<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: MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------------ ------------
Commission file number: 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
May 7, 1999, was 6,249,525.
<PAGE> 2
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
March 31, 1999 and December 31, 1998..................................................... 3
Condensed Consolidated Statements of Income
Three Months Ended March 31, 1999 and 1998............................................... 4
Condensed Consolidated Statements of Cash Flows
Three Months Ended March 31, 1999 and 1998............................................... 5
Notes to Condensed Consolidated Financial Statements..................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 7
Item 3. Quantitative and Qualitative Disclosures about Market Risk............................... 13
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K......................................................... 14
SIGNATURES. 15
INDEX TO EXHIBITS.................................................................................... 16
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
in thousands 1999 1998
- ----------------------------------------------------------------------------------------------------------------
ASSETS: (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $16,022 $16,843
Accounts receivable, net 10,217 9,893
Prepaid and deferred expenses 2,070 1,873
- ----------------------------------------------------------------------------------------------------------------
Total current assets 28,309 28,609
- ----------------------------------------------------------------------------------------------------------------
Property and equipment, net 3,639 3,674
Goodwill, net 3,710 3,820
Other assets 256 144
- ----------------------------------------------------------------------------------------------------------------
Total assets $35,914 $36,247
================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current liabilities:
Borrowings under lines of credit $97 $105
Accounts payable 1,310 1,781
Accrued expenses 2,940 3,544
Deferred revenue 5,024 4,745
- ----------------------------------------------------------------------------------------------------------------
Total current liabilities 9,371 10,175
- ----------------------------------------------------------------------------------------------------------------
Minority interest 486 472
Shareholders' equity:
Common stock 22,404 22,332
Preferred stock 0 0
Retained earnings 3,547 3,073
Cumulative translation adjustment 106 195
- ----------------------------------------------------------------------------------------------------------------
Total shareholders' equity 26,057 25,600
- ----------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $35,914 $36,247
================================================================================================================
</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
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------------
in thousands except share and per share data 1999 1998
- -----------------------------------------------------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C>
Revenue:
Software licenses $5,276 $4,816
Services 5,090 3,919
- -----------------------------------------------------------------------------------------------------------------
Total revenue 10,366 8,735
- -----------------------------------------------------------------------------------------------------------------
Cost of revenue:
Software licenses 868 509
Services 2,689 2,199
- -----------------------------------------------------------------------------------------------------------------
Total cost of revenue 3,557 2,708
- -----------------------------------------------------------------------------------------------------------------
Gross profit 6,809 6,027
- -----------------------------------------------------------------------------------------------------------------
Operating expenses:
Sales and marketing 3,920 3,285
Research and development 1,322 1,217
General and administrative 953 838
Goodwill amortization 113 41
Acquisition-related and non-recurring charges 0 1,200
- -----------------------------------------------------------------------------------------------------------------
Total operating expenses 6,308 6,581
- -----------------------------------------------------------------------------------------------------------------
Operating income (loss) 501 (554)
Other income, net 196 218
- -----------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and minority interest 697 (336)
Provision for income taxes 209 261
- -----------------------------------------------------------------------------------------------------------------
Net income (loss) before minority interest 488 (597)
Minority interest in net income of subsidiary 14 16
- -----------------------------------------------------------------------------------------------------------------
Net income (loss) $474 ($613)
- -----------------------------------------------------------------------------------------------------------------
Basic net income (loss) per common share $0.08 ($0.10)
- -----------------------------------------------------------------------------------------------------------------
Weighted average common shares 6,235,247 6,113,210
- -----------------------------------------------------------------------------------------------------------------
Diluted net income (loss) per common share $0.08 ($0.10)
- -----------------------------------------------------------------------------------------------------------------
Weighted average common and common equivalent shares 6,247,630 6,113,210
=================================================================================================================
</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
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------------------
in thousands 1999 1998
- -------------------------------------------------------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $474 ($613)
Adjustments to reconcile net income to net cash
used in operating activities:
Acquisition-related and non-recurring charges 0 1,200
Depreciation and amortization 480 369
Loss on disposal of assets, net 4 4
Minority interest in net income of subsidiary 14 16
Changes in assets and liabilities:
Accounts receivable (691) 93
Prepaid and deferred expenses (245) 16
Other assets (135) 29
Accounts payable (245) (772)
Accrued expenses (487) (1,110)
Deferred revenue 351 (325)
- -------------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (480) (1,093)
- -------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from the sale of property and equipment 0 12
Purchases of property and equipment (368) (555)
Purchase of DTI Asia Pte. Ltd., net of cash acquired 0 (563)
- -------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (368) (1,106)
- -------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net borrowings (payments) under line of credit agreements (8) 39
Proceeds from the issuance of common stock 72 144
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 64 183
- -------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash (37) (27)
- -------------------------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents (821) (2,043)
Cash and cash equivalents at beginning of period 16,843 20,261
- -------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $16,022 $18,218
- -------------------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $1 $6
Income taxes $202 $812
- -------------------------------------------------------------------------------------------------------------------
Details of acquisition of DTI Asia Pte. Ltd.:
Net liabilities, excluding cash acquired ($59)
Purchase price in excess of the net assets acquired 734
Purchased in-process research and development 980
Stock issued (1,092)
- -------------------------------------------------------------------------------------------------------------------
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, 1998.
Operating results for the three month periods ended March 31, 1999 and 1998
are not necessarily indicative of the results that may be expected for the full
year.
(2) - COMPREHENSIVE INCOME
In July 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income," which
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. Comprehensive
income (loss) is $385,000 and ($644,000) for the three month periods ended March
31, 1999 and 1998, respectively. The difference between net income (loss), as
reported in the accompanying condensed consolidated statements of income, and
comprehensive income (loss) is the foreign currency translation adjustment for
the respective periods.
(3) - EARNINGS PER SHARE
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share." All prior period per share
data presented has been restated to conform to this new statement. The following
table reconciles the weighted average number of shares in the basic net income
(loss) per common share calculation to the number of shares in the diluted net
income (loss) per common share calculation:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-------------------------------------
1999 1998
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Weighted average common shares used in basic net income (loss) per
common share............................................................ 6,235,247 6,113,210
Effect of stock options................................................. 12,383 --
--------- ---------
Weighted average common and common equivalent shares used in diluted net
income (loss) per common share.......................................... 6,247,630 6,113,210
========= =========
</TABLE>
For the three months ended March 31, 1998, the effect of stock options
outstanding for the purchase of 62,131 shares was not included in the net loss
per common share calculation because doing so would have been anti-dilutive.
(4) - 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
6
<PAGE> 7
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.
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 consolidated financial statements and the notes 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 an 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 to be in the future,
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 by 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; risks inherent in seeking and consummating acquisitions,
including the diversion of management attention to the assimilation of the
operations and personnel of the acquired business; fluctuations in foreign
exchange rates; the impact of undetected errors or defects, including those
associated with Year 2000 date functions, on the Company's current products,
vendors and internal systems; 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 the Company's Securities and
Exchange Commission reports.
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.
7
<PAGE> 8
RESULTS OF OPERATIONS
REVENUE
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------------------
dollars in thousands 1999 1998 % CHANGE
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Software licenses $ 5,276 $ 4,816 9.6%
% of total revenue 50.9% 55.1%
Services $ 5,090 $ 3,919 29.9%
% of total revenue 49.1% 44.9%
- -----------------------------------------------------------------------
Total revenue $10,366 $ 8,735 18.7%
=======================================================================
</TABLE>
The Company's total revenue increased 18.7% during the three month period
ended March 31, 1999, as compared to the corresponding period in 1998. The
growth in revenue resulted from an increase in the services provided to the
Company's customers, as well as from increased sales of third party software
products licensed through the Company's European and Canadian subsidiaries. The
Company achieved revenue growth in excess of 10% in each of its major sales
geographies including North America, Europe and Asia during the first quarter of
1999, as compared to the first quarter of 1998.
Revenue from international customers accounted for approximately 63.3% and
62.0% of the Company's total revenue during the three months ended March 31,
1999 and 1998, respectively. The increase in international revenue as a percent
of total revenue was due primarily to increased sales of the Company's software
products and services in Europe and Asia as well as the weakening of the U.S.
dollar in 1999 relative to certain international currencies. 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 U.S. dollar strengthens in
1999 relative to the European, Canadian 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.
The Company's international revenue has in the past been negatively impacted
by economic weakness in certain countries in Asia, including Japan. If the
economies in Asia deteriorate further in 1999, the Company's overall Asian
revenue could be adversely impacted, which could have a material adverse effect
on the Company's consolidated results of operations. Consequently, the Company
remains cautious in its overall outlook for Asian revenue in 1999. 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 Canadian
subsidiaries. Software licenses revenue increased 9.6% during the three month
period ended March 31, 1999, as compared to the corresponding period in 1998.
This increase resulted primarily from a higher volume of third party software
licenses sold worldwide as well as increased sales of the Company's ADAMS
interface products, including its Dynamic Designer product. Revenue from third
party software products totaled approximately $1.1 million, or 10.3% of total
revenue during the three months ended March 31, 1999, as compared to $482,000,
or 5.5% of total revenue during the corresponding period in 1998. The increase
in revenue from third party software products is a result of incremental sales
generated by the Company's Canadian subsidiary, which was established in August
1998 with the Company's acquisition of the Design Analysis Group and certain
other assets of H.G.E. Inc.
Services revenue consists of revenue from software maintenance agreements
and professional services, including consulting, training and funded research
and development. Total services revenue increased 29.9% during the three month
period ended March 31, 1999, as compared to corresponding period in 1998. Both
the software maintenance and the professional service components of services
revenue experienced solid growth during the first three months of 1999. Software
maintenance revenue and professional services revenue grew 34.1% and 28.1%,
respectively,
8
<PAGE> 9
during the three month period ended March 31, 1999, as compared to the
corresponding period in 1998. 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 MARCH 31,
--------------------------------------
dollars in thousands 1999 1998 % CHANGE
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cost of software licenses $868 $509 70.5%
Gross profit margin on software licenses revenue 83.5% 89.4%
Cost of services $2,689 $2,199 22.3%
Gross profit margin on services revenue 47.2% 43.9%
================================================================================================
</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 increased 70.5% from the
first quarter of 1998 to approximately $868,000 in the first quarter of 1999.
The $359,000 absolute dollar increase was due to higher royalties paid to third
parties whose products were licensed through the Company's Canadian and European
subsidiaries, and, to a lesser extent, additional royalties paid to third
parties whose products are embedded in the Company's ADAMS software.
Gross profit margin on software licenses revenue was 83.5% and 89.4% during
the three month periods ended March 31, 1999 and 1998, respectively. The decline
in gross profit margin was due to the increased sales of third party software
products as a percent of total software licenses revenue. The gross profit
margin derived from sales of third party software products has historically been
lower than the gross profit margin derived from sales of the Company's software
products.
Cost of services includes payroll and overhead expenses attributable to
hotline support, consulting, training and funded research and development. Cost
of services increased 22.3% during the three month period ended March 31, 1999,
as compared to the corresponding period in 1998. This increase in cost of
services was primarily due to the hiring of additional employees to support the
growth in services provided to the Company's customers during 1999.
Gross profit margin on services revenue was 47.2% and 43.9% during the three
month periods ended March 31, 1999 and 1998, respectively. The increase in gross
profit margin on services revenue was due primarily to the increased software
maintenance revenue as a percentage of total services revenue. Historically,
revenue from software maintenance agreements has generated higher profit margins
than revenue from professional services.
9
<PAGE> 10
OPERATING EXPENSES
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------------
dollars in thousands 1999 1998 % CHANGE
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Sales and marketing $3,920 $3,285 19.3%
% of total revenue 37.8% 37.6%
Research and development $1,322 $1,217 8.6%
% of total revenue 12.8% 13.9%
General and administrative $ 953 $ 838 13.7%
% of total revenue 9.2% 9.6%
Goodwill Amortization $ 113 $ 41 175.6%
% of total revenue 1.1% 0.5%
Purchased in-process research and development $ 0 $1,200
% of total revenue 0.0% 13.7%
================================================================================================================
</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 month period ended March 31, 1999, as compared to corresponding period
in 1998, resulted from the Company's continued expansion of its worldwide sales
and marketing organization. Total sales and marketing employees increased to 99
at March 31, 1999, an increase of 25.3% from 79 at March 31, 1998. 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 increase in research and development expenses during the three
month period ended March 31, 1999, as compared to corresponding period in 1998,
primarily resulted 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 13.7% during the three month period ended March 31, 1999, as compared
to the corresponding period in 1998. The absolute dollar increase in these
expenses was 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.
Goodwill amortization includes the amortization of purchase price in excess
of net assets on the Company's acquisitions. Goodwill amortization increased
175.6% during the three month period ended March 31, 1999, as compared to the
corresponding period in 1998, due to increased goodwill associated with the
Company's acquisitions throughout 1998. The Company amortizes goodwill over the
periods estimated to be benefited from the acquisitions, after considering such
factors as demand, competition, service lives of employees and expected actions
of competitors.
10
<PAGE> 11
Acquisition-related and non-recurring charges were approximately $1.2
million in the three month period ended March 31, 1998, and consist primarily of
the write-off of purchased in-process research and development ("R&D")
associated with the Company's acquisition of DTI Asia Pte. Ltd ("DTI"). The
value assigned to in-process R&D was determined by an independent appraisal of
the acquired company's assets, both tangible and intangible. The portion of the
aggregate purchase price assigned to in-process R&D was determined by
identifying research projects for which technological feasibility had not yet
been established. The appraisal considered such factors as the estimated percent
complete of each project in process at the date of acquisition, the estimated
remaining costs to develop the in-process R&D into commercially viable products
and the estimated discounted net future cash flows from such products. If the
Company were unable to complete the R&D projects in a timely manner or lost key
personnel from the acquired companies, revenue and operating income in future
periods could be adversely impacted.
DTI was a start-up company, established in 1994, and consisted of four
employees located on three continents whose time was primarily dedicated to
developing motion simulation technology for the mid-range CAD market.
Significant projects in process at the date of acquisition included: (1)
integrating the Company's ADAMS solution engine with the acquired company's
existing technology; (2) developing advanced "wizards" to increase ease of use;
and (3) adding finite element analysis capabilities. The value of the in-process
R&D was appraised using the milestone approach, and involved the following
assumptions: the net cash inflows from the in-process R&D commencing in the
fourth quarter of 1998, operating expenses consistent with historical levels and
a risk-adjusted discount rate of 35.0%. Since the acquisition, the Company has
completed integration of the ADAMS solution engine and released a new version of
the acquired company's product line featuring increased ease of use. Costs
associated with the completion of these projects were consistent with the
assumptions used in the valuation.
OTHER INCOME, NET
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------------
dollars in thousands 1999 1998 % CHANGE
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Other income, net $196 $218 -10.1%
% of total revenue 1.9% 2.5%
================================================================================================================
</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
March 31, 1999, as compared to the corresponding period in 1998, primarily
resulted from a decrease in interest earned during the quarter given the
Company's lower cash and cash equivalents balance. 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 30.0% and (77.7%) for the three
months ended March 31, 1999 and 1998, respectively. The difference between the
Company's effective rate and the 34.0% statutory federal rate during the three
month period ended March 31, 1999 resulted primarily 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 three month period ended March
31, 1998 was primarily due to the non-deductibility of the $1.2 million in
acquisition-related and non-recurring charges incurred by the Company during the
period. Excluding this charge, the Company's effective tax rate for the first
quarter 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.
11
<PAGE> 12
MINORITY INTEREST IN NET INCOME OF SUBSIDIARY
In April 1997, the Company established a Japanese subsidiary, Mechanical
Dynamics Japan K.K. ("MDI-Japan"), through a joint venture agreement with
ISI-Dentsu of Tokyo, Japan, the distributor of the Company's software in Japan.
Minority interest in net income of subsidiary of $14,000 and $16,000 for the
three month periods ended March 31, 1999 and 1998, respectively, represents
ISI-Dentsu's 34% interest in the net income of MDI-Japan.
EMPLOYEES
The number of the Company's worldwide employees increased 24.3% to 297 at
March 31, 1999, compared with 239 at March 31, 1998. Employment increased
significantly to support the Company's growing operations worldwide. This
increase in headcount includes 16 employees added from the Company's acquisition
of the Design Analysis Group of H.G.E. Inc in August 1998.
YEAR 2000 COMPLIANCE
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 its business and has developed a plan for Year 2000
information systems compliance in each. The areas are: (1) the Company's
products, including third party software embedded in the Company's products, (2)
business management and accounting systems, (3) computing and communications
infrastructure, and (4) 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 Company's primary business management and accounting
systems were replaced by the Company effective January 1999. The cost of the new
systems, including certain hardware upgrades, was approximately $150,000. 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 third quarter of 1999. A list of key suppliers to the
Company has been developed. Key suppliers have been contacted and are being
asked 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. While the Company believes that its efforts to address Year 2000
issues for which it is responsible should be successful, it is possible that
there will be undetected errors or defects associated with Year 2000 date
functions in the Company's products and internal systems or those of its key
suppliers. If this should occur, it is possible that the Company could be
involved in litigation. Further, although the Company does not believe that it
has any obligation to continue to support prior versions of its products after
the termination of maintenance contracts covering those products, nor any
obligation to make prior versions of its products, including custom applications
written by the Company, Year 2000 compliant, it is possible that its customers
may take a contrary position and initiate litigation. Because of the
unprecedented nature of litigation in this area, it is uncertain how the Company
may be affected by it. In the event of such litigation or the occurrence of one
or more problems associated with Year 2000 compliance, the Company's business,
financial condition, or results of operations could be materially adversely
affected.
EURO CONVERSION
In January 1999, 11 of the 15 member countries of the European Union
established fixed conversion rates between their existing sovereign currencies
and the Euro, making the Euro their common legal currency on that date. There
will be a transition period from January 1, 1999 to January 1, 2002, during
which the old currencies will
12
<PAGE> 13
remain legal tender in the participating countries as denominations of the Euro.
During the transition period, public and private parties may pay for goods and
services using either the Euro or the participating country's former currency.
Conversion rates, however, will no longer be computed directly from one former
currency to another.
The Company is currently evaluating the business implications of conversion
to the Euro, including technical adaptation of information technology and other
systems to accommodate Euro-denominated transactions, long-term competitive
implications of the conversion, and the effect on market risk with respect to
financial instruments. At this time, the Company does not expect that the Euro's
introduction will have a material impact on its results of operations during or
after the transition period.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased $821,000 during the first three months
of 1999 to $16.0 million at March 31, 1999, compared with $16.8 million at
December 31, 1998. Through March 31, 1999, cash and cash equivalents decreased
primarily as a result of the $480,000 in cash used in operations to fund working
capital needs and $368,000 in cash used to purchase property and equipment.
At March 31, 1999, 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 March 31, 1999.
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
March 31, 1999. 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 $510,000. Approximately $97,000 in borrowings
was outstanding under these facilities as of March 31, 1999.
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,
capital expenditures and stock repurchases for the next twelve months and the
foreseeable future. The Company has not paid dividends during the period from
1996 through the first quarter of 1999 and intends to continue its policy of
retaining earnings to finance future growth.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Other than as disclosed in this report on Form 10-Q, there have been no
significant changes in our market risk exposure as described in Management's
Discussion and Analysis of Financial Condition and Results of Operations
included as Item 7a. on Form 10-K for the year ended December 31, 1998 and
incorporated herein by reference.
13
<PAGE> 14
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 March 31, 1999.
14
<PAGE> 15
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: May 14, 1999 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)
15
<PAGE> 16
INDEX TO EXHIBITS
NUMBER EXHIBIT TITLE
- -------------------------------------------------------------
(11) Statement Re Computation of Per Share Earnings
(27) Financial Data Schedule
16
<PAGE> 1
EXHIBIT 11
MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------
in thousands, except share and per share data 1999 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
BASIC NET INCOME (LOSS) PER COMMON SHARE:
Net income (loss) $474 ($613)
Weighted average common shares 6,235,247 6,113,210
- -------------------------------------------------------------------------------------------------------------------
Basic net income (loss) per common share $0.08 ($0.10)
- -------------------------------------------------------------------------------------------------------------------
DILUTED NET INCOME (LOSS) PER COMMON SHARE:
Net income (loss) $474 ($613)
Weighted average common shares 6,235,247 6,113,210
Effect of stock options and warrants 12,383 0
- -------------------------------------------------------------------------------------------------------------------
Weighted average common and common equivalent shares 6,247,630 6,113,210
- -------------------------------------------------------------------------------------------------------------------
Diluted net income (loss) per common share $0.08 ($0.10)
===================================================================================================================
</TABLE>
17
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0001011451
<NAME> MECHANICAL DYNAMICS, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 16,022
<SECURITIES> 0
<RECEIVABLES> 10,527
<ALLOWANCES> (310)
<INVENTORY> 0
<CURRENT-ASSETS> 28,309
<PP&E> 7,470
<DEPRECIATION> (3,831)
<TOTAL-ASSETS> 35,914
<CURRENT-LIABILITIES> 9,371
<BONDS> 0
0
0
<COMMON> 22,404
<OTHER-SE> 3,653
<TOTAL-LIABILITY-AND-EQUITY> 35,914
<SALES> 0
<TOTAL-REVENUES> 10,366
<CGS> 0
<TOTAL-COSTS> 9,865
<OTHER-EXPENSES> (196)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 697
<INCOME-TAX> 209
<INCOME-CONTINUING> 474
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 474
<EPS-PRIMARY> 0.08
<EPS-DILUTED> 0.08
</TABLE>
