Schnitger Corporation

MSC rides a winding road

MSC Software proved last week that it is not immune to the slowdown in spending seen
by other PLM suppliers. Total Q4 revenue of $65 million was down 9% from a year ago,
leading the company to an operating loss for the quarter. For the year MSC reported total
revenue of $254.4 million, up 3% from last year’s $246.7 million, but with a loss from
continuing operations of $21.3 million, compared to a loss from continuing operations of
$2.6 million for FY 2007.
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MSC, like ANSYS, dramatically lowered its guidance for 2009 now expecting revenues to
decline somewhere around 12% in 2009, most of that in the software category. Revenue in
Q1 and Q2 will be down 15% "plus or minus several percentage points".

Once again, highlights and lowlights from the earnings release and call. On the plus side:

– Maintenance revenue remains MSC’s financial backbone, accounting for 54% of total
revenue for 2008. This high level of repeatability provides visibility into the future and shows
that MSC’s customers do rely on this technology to succeed. But there’s a downside,
too… see below

– Geographic performance held fairly constant; for the year, the Americas had the
strongest performance with revenue growth of 7% to $80 million; EMEA was essentially
flat at $96 million and Asia Pac grew by 3% to $78 million.

– Customers continue to see the value of MSC’s enterprise message, as enterprise
solutions accounted for an increasing proportion of total software revenue throughout the
year, totalling perhaps $17.5 millio. However, buyers do seem lukewarm on the company’s
MD message, as this category of product was a lumpy proportion of total software
revenue, accounting for perhaps $11 million in revenue. In Q4, it appears that customers
elected to go with traditional engineering apps as MD revenue was the lowest of the year.
It’s important to point out that MSC did generate 32% of total revenue from these new
product categories in 2008, up 21% over 2007.

But there are negatives, too:

– MSC reported that software revenue declined $4 million in Q4 and $6 million (or 6%) for
the year. Sam Auriemma, CFO, said that the company experienced "deals being delayed
or deferred due to spending freezes, budgetary restrictions, and generally longer approval
processes, particularly in Europe" during Q4. Before Q4, the company was on track to
grow software revenue, year over year. The "chilling effect" of Q4 can’t be understated,
and, as company execs pointed out, is a worrisome harbinger for 2009.

– Software revenue for the year fell from $94.7 million to $89.3 million even as maintenance
revenue climbed $12 million to account for almost all of the net gain seen by MSC in 2008.

– My earlier musings about large deals were partially correct. MSC closed more large
deals every quarter of 2008 than in the comparable quarter of 2007, but the average deal
size dropped from $350K in Q4 2007 to $250K in Q4 2008. The total value of these deals
dropped from $38 million in Q4 2007 to $33 million in Q4 2008. That 13% decline will be
hard to make up in smaller sales.

– MSC (and other companies) rely on maintenance revenue to provide a cushion in case of
bad economic times. MSC’s maintenance revenue has been falling as a proportion of total
revenue, partially as a result of lower license sales. For 2008, it was 54%, but in Q4 this
fell to 51%. The company feels that it will not decline proportionately with software revenue
— we’ll see.

One more thing, since I made the point about ANSYS: MSC spends about 20% of revenue
on R&D. While this dollar total ($51 million) is substantially lower than ANSYS’ ($71.5
million) , it could be argued that MSC’s investment is more targeted at FEA (rather than
ANSYS’ FEA, CFD and electromagentics). Not saying either is better … but someone
wrote in to ask …

All in all, MSC is doing the right things, and following the lead of many of its customers:
when your core markets let you down, seek new ones. When your products need to be
updated, take the time to do that. While a turnaround is never easy, and always takes
longer than expected, MSC seems to be on the right track.Let’s hope economic factors
out of the company’s control don’t derail the recovery.

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