<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal period ended: SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ____________ to
____________
Commission file number: 0-20679
MECHANICAL DYNAMICS, INC.
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2163045
(State of incorporation) (I.R.S. Employer Identification No.)
2301 COMMONWEALTH BLVD.
ANN ARBOR, MICHIGAN 48105
(734) 994-3800
(Address of principal executive offices, including zip
code, and telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [ ] No
The number of outstanding shares of the Registrant's common stock, as of
November 11, 1998, was 6,225,206.
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MECHANICAL DYNAMICS, INC.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.....................................................................
Condensed Consolidated Balance Sheets
September 30, 1998 and December 31, 1997................................................. 3
Condensed Consolidated Statements of Income
Three and Nine Months Ended September 30, 1998 and 1997.................................. 4
Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 30, 1998 and 1997............................................ 5
Notes to Condensed Consolidated Financial Statements..................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 8
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K......................................................... 15
SIGNATURES.......................................................................................... 16
INDEX TO EXHIBITS................................................................................... 17
</TABLE>
2
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
in thousands 1998 1997
- ------------------------------------------------------------------------------------------------------------
(Unaudited)
<S> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents $16,501 $20,261
Accounts receivable 8,196 8,000
Prepaid and deferred expenses 1,822 1,206
- ------------------------------------------------------------------------------------------------------------
Total current assets 26,519 29,467
- ------------------------------------------------------------------------------------------------------------
Net property and equipment 3,479 2,887
Other assets 3,797 1,793
- ------------------------------------------------------------------------------------------------------------
Total assets $33,795 $34,147
- ------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current liabilities:
Borrowings under lines of credit $130 $45
Accounts payable 1,148 1,474
Accrued expenses 2,976 3,734
Deferred revenue 4,377 4,462
- ------------------------------------------------------------------------------------------------------------
Total current liabilities 8,631 9,715
- ------------------------------------------------------------------------------------------------------------
Minority interest 488 462
Shareholders' equity:
Common stock 21,905 20,838
Preferred stock 0 0
Retained earnings 2,824 3,290
Cumulative translation adjustment (53) (158)
- ------------------------------------------------------------------------------------------------------------
Total shareholders' equity 24,676 23,970
- ------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $33,795 $34,147
- ------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
<PAGE> 4
MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- --------------------------
in thousands except share and per share data 1998 1997 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue:
Software licenses $4,093 $4,568 $13,530 $12,484
Services 4,087 3,111 12,290 9,101
- ---------------------------------------------------------------------------------------------------------------------------
Total revenue 8,180 7,679 25,820 21,585
- ---------------------------------------------------------------------------------------------------------------------------
Cost of revenue:
Software licenses 689 271 1,489 563
Services 2,414 1,606 6,900 4,868
- ---------------------------------------------------------------------------------------------------------------------------
Total cost of revenue 3,103 1,877 8,389 5,431
- ---------------------------------------------------------------------------------------------------------------------------
Gross profit 5,077 5,802 17,431 16,154
- ---------------------------------------------------------------------------------------------------------------------------
Operating expenses:
Sales and marketing 3,545 3,087 10,167 8,578
Research and development 1,375 1,223 3,911 3,358
General and administrative 893 799 2,596 2,383
Purchased in-process research and development 203 0 1,403 0
- ---------------------------------------------------------------------------------------------------------------------------
Total operating expenses 6,016 5,109 18,077 14,319
- ---------------------------------------------------------------------------------------------------------------------------
Operating income (loss) (939) 693 (646) 1,835
Other income, net 207 236 622 592
- ---------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and minority interest (732) 929 (24) 2,427
Provision (credit) for income taxes (160) 280 416 731
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) before minority interest (572) 649 (440) 1,696
Minority interest in net income (loss) of subsidiary 14 0 26 (19)
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) ($586) $649 ($466) $1,715
- ---------------------------------------------------------------------------------------------------------------------------
Basic net income (loss) per common share ($0.09) $0.11 ($0.08) $0.30
- ---------------------------------------------------------------------------------------------------------------------------
Weighted average common shares 6,213,082 5,781,991 6,173,224 5,771,036
- ---------------------------------------------------------------------------------------------------------------------------
Diluted net income (loss) per common share ($0.09) $0.11 ($0.08) $0.29
- ---------------------------------------------------------------------------------------------------------------------------
Weighted average common and common equivalent shares 6,213,082 5,842,828 6,173,224 5,870,694
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
<PAGE> 5
MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
in thousands 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ($466) $1,715
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Purchased in-process research and development 1,403 0
Depreciation and amortization 1,165 684
Loss on disposal of assets, net 39 28
Minority interest in net income (loss) of subsidiary 26 (19)
Changes in assets and liabilities:
Accounts receivable (418) (1,209)
Prepaid and deferred expenses (264) 202
Other assets (50) (96)
Accounts payable (176) (67)
Accrued expenses (784) (202)
Deferred revenue (636) (63)
- -----------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (161) 973
- -----------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from the sale of property and equipment 19 48
Purchases of property and equipment (1,507) (1,136)
Purchase of HGE, Inc., net of cash acquired (2,040) 0
Purchase of DTI Asia Pte. Ltd., net of cash acquired (563) 0
- -----------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (4,091) (1,088)
- -----------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net borrowings (payments) under line of credit agreements 85 (45)
Proceeds from the issuance of common stock 335 202
Minority investment in consolidated subsidiary 0 467
- -----------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 420 624
- -----------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 72 (41)
- -----------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (3,760) 468
Cash and cash equivalents at beginning of period 20,261 20,570
- -----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $16,501 $21,038
- -----------------------------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information: Cash paid during the period
for:
Interest $10 $10
Income taxes $1,270 $673
- -----------------------------------------------------------------------------------------------------------------------------
Details of acquisition of HGE, Inc.:
Net liabilities, excluding cash acquired ($118)
Purchase price in excess of the net assets acquired 1,955
Purchased in-process research and development 203
- ---------------------------------------------------------------------------------------------------------------
Net cash used to acquire HGE, Inc. $2,040
- ---------------------------------------------------------------------------------------------------------------
Details of acquisition of DTI Asia Pte. Ltd.:
Net liabilities, excluding cash acquired ($59)
Purchase price in excess of the net assets acquired 154
Purchased in-process research and development 1,200
Stock issued (732)
- ---------------------------------------------------------------------------------------------------------------
Net cash used to acquire DTI Asia Pte. Ltd. $563
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
<PAGE> 6
MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
include the accounts of Mechanical Dynamics, Inc. ("MDI" or the "Company") and
its subsidiaries, and have been prepared in accordance with generally accepted
accounting principles for interim financial information and with Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. The Company believes all adjustments, consisting of normal
recurring adjustments considered necessary for a fair presentation, have been
included. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Form 10-K for the
year ended December 31, 1997.
Operating results for the three and nine month periods ended September 30,
1998 and 1997 are not necessarily indicative of the results that may be expected
for the full year.
(2) - ACQUISITIONS
In August 1998, the Company acquired the Design Analysis Group and certain
other assets of H.G.E. Inc., an engineering software and services firm based in
Toronto, Ontario. The aggregate purchase price of approximately $2.0 million
consisted entirely of cash. The acquisition has been accounted for under the
purchase method of accounting. In connection with the acquisition, the Company
recorded a non-recurring charge to operations in the third quarter of 1998 of
approximately $203,000, associated with the write-off of in-process research and
development acquired in the transaction that had not reached technological
feasibility. The remaining excess of the aggregate purchase price over the fair
value of the net assets acquired has been recognized as goodwill and will be
amortized over a twelve-year period. The operating results of the Design
Analysis Group of H.G.E. Inc. have been included in the consolidated results of
operations from the date of acquisition.
In January 1998, the Company acquired 100% of the outstanding capital stock
of DTI Asia Pte. Ltd. ("DTI"), a provider of mechanical design simulation
software embedded in the AutoCAD and Mechanical Desktop product lines from
Autodesk, Inc. The aggregate purchase price of approximately $1.3 million
consisted of $563,000 in cash and 142,540 shares of the Company's common stock
valued at $732,000. The acquisition has been accounted for under the purchase
method of accounting. In connection with the acquisition, the Company recorded a
non-recurring charge to operations in the first quarter of 1998 of approximately
$1.2 million, associated with the write-off of in-process research and
development acquired in the transaction that had not reached technological
feasibility. The remaining excess of the aggregate purchase price over the fair
value of the net assets acquired has been recognized as goodwill and will be
amortized over a five-year period. The operating results of DTI have been
included in the consolidated results of operations from the date of acquisition.
(3) - COMPREHENSIVE INCOME
In July 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 establishes standards for reporting and display of comprehensive
income and its components in a full set of financial statements. Comprehensive
income is the total of net income and all other non-owner changes in equity. The
Company adopted this standard effective January 1, 1998. Total comprehensive
income (loss) was ($417,000) and $555,000 for the three month periods ended
September 30, 1998 and 1997, respectively, and ($361,000) and $1,611,000 for the
nine month periods ended September 30, 1998 and 1997, respectively. The
difference between net income, as reported in the accompanying condensed
consolidated statements of income, and total comprehensive income was the
foreign currency translation adjustment for the respective periods.
6
<PAGE> 7
(3) - DERIVATIVES
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and hedging activities. It requires that
an entity record all derivatives as either assets or liabilities at fair value.
Under certain conditions, a derivative may be designated as a hedge of (1)
potential changes in the fair value of an asset or liability or firm commitment,
(2) the foreign currency exposure of a forecasted transaction, or (3) the
foreign currency exposure of the net investment in a foreign operation. The
accounting for changes in the fair value of a derivative instrument depends on
the intended use of the derivative and the resulting designation. The statement
is effective for all fiscal quarters of fiscal years beginning after June 15,
1999. The Company's derivative activities are currently limited to entering into
forward contracts to hedge potential changes in the fair value of its
receivables denominated in certain foreign currencies.
(4) - SUBSEQUENT EVENT
In November 1998, the Board of Directors authorized management of the
Company to repurchase up to 500,000 shares of the Company's common stock. No
shares have been repurchased to date.
In October 1998, the Company announced a strategic partnership with the
University of Iowa in which component-level durability sensitivity analysis
technology developed by the University will be integrated with the Company's
ADAMS virtual prototyping software to provide system-level durability design
sensitivity analysis capabilities. In connection with the transaction, the
Company expects to report a one-time charge in the fourth quarter of 1998 of
$400,000, associated with the write-off of in-process research and development
acquired from the University. The purchase price will be allocated to
in-process research and development as the software has not reached
technological feasibility and no other tangible or intangible assets have been
identified.
7
<PAGE> 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS Of FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion provides an analysis of the Company's financial
condition and results of operations, and should be read in conjunction with the
Company's condensed consolidated financial statements and the notes thereto
included in Item 1 of this Form 10-Q.
OVERVIEW
The Company develops, markets and supports virtual prototyping solutions.
The Company's virtual prototyping software allows the engineer or designer to
design a complete product by simulating, both visually and mathematically, a
product in motion. The Company's principal software product, ADAMS Full
Simulation Package, is used by customers to simulate mechanical systems. The
Company's revenue has in the past been, and is expected in the future to be,
derived primarily from its ADAMS Full Simulation Package and related software
products and services.
FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY
Except for the historical information contained in this report, the matters
herein contain "forward-looking" statements (as defined in the Private
Securities Litigation Reform Act of 1995) that involve risk and uncertainty.
These forward-looking statements include, but are not limited to, revenue
levels, including the level of international revenue, certain costs and
operating expense levels, the level of other income, the Company's liquidity and
capital needs and various business environment and trend information. Actual
future results and trends may differ materially depending on a variety of
factors, including the volume and timing of orders received during the quarter,
the mix of and changes in distribution channels through which the Company's
products are sold, the timing and acceptance of new products and product
enhancements of the Company or its competitors, changes in pricing, the level of
the Company's sales of third party products, purchasing patterns of distributors
and customers, competitive conditions in the industry, business cycles affecting
the markets in which the Company's products are sold, extraordinary events, such
as litigation or acquisitions, including related charges, and economic
conditions generally or in various geographic areas. All of the foregoing
factors are difficult to forecast. The future operating results of the Company
may fluctuate as a result of these and other risk factors detailed from
time-to-time in reports filed by the Company with the Securities and Exchange
Commission.
Due to all of the foregoing factors, the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as an indication of future performance.
It is likely that, in some future quarters, the Company's operating results will
be below the expectations of stock market analysts and investors. In such an
event, the price of the Company's Common Stock would likely be materially
adversely affected.
8
<PAGE> 9
RESULTS OF OPERATIONS
REVENUE
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------------ ----------------------------------------
dollars in thousands 1998 1997 % CHANGE 1998 1997 % CHANGE
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Software licenses $4,093 $4,568 -10.4% $13,530 $12,484 8.4%
% of total revenue 50.0% 59.5% 52.4% 57.8%
Services $4,087 $3,111 31.4% $12,290 $9,101 35.0%
% of total revenue 50.0% 40.5% 47.6% 42.2%
- -----------------------------------------------------------------------------------------------------------------------------
Total revenue $8,180 $7,679 6.5% $25,820 $21,585 19.6%
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
In August 1998, the Company acquired the Design Analysis Group and certain
other assets of H.G.E. Inc., an engineering software and services firm based in
Toronto, Ontario. Revenue from the Design Analysis Group has been in the past,
and is expected to be in the future, derived primarily from sales of third party
software products, professional services and sales of the Company's software
products. The operating results of the Design Analysis Group have been included
in the Company's consolidated results of operations from the date of
acquisition.
The Company's total revenue increased 6.5% and 19.6% during the three and
nine month periods ended September 30, 1998, respectively, as compared to the
corresponding periods in 1997. The growth in revenue during the three and nine
month periods ended September 30, 1998 resulted from an increase in services
provided to the Company's customers, as well as an increase in sales of third
party software products. The revenue growth experienced by the Company during
the third quarter of 1998 was partially offset by a decline in sales of the
Company's software products.
Revenue from international customers, defined as customers outside of North
America, accounted for approximately 62.5% and 72.5% of the Company's total
revenue during the three months ended September 30, 1998 and 1997, respectively.
International revenue accounted for approximately 63.0% and 66.7% of total
revenue during the nine months ended September 30, 1998 and 1997, respectively.
The decrease in international revenue as a percent of total revenue during the
three month period ended September 30, 1998 was due primarily to a decline in
revenue from Asia, as well as an increase in revenue from North America, due in
part to the company's recent acquisition of the Design Analysis Group. The
revenue decline experienced by the Company in Asia during the third quarter
resulted primarily from continuing economic pressures facing Japan and Korea, as
well as the strengthening of the dollar relative to the Japanese yen. During the
third quarter alone, the strong dollar negatively impacted the Company's
Japanese revenue by approximately $335,000. The strengthening of the dollar
relative to the Japanese and European currencies negatively affected the
Company's international revenue during the first nine months of 1998 by
approximately $950,000. Since most of the Company's international operating
expenses were incurred in foreign currencies, the net impact of exchange rate
fluctuations on income from operations was considerably less than the impact on
revenue. If the dollar continues to strengthen in 1998 relative to the European
and Japanese currencies, the Company's international revenue will be negatively
impacted, which could have a material adverse effect on the Company's
consolidated results of operations. In addition, if the economies in Asia
continue to deteriorate in 1998 and beyond, the Company's overall Asian revenue
could continue to be materially adversely impacted, which could have a material
adverse effect on the Company's consolidated revenue and results of operations.
The Company expects that international revenue will continue to account for a
significant portion of its total revenue in future periods.
Software licenses revenue consists primarily of license fees for the
Company's software products and, to a lesser extent, license fees for third
party software products licensed through the Company's European and North
American subsidiaries. Software licenses revenue decreased 10.4% and increased
8.4% during the three and nine month periods ended September 30, 1998,
respectively, as compared to corresponding periods in 1997. The decrease in the
three month period ended September 30, 1998 resulted primarily from decreased
software license sales in Japan and Korea, partially offset by increased sales
of third party software products in Europe and North America. The
9
<PAGE> 10
increase in software licenses revenue during the nine months ended September 30,
1998 resulted primarily from increased sales of third party software products in
Europe and North America, and, to a lesser extent, from increased sales of the
Company's software products in these regions. These increases were partially
offset by a decrease in sales of the Company's software products in Asia.
Services revenue consists of revenue from software maintenance agreements
and professional services, including consulting, training and funded research
and development. Services revenue increased 31.4% and 35.0% during the three and
nine month periods ended September 30, 1998, respectively, as compared to
corresponding periods in 1997. Both the software maintenance and the
professional service components of services revenue have experienced solid
growth during the first nine months of 1998. Software maintenance revenue grew
25.9% and 23.0% during the three and nine month periods ended September 30,
1998, respectively, as compared to similar periods in 1997. Professional
services revenue grew 37.7% and 45.1% during the three and nine month periods
ended September 30, 1998, respectively, as compared to similar periods in 1997.
The overall increase in services revenue reflects the Company's continued
emphasis on providing total solutions to its customers.
COST OF REVENUE
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------------ ----------------------------------------
dollars in thousands 1998 1997 % Change 1998 1997 % Change
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Cost of software licenses $689 $271 154.2% $1,489 $563 164.5%
% of software licenses revenue 16.8% 5.9% 11.0% 4.5%
Cost of services $2,414 $1,606 50.3% $6,900 $4,868 41.7%
% of services revenue 59.1% 51.6% 56.1% 53.5%
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
Cost of software licenses includes software royalty fees, media costs,
payroll and other costs attributable to software documentation and distribution,
and an allocation of depreciation, utilities and other overhead expenses
incurred by the Company. Cost of software licenses revenue increased 154.2% and
164.5% during the three and nine month periods ended September 30, 1998,
respectively, as compared to corresponding periods in 1997. These increases were
due to higher royalties paid to third parties whose products were licensed
through the Company's European and North American subsidiaries, and, to a lesser
extent, additional royalties paid to third parties whose products are embedded
in the Company's ADAMS software.
Cost of services includes payroll and overhead expenses attributable to
hotline support, consulting, training and funded research and development. Cost
of services revenue grew 50.3% and 41.7% during the three and nine month periods
ended September 30, 1998, respectively, as compared to similar periods in 1997.
These increases resulted from the hiring of additional employees to support the
growth in services provided to the Company's customers during 1998.
Gross profit on software licenses revenue was 83.2% and 94.1% during the
three month periods ended September 30, 1998 and 1997, respectively. Gross
profit on software licenses revenue was 89.0% and 95.5% during the nine month
periods ended September 30, 1998 and 1997, respectively. The decline in gross
profit percentage during the three and nine month periods, as compared to the
corresponding periods in 1997, was due to the increased sales of third party
software products compared to sales of the Company's software products.
Gross profit on services revenue was 40.9% and 48.4% during the three month
periods ended September 30, 1998 and 1997, respectively. Gross profit on
services revenue was 43.9% and 46.5% during the nine month periods ended
September 30, 1998 and 1997, respectively. The decline in gross profit
percentage during the three and nine month periods, as compared to the
corresponding periods in 1997, was primarily due to the increased professional
services revenue as a percentage of total services revenue. Historically,
professional services revenue has generated lower profit margins than revenue
from software maintenance agreements. In 1998, the Company has experienced
strong demand for professional services from both its existing customer base as
well as new customers.
10
<PAGE> 11
OPERATING EXPENSES
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
---------------------------------------- ----------------------------------------
dollars in thousands 1998 1997 % Change 1998 1997 % Change
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Sales and marketing $3,545 $3,087 14.8% $10,167 $8,578 18.5%
% of total revenue 43.3% 40.2% 39.4% 39.7%
Research and development $1,375 $1,223 12.4% $3,911 $3,358 16.5%
% of total revenue 16.8% 15.9% 15.1% 15.6%
General and administrative $893 $799 11.8% $2,596 $2,383 8.9%
% of total revenue 10.9% 10.4% 10.1% 11.0%
Purchased in-process research
and development $203 $0 $1,403 $0
% of total revenue 2.5% 0.0% 5.4% 0.0%
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
Sales and marketing expenses include costs associated with the Company's
sales channels, such as personnel, commissions, sales office costs, travel,
promotional events, sales order processing, including license administration and
order fulfillment, and advertising and public relations programs. Sales and
marketing expenses also include an allocation of overhead expenses incurred by
the Company. The absolute dollar increase in sales and marketing expenses during
the three and nine month periods ended September 30, 1998, as compared to
corresponding periods in 1997, resulted from the Company's continued expansion
of its worldwide sales and marketing organization. Total sales and marketing
employees increased to 90 at September 30, 1998, an increase of 34.3% from 67 at
September 30, 1997. The Company expects to continue to expand its sales and
marketing organization in the future to meet the growing demand for its products
and services.
Research and development expenses include all payroll costs attributable to
research and development activities. Research and development expenses also
include an allocation of overhead expenses incurred by the Company. Costs
associated with funded research and development projects are included in cost of
services. The absolute dollar increase in research and development expenses
during the three and nine month periods ended September 30, 1998, as compared to
corresponding periods in 1997, resulted primarily from an increase in personnel
and related costs in support of expanded development efforts. The Company
intends to continue to invest significant resources in research and development
in the future.
General and administrative expenses include the cost of salaries, employee
benefits and other payroll costs associated with the Company's finance,
accounting, human resources, information systems and executive management
functions. General and administrative expenses also include an allocation of
overhead expenses incurred by the Company. General and administrative expenses
increased 11.8% and 8.9% during the three and nine month periods ended September
30, 1998, respectively, as compared to corresponding periods in 1997. The
absolute dollar increases in these expenses were primarily due to additional
expenses incurred to support the Company's worldwide growth. The Company expects
general and administrative expenses to increase in absolute dollars in the
future. However, these expenses may vary as a percentage of total revenue from
period to period.
Purchased in-process research and development includes a non-recurring
charge to operations of approximately $1.4 million for the nine month period
ended September 30, 1998 associated with the write-off of in-process research
and development that had not reached technological feasibility as of the dates
of acquisition. The Company wrote-off of approximately $1.2 million and $203,000
in connection with the purchase of DTI Asia Pte. Ltd. in January 1998 and the
Design Analysis Group of H.G.E. Inc. in August 1998, respectively. The
accounting for these acquisitions is summarized in Note 2 of Notes to Condensed
Consolidated Financial Statements.
11
<PAGE> 12
OTHER INCOME, NET
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------------ ----------------------------------------
dollars in thousands 1998 1997 % Change 1998 1997 % Change
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Other income, net $207 $236 -12.3% $622 $592 5.1%
% of total revenue 2.5% 3.1% 2.4% 2.7%
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
Other income, net consists of net interest income (expense), foreign
currency transaction gain (loss) and gain (loss) on the disposal of property and
equipment. The decrease in other income, net during the three month period ended
September 30, 1998, as compared to the corresponding period in 1997, primarily
resulted from a decrease in interest earned during the quarter given the
Company's lower cash and cash equivalents balance. This was partially offset by
a decrease in the net loss recognized on foreign currency transactions. The
increase in other income, net during the nine month period ended September 30,
1998, as compared to the corresponding period in 1997, primarily resulted from a
decrease in foreign currency transaction losses, partially offset by decreased
interest income. From time to time, the Company may enter into forward exchange
contracts to hedge exposures related to significant foreign currency
transactions. The Company does not use any other types of derivatives to hedge
such exposures nor does it speculate in foreign currency.
PROVISION FOR INCOME TAXES
The Company's effective income tax rate was (1733.3%) and 30.1% for the
first nine months of 1998 and 1997, respectively. The difference between the
Company's effective rate and the 34.0% statutory federal rate during the nine
month period ended September 30, 1998 was primarily due to the non-deductibility
of the $1.4 million write-off of in-process research and development incurred in
connection with Company's acquisitions of DTI Asia Pte. Ltd. and the Design
Analysis Group of H.G.E. Inc. Excluding these charges, the Company's effective
tax rate for the first nine months of 1998 would have been 30.2%. The remaining
difference from the 34.0% statutory federal rate resulted from tax-exempt
interest income earned by the Company as well as tax benefits gained from the
Company's foreign sales corporation. The difference between the Company's
effective rate and the 34.0% statutory federal rate during the first nine months
of 1997 was primarily due to the benefits of tax-exempt interest income and tax
benefits gained from the Company's foreign sales corporation.
MINORITY INTEREST IN NET INCOME (LOSS) OF SUBSIDIARY
In April 1997, the Company established a Japanese subsidiary, Mechanical
Dynamics Japan K.K., through a joint venture agreement with Information Services
International-Dentsu, Ltd. ("ISI-Dentsu"), the distributor of the Company's
software in Japan. The $26,000 and ($19,000) in minority interest in net income
(loss) of subsidiary for the nine months ended September 30, 1998 and 1997,
respectively, represents ISI-Dentsu's 34% interest in the net income or loss of
Mechanical Dynamics Japan K.K.
EMPLOYEES
The number of the Company's worldwide employees increased 38.7% to 276 at
September 30, 1998, compared with 199 at September 30, 1997. Employment
increased significantly to support the Company's growing operations worldwide.
This increase in headcount includes employees added from the Company's
acquisitions of DTI Asia Pte. Ltd. and the Design Analysis Group of H.G.E. Inc.
12
<PAGE> 13
YEAR 2000
The Year 2000 issue is the result of computer programs using a two-digit
format, as opposed to four digits, to indicate the year. Such computer systems
will be unable to interpret dates beyond the year 1999, which could cause a
system failure or other computer errors. The Company has assessed and identified
risks in four areas of the business and has developed a plan for Year 2000
information systems compliance in each. The four areas include: (a) the
Company's products, including third party software embedded in the Company's
products, (b) business management and accounting systems, (c) computing and
communications infrastructure, and (d) the Company's suppliers.
Since the Company's products perform few date processing tasks, there is not
a significant risk of a material disruption as a result of the Year 2000. The
Company has completed testing on current versions of the Company's primary
products, including the software delivery and license systems of the products.
No areas of non-compliance were noted which required modification to the
Company's software. The Company's product development group is currently adding
Year 2000 readiness to its quality assurance process for all products to ensure
no Year 2000 problems are introduced during the development of software and
maintenance activities. The primary business management and accounting systems
are currently being replaced by the Company and are scheduled to be ready for
use in January 1999. These systems are based on third party products that have
been certified for Year 2000 compliance. The Company's computing and
communications infrastructure is currently being reviewed. An inventory of all
infrastructure components has been established. All critical components of the
infrastructure will be migrated to Year 2000 readiness by the second quarter of
1999. A list of key suppliers to the Company has been developed. Key suppliers
will need to show adequate readiness or alternate vendors will be identified.
The Company does not expect that the costs to address its Year 2000 needs
will be material to its consolidated financial position or results of
operations.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased $3.8 million during the first nine
months of 1998 to $16.5 million at September 30, 1998, compared with $20.3
million at December 31, 1997. Through September 30, 1998, cash and cash
equivalents decreased primarily as a result of approximately $2.0 million used
to acquire the Design and Analysis Group of H.G.E. Inc., $1.5 million in cash
used to purchase property and equipment, $563,000 in cash used to acquire DTI
Asia Pte. Ltd., and $161,000 of cash used in operations. These decreases were
partially offset by $335,000 of cash generated from the issuance of common stock
to employees.
At September 30, 1998, the Company's principal commitments consisted of
obligations under operating leases for facilities and equipment. The Company had
no borrowings under long-term debt arrangements at September 30, 1998.
The Company has an agreement with its principal bank for a $4.0 million line
of credit facility. No borrowings were outstanding under this agreement as of
September 30, 1998. The Company's subsidiaries in Germany, Italy, Sweden, and
France also have line of credit and overdraft facilities that provide for
aggregate borrowing availability of up to $465,000. Approximately $130,000 in
borrowings were outstanding under these facilities as of September 30, 1998.
In November 1998, the Board of Directors authorized management of the
Company to repurchase up to 500,000 shares of the Company's common stock. No
shares have been repurchased to date.
In October 1998, the Company announced a strategic partnership with the
University of Iowa in which component-level durability sensitivity analysis
technology developed by the University will be integrated with the Company's
ADAMS virtual prototyping software to provide system-level durability design
sensitivity analysis capabilities. In connection with the transaction, the
Company expects to report a one-time charge in the fourth quarter of 1998 of
$400,000, associated with the write-off of in-process research and development
acquired from the University. The purchase price will be allocated to
in-process research and development as the software has not reached
technological feasibility and no other tangible or intangible assets have been
identified. See Note 4 of Notes to Condensed Consolidated Financial Statements.
13
<PAGE> 14
In August 1998, the Company acquired the Design Analysis Group and certain
other assets of H.G.E. Inc., an engineering software and services firm focusing
on the aerospace industry. The aggregate purchase price of approximately $2.0
million consisted entirely of cash. See Note 2 of Notes to Condensed
Consolidated Financial Statements.
In January 1998, the Company acquired 100% of the outstanding capital stock
of DTI Asia Pte. Ltd., a provider of mechanical design simulation software
embedded in the AutoCAD and Mechanical Desktop product lines from Autodesk, Inc.
The aggregate purchase price of approximately $1.3 million consisted of $563,000
in cash and 142,540 shares of the Company's common stock valued at $732,000. See
Note 2 of Notes to Condensed Consolidated Financial Statements.
Long-term cash requirements, other than for normal operating expenses, are
anticipated for the development of new software products and enhancements of
existing products, financing growth, repurchases of the Company's common stock
and the possible acquisition of software products, technologies and businesses
complementary to the Company's business. The Company believes that cash flows
from operations, together with existing cash balances, and available borrowings
will be adequate to meet the Company's cash requirements for working capital and
capital expenditures for the next twelve months and the foreseeable future. The
Company has not paid dividends during the period from 1995 through the third
quarter of 1998 and intends to continue its policy of retaining earnings to
finance future growth.
14
<PAGE> 15
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
NUMBER EXHIBIT
- --------------------------------------------------------------------------------
(11) Statement Re Computation of Per Share Earnings
(27) Financial Data Schedule
(B) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the three months
ended September 30, 1998.
15
<PAGE> 16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: November 15, 1998 MECHANICAL DYNAMICS, INC.
(Registrant)
By: /s/ Michael E. Korybalski
----------------------------------------------------
Michael E. Korybalski
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
By: /s/ David Peralta
----------------------------------------------------
David Peralta
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
16
<PAGE> 17
INDEX TO EXHIBITS
NUMBER EXHIBIT TITLE
- --------------------------------------------------------------------------------
(11) Statement Re Computation of Per Share Earnings
(27) Financial Data Schedule
17
<PAGE> 1
EXHIBIT 11
MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------------------
in thousands, except share and per share data 1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------------------------
BASIC NET INCOME (LOSS) PER SHARE:
<S> <C> <C> <C> <C>
Net income (loss) ($586) $649 ($466) $1,715
Weighted average common shares outstanding 6,213,082 5,781,991 6,173,224 5,771,036
- -------------------------------------------------------------------------------------------------------------------------
Basic net income (loss) per common share ($0.09) $0.11 ($0.08) $0.30
- -------------------------------------------------------------------------------------------------------------------------
DILUTED NET INCOME (LOSS) PER SHARE:
Net income (loss) ($586) $649 ($466) $1,715
Weighted average common shares outstanding 6,213,082 5,781,991 6,173,224 5,771,036
Effect of stock options - 60,837 - 99,658
- -------------------------------------------------------------------------------------------------------------------------
Adjusted shares outstanding 6,213,082 5,842,828 6,173,224 5,870,694
- -------------------------------------------------------------------------------------------------------------------------
Diluted net income (loss) per common share ($0.09) $0.11 ($0.08) $0.29
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
18
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0001011451
<NAME> MECHANICAL DYNAMICS, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 16,501
<SECURITIES> 0
<RECEIVABLES> 8,415
<ALLOWANCES> (219)
<INVENTORY> 0
<CURRENT-ASSETS> 26,519
<PP&E> 6,693
<DEPRECIATION> (3,214)
<TOTAL-ASSETS> 33,795
<CURRENT-LIABILITIES> 8,631
<BONDS> 0
0
0
<COMMON> 21,905
<OTHER-SE> 2,771
<TOTAL-LIABILITY-AND-EQUITY> 33,795
<SALES> 0
<TOTAL-REVENUES> 25,820
<CGS> 0
<TOTAL-COSTS> 26,466
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (24)
<INCOME-TAX> 416
<INCOME-CONTINUING> (466)
<DISCONTINUED> 0
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<CHANGES> 0
<NET-INCOME> (466)
<EPS-PRIMARY> (0.08)
<EPS-DILUTED> (0.08)
</TABLE>
