thereof if done by an `Operator' or similar
entity designated in the REA) of the exterior of all buildings, landscaping
and parking area; and
(iii) Assessment provisions for the reimbursement of costs
incurred by an `Operator' or similar entity designated in the REA who is
authorized to enforce the REA and/or perform certain maintenance and repair
functions specified therein. Such assessments will be allocated by either a
separate charge attributable directly to work or services provided for the
Premises, or an in-common basis for the whole Project, in which case a pro
rata allocation to the Premises will be made based upon the gross square
footage of the Building compared with the gross square footage of all
completed buildings within the Project.
Tenant agrees that this Lease and the Tenants occupancy of the
Premises hereunder shall, upon the recordation of the REA in the Official
Records of Orange County, be subject and subordinate to the REA, and Tenant
agrees to abide thereby. Landlord shall make a copy of the REA available to
Tenant concurrently with or promptly following its recordation.
(d) Landlord shall, at Landlord's sole cost and expense, construct
and complete the Building, the Common Areas and the parking area as described
in the Outline Specifications attached as Exhibit "H" to this Lease, in a
good and workmanlike manner, substantially in compliance with the plans and
specifications therefor prepared by Landlord and approved by the City of
Santa Ana, and in compliance with applicable Laws.
(e) Notwithstanding any other provision in this Lease to the
contrary, if the Commencement Date of this Lease has not occurred on or
before January 5, 2002 (i.e., one year following the Target Commencement
Date), then Tenant shall thereafter, upon written notice to Landlord and any
lender previously identified to Tenant under Section 19(l), have the right to
terminate this Lease in the same manner as is provided in Section 19(l)
including subparts (i) and (ii) thereof. The January 5, 2002 date shall be
extended for the period of any Tenant Delay under the Work Letter.
-21-
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT 21
MATERIAL SUBSIDIARIES OF THE REGISTRANT
STATE OR COUNTRY PERCENTAGE OF
SUBSIDIARY OF INCORPORATION OWNERSHIP
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Aries Technology, Inc. Delaware 100%
- ----------------------------------------------------------------------------------------------------------
Knowledge Revolution, Inc. California 100%
- ----------------------------------------------------------------------------------------------------------
MSC Japan, Ltd. Japan 100%
- ----------------------------------------------------------------------------------------------------------
MSC Italia Italy 100%
- ----------------------------------------------------------------------------------------------------------
MSC, Ltd. Hong Kong 100%
- ----------------------------------------------------------------------------------------------------------
MacNeal-Schwendler France France 100%
- ----------------------------------------------------------------------------------------------------------
MSC BV The Netherlands 100%
- ----------------------------------------------------------------------------------------------------------
MSC Ltd. U.K. 100%
- ----------------------------------------------------------------------------------------------------------
MSC GmbH Germany 100%
- ----------------------------------------------------------------------------------------------------------
MSC Iberica, S.A. Spain 100%
- ----------------------------------------------------------------------------------------------------------
MSC Foreign Sales Corporation California 100%
- ----------------------------------------------------------------------------------------------------------
PDA Engineering California 100%
- ----------------------------------------------------------------------------------------------------------
MARC Analysis Research Corporation California 100%
- ----------------------------------------------------------------------------------------------------------
Universal Analytics, Inc. California 100%
- ----------------------------------------------------------------------------------------------------------
Computerized Structural Analysis and Research Corporation California 100%
- ----------------------------------------------------------------------------------------------------------
</TABLE>
75
<PAGE>
EXHIBIT 23
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statements (Form S-8 No. 33-51744, No. 33-65239, No. 333-12189, No. 333-62187
and No. 333-84219 pertaining to the 1991 Stock Option Plan of MSC.Software
Corporation, the MSC.Software Corporation 1996 Employee Stock Purchase Plan
and the 1998 Stock Option Plan of MSC.Software Corporation and to the
incorporation by reference in the Registration Statements (Form S-3 No.
333-89317 and 333-86809) of MSC.Software Company and the related Prospectuses
and amendment No. 1 to the Registration Statement (Form S-3 No. 333-89319)
and the related Prospectus of our report dated February 23, 2000, with
respect to the consolidated financial statements of MSC.Software Corporation
included in the Annual Report (Form 10-K) for the year ended December 31,
1999.
/s/ Ernst & Young LLP
Los Angeles, California
March 24, 2000
76
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<CIK> 0000717238
<NAME> MSC.SOFTWARE CORPORATION
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 10,822
<SECURITIES> 16,481
<RECEIVABLES> 43,279
<ALLOWANCES> (3,605)
<INVENTORY> 0
<CURRENT-ASSETS> 82,919
<PP&E> 29,388
<DEPRECIATION> (20,493)
<TOTAL-ASSETS> 140,617
<CURRENT-LIABILITIES> 59,395
<BONDS> 56,574
0
0
<COMMON> 31,754
<OTHER-SE> (14,067)
<TOTAL-LIABILITY-AND-EQUITY> 140,617
<SALES> 0
<TOTAL-REVENUES> 125,397
<CGS> 46,255
<TOTAL-COSTS> 135,438
<OTHER-EXPENSES> 3,134
<LOSS-PROVISION> 2,203
<INTEREST-EXPENSE> 4,461
<INCOME-PRETAX> (13,175)
<INCOME-TAX> (196)
<INCOME-CONTINUING> (12,979)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (12,979)
<EPS-BASIC> (0.95)
<EPS-DILUTED> (0.95)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<CIK> 0000717238
<NAME> MSC.SOFTWARE CORPORATION
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<EXCHANGE-RATE> 1
<CASH> 21,735
<SECURITIES> 183
<RECEIVABLES> 41,177
<ALLOWANCES> (3,182)
<INVENTORY> 0
<CURRENT-ASSETS> 82,489
<PP&E> 32,015
<DEPRECIATION> (23,430)
<TOTAL-ASSETS> 187,220
<CURRENT-LIABILITIES> 70,833
<BONDS> 74,624
0
0
<COMMON> 32,451
<OTHER-SE> (7,645)
<TOTAL-LIABILITY-AND-EQUITY> 187,220
<SALES> 0
<TOTAL-REVENUES> 149,235
<CGS> 38,261
<TOTAL-COSTS> 146,599
<OTHER-EXPENSES> (6,399)
<LOSS-PROVISION> 245
<INTEREST-EXPENSE> 5,788
<INCOME-PRETAX> 9,035
<INCOME-TAX> 3,938
<INCOME-CONTINUING> 5,097
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,097
<EPS-BASIC> 0.37
<EPS-DILUTED> 0.37
</TABLE>
