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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549




FORM 10-K

|                |  |                                                                                         
|--------------- |  | ----------------------------------------------------------------------------------------
|(Mark One)      |  |                                                                                         
|X IN BALLOT BOX |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934    
|                |  | For the fiscal year ended: December 31, 2001,OR                                         
|OPEN BALLOT BOX |  | 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.)

2300 Traverwood Drive
Ann Arbor, Michigan 48105
(734) 994-3800
(Address of principal executive offices, including zip
code, and telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

|                          |  |                                                
|------------------------- |  | -----------------------------------------------
|Title of each class: None |  | Name of each exchange on which registered: None

Securities registered pursuant to Section 12(g) of the Act:Common Shares, no par value
(Title of class)

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 IN BALLOT BOX Yes |  | OPEN BALLOT BOX No

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X IN BALLOT BOX

The aggregate market value of the voting stock of the Registrant held by
non-affiliates of the Registrant as of March 5, 2002, computed by reference to
The Nasdaq Stock Market closing price on such date, was approximately
$60,068,000.

The number of outstanding shares of the Registrants common stock, as of March
5, 2002, was 6,185,587.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2002 Annual Meeting of
Shareholders are incorporated by reference into Part III.





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|                                                   |                                                                                               |  |  |  |  |  |  | 
|-------------------------------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|FORM 10-K                                         
|PART I                                            
|                                                   | Item 1. Business                                                                             
|                                                   | Item 2. Properties                                                                           
|                                                   | Item 3. Legal Proceedings                                                                    
|                                                   | Item 4. Submission of Matters to a Vote of Security Holders                                  
|PART II                                           
|                                                   | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                
|                                                   | Item 6. Selected Consolidated Financial Data                                                 
|                                                   | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                                   | Item 7a. Quantitative and Qualitative Disclosures about Market Risk                          
|                                                   | Item 8. Financial Statements and Supplementary Data                                          
|                                                   | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 
|PART III                                          
|                                                   | Item 10. Directors and Executive Officers of the Registrant                                  
|                                                   | Item 11. Executive Compensation                                                              
|                                                   | Item 12. Security Ownership of Certain Beneficial Owners and Management                      
|                                                   | Item 13. Certain Relationships and Related Transactions                                      
|PART IV                                           
|                                                   | Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K                     
|SIGNATURES                                        
|INDEX TO EXHIBITS                                 
|EX-10.1 Amended/Restated Employ Agmnt - Korybalski
|EX-10.2 Amend/Restated Employment Agmnt - Ryan    
|EX-10.3 Amend/Restated Employment Agmnt - Peralta 
|EX-10.4 Amend/Restated Employ Agmnt - Peterson    
|EX-11 Statement re: Computation Earnings Per Share
|EX-21 Subsidiaries of the Registrant              
|EX-23.1 Consent of Independent Public Accountants 



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MECHANICAL DYNAMICS, INC.

FORM 10-K
TABLE OF CONTENTS

|                  |  |                                                                                       |  |     
|----------------- |  | ------------------------------------------------------------------------------------- |  | ----
|                  |  |                                                                                       |  | Page
|                  |  |                                                                                       |  |     
|                  |  | PART I                                                                                |  |     
|Item 1.           |  | Business                                                                              |  | 3   
|Item 2.           |  | Properties                                                                            |  | 13  
|Item 3.           |  | Legal Proceedings                                                                     |  | 13  
|Item 4.           |  | Submission of Matters to a Vote of Security Holders                                   |  | 13  
|                 
|                  |  | PART II                                                                               |  |     
|Item 5.           |  | Market for Registrants Common Equity and Related Stockholder Matters                 |  | 14  
|Item 6.           |  | Selected Consolidated Financial Data                                                  |  | 15  
|Item 7.           |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 16  
|Item 7a           |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 22  
|Item 8.           |  | Financial Statements and Supplementary Data                                           |  | 24  
|Item 9.           |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  |  | 41  
|                 
|                  |  | PART III                                                                              |  |     
|Item 10.          |  | Directors and Executive Officers of the Registrant                                    |  | 41  
|Item 11.          |  | Executive Compensation                                                                |  | 42  
|Item 12.          |  | Security Ownership of Certain Beneficial Owners and Management                        |  | 42  
|Item 13.          |  | Certain Relationships and Related Transactions                                        |  | 42  
|                 
|                  |  | PART IV                                                                               |  |     
|Item 14.          |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                       |  | 43  
|                 
|SIGNATURES        |  | 45                                                                                   
|                 
|INDEX TO EXHIBITS |  | 46                                                                                   

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PART I




Item 1. Business

General

Since Mechanical Dynamics, Inc. (MDI or the Company) was incorporated
in Michigan in 1977, the Company has developed, marketed and supported virtual
prototyping solutions. The Companys ADAMSmechanical system simulation
software allows engineering teams to create virtual prototypes of their complex
mechanical system designs on the computer. By realistically simulating the
full-motion behavior of their designs, they can explore multiple design
variations, testing and refining until optimizing system performance. In doing
so, they reduce the need for costly, time-consuming physical prototype testing,
while significantly improving product quality.

ADAMSmakes the idea of concurrent engineering real. It enables those
involved at each step of the product development process  from initial concept
through design and testing  to interact with the virtual prototype, to see the
whole system in motion and provide input even from the earliest stages. This
not only shortens the development cycle and increases product quality, but also
improves the product development process itself.

In recent years, the Company has made strategic business acquisitions to
expand its ability to develop and market new products to customers. In 1994,
the Company acquired five European entities that previously had distributed the
Companys products in Europe and are now wholly-owned subsidiaries: Mechanical
Dynamics GmbH, a German corporation; Mechanical Dynamics Sarl, a French
corporation; Mechanical Dynamics International Ltd., a United Kingdom
corporation; Mechanical Dynamics Sweden AB, a Swedish corporation; and
Mechanical Dynamics Italy srl, an Italian corporation.

In 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) of Tokyo, Japan, the
distributor of the Companys software in Japan. In 1997, the Company also
acquired StatDesign, Inc., an engineering software and services firm based in
Dearborn, Michigan.

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. In August 1998, the Company established a Canadian subsidiary,
Mechanical Dynamics Ltd. (MDI-Canada). Immediately following its formation,
MDI-Canada acquired the Design Analysis Group and certain other assets of
H.G.E. Inc. (HGE), an engineering software and services firm focusing on the
aerospace industry based in Toronto, Ontario, Canada. In November 1998, the
Company formed a strategic partnership with the University of Iowa in which
component-level durability sensitivity analysis technology developed by the
University would be integrated with the Companys ADAMSvirtual prototyping
software to provide system-level durability design sensitivity analysis
capabilities.

In December 2000, the Company acquired ESTECH Corporation (ESTECH), a
computer-aided engineering service provider based in Yokohama, Japan, from
Nissan Motor of Japan and Structural Dynamics Research Corporation. The
aggregate purchase price approximated $8.8 million and was paid entirely in
cash. See Note 2 of Notes to Consolidated Financial Statements.

ADAMS® and the Companys logo are registered trademarks of the Company.
ADAMS Full Simulation Package, ADAMS/Aircraft, ADAMS/Animation, ADAMS/AutoFlex,
ADAMS/Car, ADAMS/Chassis, ADAMS/Controls, ADAMS/Driveline, ADAMS/Driver,
ADAMS/Durability, ADAMS/EDM, ADAMS/Engine, ADAMS/Exchange, ADAMS/Flex,
ADAMS/Hydraulics, ADAMS/Insight, ADAMS/Linear, ADAMS/PostProcessor, ADAMS/Pre,
ADAMS/Rail, ADAMS/Solver, ADAMS/Tire, ADAMS/View, ADAMS/Vibration, CAT/ADAMS,
Dynamic Designer, MECHANISM/Pro and SD/ADAMSare trademarks of the Company. All
rights reserved. All other trade names and trademarks appearing in this Form
10-K are the property of their respective holders.

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Products

MDI develops, markets and supports virtual prototyping software capable of
simulating the many varied and complex component interactions and operating
environments that companies face when designing their products. The Companys
primary software line is the ADAMS Professional Series. The principal product
in this line, the ADAMS Full Simulation Package,is comprised of ADAMS/Solver
and ADAMS/View, and can be used as a self-contained software package or with
additional modules developed by the Company as well as with third-party
software. In addition, certain original equipment manufacturers (OEMs)
license the Companys motion simulation software in order to embed the
Companys software in the OEMs design software packages. The U.S. list price
for the ADAMS Full Simulation Packageis approximately $27,000 per license
depending upon configuration. The U.S. list prices for the Companys
additional software products typically range from $3,000 to $32,000. In the
future, the Company intends to offer additional products as part of its ADAMS
software product line. Since the Companys sales are concentrated in the ADAMS
Professional Seriesproduct line, a decline in the demand for ADAMSsoftware
and services would have a material adverse effect on the Companys business,
financial condition and results of operations.

ADAMSsoftware is available on a number of platforms, including Intel
Pentium-based PCs running the Microsoft Windows NT or 2000 operating systems
and UNIX-based workstations and servers from Silicon Graphics, Hewlett-Packard,
Sun Microsystems, and IBM.

Professional Series

Full Simulation Package

     ADAMS/Solveris the underlying solution engine. ADAMS/Solver
automatically formulates and solves the equations of motion to provide complete
kinematic, static and dynamics analysis of mechanical systems.

     ADAMS/Viewis an interactive graphical environment for the full ADAMS
product line. ADAMS/Viewcombines simple iconic, point-and-click operation with
advanced model-building, simulation, animation and xy plotting capabilities.

Industry-specific software

     ADAMS/Carand ADAMS/Preare special versions of ADAMSdesigned
specifically for advanced simulation of full vehicles and chassis subsystems.
Embedded within the software are the specialized design and analytical
expertise of automotive industry leaders. A custom menu-driven user interface
highlights capabilities familiar to vehicle designers so customers can use
these products with little formal training.

     ADAMS/Driverallows the user to add the element of human driver response
to vehicle simulations. ADAMS/Drivercan simulate the actions and reactions of
a vehicles operator under a variety of driving conditions.

     ADAMS/Drivelineprovides engineers and analysts with specialized tools
for modeling and simulating driveline components and studying the dynamic
behavior of the entire driveline during different input conditions.
ADAMS/Drivelinecan also be used to explore interactions between driveline and
chassis components, such as suspensions, steering systems, brakes and the
vehicle body.

     ADAMS/Engineis a specialized software environment which enables an
engineering team to predict, refine, and optimize the high-frequency
performance of powertrain components and subsystems as part of an overall
vehicle design. Users can also combine their designs of individual powertrain
components and subsystems into a complete engine simulation, allowing them to
solve problems of structural load, life, durability, vibration, and performance
within defined cost, weight, and packaging constraints.

     ADAMS/Aircraftwas developed by the Company in collaboration with a
major aircraft manufacturer. ADAMS/Aircraftis a special version of ADAMS
designed specifically for simulation of complete aircraft and provides a
specialized, scalable environment for this purpose. A custom menu-driven user
interface highlights


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capabilities familiar to aircraft designers so they can use ADAMS/Aircraft
with little formal training. Currently, the environment provides for the
modeling of landing gear to study aircraft takeoff, landing, and ground
maneuvers.

     ADAMS/Railwas developed by the Company in collaboration with Dutch Rail
and provides virtual prototyping capabilities tailored to the needs of the
worldwide railcar manufacturing industry. The software combines specialized
railcar design and analytical know-how with custom menus and functions
developed specifically for railcar engineers.

     ADAMS/Tireis a comprehensive set of tools for simulating the complex
force interactions between rubber tires and driving surfaces. This can be
important input for understanding vehicle behavior under a variety of
conditions.

Visualization and Other Options

     ADAMS/Insightprovides experimental design methods for improved
understanding and refinement of complex mechanical system designs. It enables
web-based collaboration through allowing experiment results to be posted and
shared among engineering groups.

     ADAMS/PostProcessoris a high-performance tool for visualizing ADAMS
simulation results. Used as a standalone environment or integrated with
ADAMS/View, ADAMS/PostProcessorsimplifies and speeds the steps required to
view, study, and understand ADAMSsimulation results.

Extension Products

Extension Productsare those that enable ADAMSto be used by more members
of the product development team, to gain a broader understanding of the
performance of their mechanical systems.

     ADAMS/Controlsenables the integration of non-linear ADAMSmechanical
models with controllers developed in leading control system design packages
such as MATLAB and EASY5. The product allows users to test how control systems
will affect their mechanical system, and visualize the effects of both controls
and mechanics in an integrated virtual system test environment.

     ADAMS/Flexenables the automatic exchange of data between ADAMSand
finite element analysis (FEA) software, including ANSYS, ABAQUS, and
MSC/NASTRAN.This two-way interface provides for accurate loading conditions
for FEA and a more complete understanding of flexible effects on mechanical
system performance.

     ADAMS/AutoFlexenables the automatic creation of simple flexible
components within the ADAMSenvironment, thereby removing the step of importing
data from FEA software and speeding up the iterative design process.

     ADAMS/Hydraulicsenables the simulation of complex mechanical systems
that are powered by hydraulic elements. Static, linear, transient, and dynamic
analyses are all supported for combined mechanical and hydraulic models.

     ADAMS/Linearenables the linearization of the inherently non-linear
equations of motion that are typically formulated by ADAMS.Having such data in
linear form can significantly enhance the ability to study the stability and
vibratory behavior of mechanical system models. ADAMS/Linearcan also provide
an easy link to popular control system design packages such as MATLAB.

     ADAMS/Vibrationenables simulations in the frequency domain versus the
time domain. This is useful when studying the relatively small vibratory
behavior of moving mechanical systems. Both inputs and outputs are defined in
the frequency domain.

     ADAMS/Durabilityenables the prediction of the fatigue characteristics
of one or more components within a mechanical system. Stresses can be
recovered on flexible components in the system and used to assess the strength
of these components under dynamic loading conditions. Time-histories of
component loads can also be exported to

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leading fatigue prediction software, such as nCode, which then use this
and other information to predict how long the components will last, based on
anticipated operating conditions.

     ADAMS/EDMenables the incorporation of empirical dynamic models of
compliant components, such as bushings, springs, and shocks. Experimental data
is imported from physical test equipment manufacturers such as MTS Systems to
provide a higher-fidelity representation of the mechanical system.

CAD/CAM Interface Products

     ADAMS/Exchangeprovides an industry-standard, two-way interface for
exchanging model geometry between ADAMSand many other CAD/CAM packages. This
saves time in data transfer, while enhancing the accuracy and realism of
mechanical system simulations.

     CAT/ADAMSwas developed by the Company in collaboration with a
consortium of major automotive manufacturers and was designed to facilitate the
exchange of data between ADAMSand the widely used CATIA computer-aided design,
manufacturing, and engineering (CAD/CAM/CAE) package from Dassault Systemes.

     Dynamic Designerwas purchased by the Company in conjunction with its
acquisition of DTI Asia Pte. Ltd. in January 1998. Dynamic Designeris a
mechanical design simulation software product embedded in leading mid-range CAD
environments, which today includes the AutoCAD and Mechanical Desktop product
lines from Autodesk, Inc., the SolidWorks product line from SolidWorks Corp.,
and the Solid Edge product line from Unigraphics Solutions, Inc.

     MECHANISM/Prois a program specifically designed for Parametric
Technology Corp.s (PTC) Pro/ENGINEER environment. MECHANISM/Proconverts
assemblies created within PTCs Pro/ASSEMBLY software into realistic, fully
three-dimensional mechanical system models. MECHANISM/Procan verify and
evaluate motion paths, locate lock-up positions, detect interferences,
establish work-space envelopes and calculate joint reaction forces.

OEM Products

OEM Productsare kinematic and dynamics motion simulation products that
are embedded in OEMs design software packages. The Company has entered into
license agreements or arrangements with several OEMs, including Structural
Dynamics Research Corporation (SDRC), Unigraphics Solutions, Inc., Bentley
Systems, Engineering Animation, Inc., SolidWorks Corp., and Tecnomatix
Technologies Ltd. under which the OEMs are licensed to embed the Companys
products in the OEMs software packages. These products provide limited virtual
prototyping capabilities, and can be upgraded by licensing ADAMS/Solver
directly from the Company.

Services

Software Maintenance Services

A critical component of MDIs strategy is to provide a wide range of
customer support services. These services include hotline support and on-site
support and training. Product support is provided pursuant to renewable annual
maintenance contracts. Customers who purchase maintenance agreements receive
product enhancement releases and hotline support at no additional charge.
On-site support and training are priced separately. Approximately 23.6%, 23.1%
and 19.7% of the Companys total revenue was realized from maintenance
contracts in 2001, 2000 and 1999, respectively.

Professional Services

The Company provides consulting, training and funded research and
development services to customers in connection with a wide range of product
design and engineering projects. MDIs primary objectives with regard to its
services include: (1) providing total solutions to its customers problems; (2)
leveraging software sales; (3) enhancing

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customer loyalty and repeat and renewal business; (4) growing the services
business of the Company profitably; (5) aggressively exploring and penetrating
new markets; and (6) obtaining customer feedback on its products.

The Company strives to identify key companies within various industries
with whom it seeks to develop close working relationships. The Company seeks to
foster technological partnerships with these companies by providing a
comprehensive service package, which addresses the particular virtual
prototyping needs of the companies. By doing this, MDI provides a total
solution for the customer, which can lead to increased acceptance of virtual
prototyping in the applicable industry.

The Companys services staff provides these services on either a time and
materials or a fixed fee basis depending on the project and the requirements of
the customer. Contract fees range from a few thousand dollars to several
hundred thousand dollars depending upon the scope of the project, and contract
durations range from a few weeks to several years. From time to time the
Company has incurred losses in connection with fixed price contracts. If the
Company underestimates the expenses required to perform under fixed fee
contracts, it could incur losses on these contracts. The Company has not
incurred a material loss from underestimating the expenses on any fixed fee
contract during 2001, 2000 or 1999.

Customers

The Companys customers include companies in a wide variety of industries.
Historically, the Companys largest customers have been automobile
manufacturers and automotive suppliers operating in an industry which can be
highly cyclical. During 2001, 2000 and 1999, automotive-related customers
accounted for approximately 52.7%, 56.6% and 54.0% of the Companys total
revenue, respectively. No customer accounted for greater than 10% of the
Companys total revenue in 2001, 2000 or 1999.

Segments within the auto industry, in each of the United States, Europe
and Japan, have, from time to time, including 2001, experienced significant
economic downturns characterized by decreased product demand, reductions in
capital expenditures, production over-capacity, price erosion, work slowdowns,
strikes and layoffs. The Companys operations may in the future reflect
substantial fluctuations from period to period as a consequence of such
industry patterns, general economic conditions affecting the timing of orders
from major customers and other factors affecting capital spending. There can
be no assurance that such factors will not have a material adverse effect upon
the Companys business, financial condition and results of operations.

Sales and Marketing

The Company markets its products through direct sales in North America,
Europe and to a lesser extent in Asia, a group of international distributors in
over 25 countries and through reselling alliances with certain integrated
mechanical CAD/CAM/CAE software vendors. The Company conducts sales activities
from its headquarters in Ann Arbor, Michigan, domestic sales offices in Long
Beach, CA; Atlanta, GA; Austin, TX; Chicago, IL; Cleveland, OH; Trenton, NJ;
Phoenix, AZ; and Seattle, WA, as well as its subsidiaries offices in England,
France, Czech Republic, Germany (three offices), Italy (two offices), Sweden (2
offices), Canada (2 offices), Japan (2 offices) and Singapore, and its foreign
branch offices in China and India. The Company employs engineers and
technically proficient salespersons capable of serving the technology needs of
current and prospective customers engineering, design and manufacturing
staffs.

The Company has formed strategic alliances with several leading hardware
vendors, including Hewlett-Packard, Silicon Graphics and Sun Microsystems.
Through these strategic alliances, the Company and the vendor participate in
various projects which enhance both the visibility and acceptance of the
Companys products, such as joint presentations to customers and the trade
press, joint advertising and promotion, conference presentations and displays.

The Company also has alliances with vendors of complementary
computer-aided engineering and testing solutions, such as ANSYS Inc., HKS Inc.,
MSC.Software Corp., MTS Systems Corp., The Mathworks, Inc., nCode International
Ltd., Cosin, and Structural Research & Analysis Corp. These relationships
entail collaborative development to support interfaces between the products of
the Company and each partner, as well as cooperative

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marketing and selling activity. By working with these vendors, the Company
seeks to satisfy the needs of its customers across a wide range of
computer-aided engineering and testing applications. The Company and its
partners jointly participate in promotional activities, trade shows, user
conferences, customer presentations and customer proposals.

The Company markets and sells third party software products through
distributor agreements with certain other CAE vendors whose technologies help
it provide a total solution to its customers. As of December 31, 2001 the
Company distributes software products of ANSYS, Inc. in both the United Kingdom
and Canada in addition to providing consulting services related to those
products. In certain regions in Italy, the Company distributes I-DEAS, a
product of Structural Dynamics Research Corporation. Revenue from third party
software products accounted for approximately 8.0%, 10.0% and 9.7% of the
Companys total revenue in 2001, 2000 and 1999, respectively.

The Company has formed relationships with several CAD/CAM companies,
including Autodesk, Inc., Dassault Systemes, EDS PLM Solutions, Parametric
Technology Corp., and SolidWorks Corp. Through these alliances, the Company
collaborates with its partners to develop and support embedded, add-on software
modules for each CAD/CAM environment. These embedded modules enable CAD/CAM
users to model and simulate mechanical systems and interface with the Companys
full ADAMSproduct line. The Company believes that strategic alliances are
important to its long-term success and intends to continue to pursue such
alliances in the future.

International revenue (i.e.,revenue from sales outside of North America)
accounted for approximately 69.8%, 64.2% and 61.7% of the Companys total
revenue in 2001, 2000 and 1999, respectively. In December 2000, the Company
acquired ESTECH, a computer-aided engineering service provider based in
Yokohama, Japan, from Nissan Motor of Japan and Structural Dynamics Research
Corporation. See Note 2 of Notes to Consolidated Financial Statements. A
summary of the Companys revenue by geographic area is presented in Note 7 of
Notes to Consolidated Financial Statements.

The Company relies primarily on a direct sales force in North America and
Europe. Outside of North America and Europe, the Company relies on a
combination of a direct sales force and distributors and sales representatives
for the licensing and support of its products. Distributors and sales
representatives accounted for approximately 19.2%, 24.4% and 20.4% of the
Companys total revenue in 2001, 2000 and 1999, respectively. The Companys
largest Japanese distributor, Information Services International-Dentsu, Ltd.
(ISI-Dentsu), accounted for approximately 12.0%, 16.4% and 12.6% of the
Companys total revenue in 2001, 2000 and 1999, respectively. There can be no
assurance that in the future the Companys current distributors will choose or
be able to market or service and support the Companys products effectively,
that economic conditions or industry demand will not adversely affect the
distributors or that such distributors will not devote greater resources to
marketing and supporting products of other companies. Additionally, because
the Companys products are typically used by skilled professionals, in order to
be effective, a distributor must possess sufficient technical, marketing and
sales resources and must devote these resources to a lengthy sales cycle,
customer training and product service and support. Only a limited number of
distributors possess such resources. The loss of or a significant reduction in
revenue from a distributor could have a material adverse effect on the
Companys business, financial condition and results of operations.

The Company generally prices its software products and services in local
currencies in Europe, Canada and Japan. The strengthening of the dollar in
2001, relative to the European, Canadian and Japanese currencies, negatively
affected 2001 international revenue by approximately $3.8 million. The
strengthening of the dollar in 2000, relative to the European currencies,
negatively affected 2000 international revenue by approximately $2.2 million.
This negative impact was partially offset by the strengthening of the Japanese
yen, which positively affected revenue by $446,000 in 2000. 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 in 2001
and 2000 was considerably less than the impact on revenue. If the U.S. dollar
strengthens in 2002 relative to the European, Canadian or 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 expects that international sales will continue to account for
a significant portion of its total revenue in future periods. The Company
intends to continue to expand its operations outside of the United States,
which will require significant management attention and financial resources.
International operations are subject to inherent

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risks, including unexpected changes in regulatory requirements, tariffs
and taxes, difficulties in staffing and managing foreign operations, longer
payment cycles, greater difficulty in accounts receivable collection,
compliance with applicable export licensing requirements and other trade
barriers and political and economic instability. Moreover, gains and losses on
the conversion to U.S. dollars of receivables and payables arising from
international operations may contribute to fluctuations in the Companys
results of operations. As more fully described in Note 1 of Notes to
Consolidated Financial Statements, the Companys risk management strategy uses
derivative financial instruments in the form of forward foreign exchange
contracts for the purpose of hedging foreign currency market exposures of its
ongoing business operations. The Company does not enter into derivative
contracts for the purpose of trading or speculative transactions. If for any
reason exchange or price controls or other restrictions on foreign currencies
were imposed, the Companys business, financial condition and results of
operations could be materially adversely affected. Currency exchange
fluctuations in countries in which the Company licenses its products in U.S.
dollars could have a material adverse effect on the Companys business,
financial condition and results of operations by resulting in pricing that is
not competitive with products priced in local currencies. In addition, the laws
of certain countries do not protect the Companys products and intellectual
property rights to the same extent as do the laws of the United States. There
can be no assurance that any of these factors will not have a material adverse
effect on the Companys future international operations and sales and,
consequently, on the Companys business, financial condition and results of
operations.

Research and Development

The Companys success depends in large part upon its ability to enhance
current products and to develop and introduce new products on a timely and
cost-effective basis. The Companys current software development efforts are
focused on developing additional products and services to complement its core
competencies of developing, marketing and supporting mechanical system modeling
and simulation software packages.

The Company has historically released at least one new version of its
software to its customers per year and intends to continue such releases. The
Company also provides periodic releases to its OEM software partners. As part
of this release process, the Company continually communicates with its
customers and partners and solicits comments for improved ease of use and
general customer satisfaction. The Companys software developers work as a
team with the Companys sales, marketing and consulting personnel to achieve a
robust, high-quality product line.

The Company also sponsors and maintains a network of academic and
commercial research affiliates to promote recognition and commercialization of
applicable emerging technology. Some of the technology areas which have
recently been explored include: kinematics, elastodynamics, numerical methods,
design sensitivity, optimization, symbolic computing, advance graphics and
visualization, user interfaces, tire dynamics, biomechanics, ergonomics,
controls design and hydraulics.

The virtual prototyping industry is characterized by rapid technological
changes, frequent new product introductions and evolving industry standards
that may render existing products and services obsolete. Consequently, to
maintain its competitive position, the Company must enhance its existing
software products and develop and introduce new products on a timely basis. In
addition, in order to maintain and broaden the market for its software
products, the Company must support a variety of computer systems and graphics
devices. There can be no assurance that the Company will not experience
difficulties that could delay or prevent the successful development,
introduction and marketing of these products, or that such new products and
product enhancements will adequately meet the requirements of the marketplace
and achieve market acceptance. If the Company is unable to develop and
introduce products in a timely manner in response to changing market conditions
or customer requirements, the Companys business, financial condition and
results of operations would be materially adversely affected.

Software products as complex as those offered by the Company may contain
defects or failures that may be detected at any point in the products life
cycle. The Company has, in the past, discovered software defects in certain of
its products. The Companys standard warranty provides that if the software
does not function to published specifications, the Company will, within a
limited time period following delivery, use its best efforts to repair or
replace the defective software without charge. To date, the Company has not
experienced significant technical errors or other product performance issues,
and warranty costs have been insignificant. There can be no assurance that,
despite testing by the Company, errors will not be found in current or new
products after

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commencement of commercial shipments, resulting in injury to the Companys
reputation, increased warranty and service costs, loss of market share or
failure to achieve market acceptance. Any such occurrence could have a material
adverse effect upon the Companys business, financial condition and results of
operations.

As of December 31, 2001, the Companys research and development group
consisted of 58 full-time employees. During 2001, 2000 and 1999, the Companys
research and development expenses were approximately $6.9 million, $6.1 million
and $5.6 million, respectively. The Company anticipates that it will commit
substantial resources to research and development in the future.

Backlog

The Company typically ships its products within 30 days after acceptance
of a customer purchase order and execution of a software license agreement.
Accordingly, the Company does not believe that its backlog at any particular
point in time is indicative of future revenue levels.

Competition

The markets for the Companys products and services are highly competitive
and subject to rapid change. The Company believes the principal competitive
factors in this market are product quality, ease of use, quality of support,
performance and price, functionality and features, ease of integration with
customers design processes, strategic alliances and vendor and product
reputation. In general, the Companys current competition comes from three
sources: the traditional method of testing hardware prototypes, whether
performed internally or externally, by the Companys current or potential
customers, other virtual prototyping software vendors, including Altair
Engineering Inc., Dassault Systemes, INTEC GmbH, LMS International,
MSC.Software Corp., Parametric Technology Corp. and Samtech Group, and the
internal software development groups of its current or potential customers. A
number of the Companys competitors have longer operating histories, greater
financial, technical, sales, marketing and other resources, greater name
recognition, more extensive distribution and sales networks and a larger, more
established customer base.

Among the Companys current and potential competitors are also a number of
large hardware and software companies that may develop or acquire products that
compete with the Companys products. Current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties to increase the ability of their products to address the needs of
the Companys prospective customers. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. Increased competition is likely to result in price
reductions, reduced operating margins and loss of market share, any of which
could materially adversely affect the Companys business, results of operations
and financial condition. There can be no assurance that the Company will be
able to compete successfully in the future or that competitive pressures will
not have a material adverse effect the Companys business, financial condition
and results of operations.

The Companys products address the market for virtual prototyping
software. Because this market is still evolving, it is difficult to assess or
predict with any assurance the growth rate, if any, and size of this market.
Also, as is typical in the case of a new and evolving industry, demand and
market acceptance for virtual prototyping software products and services are
subject to a high level of uncertainty. The Companys future financial
performance will depend in large part on growth in the virtual prototyping
market and upon the Companys ability to successfully market its ADAMSproducts
and services. There can be no assurance the virtual prototyping market will
grow in the future or that the Companys products and services will achieve
wider market acceptance. There are certain prototyping applications to which
the Companys products may not provide an effective solution due to limitations
in the capabilities of the Companys products and, as such, the Companys
products may not be accepted by certain customers. If the virtual prototyping
market fails to grow or grows more slowly than anticipated, or if the Companys
products do not achieve significant market acceptance, the Companys business,
financial condition and results of operations will be materially adversely
affected.

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Proprietary Rights

The Companys success depends in large part upon its proprietary software
technology. The Company currently relies on trade secret, copyright and
trademark laws, and license agreements with all of its customers to protect its
proprietary rights in its software products. The Company also ships its ADAMS
software with either an encoded password scheme or a security device. The
Companys software copies are locked to a specific central processing unit and
contain codes that will prohibit the user from running the software after a
certain date. The Company generally enters into proprietary information and
confidentiality agreements with its employees and distributors, and limits
access to and distribution of its software, documentation and other proprietary
information. The Company generally does not license or release the source code
for its proprietary software to third parties. Despite these precautions, there
can be no assurance that a third party will not copy or otherwise obtain and
use the Companys products or technology without authorization, or develop
similar or superior technology independently. The Company distributes its
Dynamic Designersoftware products and demonstration copies of its other
products in North America, Europe and Asia pursuant to shrink-wrap licenses.
There can be no assurance that such licenses are enforceable. In addition,
effective copyright and trade secret protection may be unavailable or limited
in certain foreign countries. Litigation may be necessary in the future to
enforce the Companys intellectual property rights, to protect the Companys
trade secrets, to determine the validity and scope of the proprietary rights of
others or to defend against claims of infringement or invalidity. Such
litigation could result in substantial costs and diversion of resources and
could have a material adverse effect on the Companys business, financial
condition and results of operations. Although the Company believes that its
products do not infringe on the proprietary rights of third parties, and
although the Company has received no communications from third parties alleging
the infringement of the proprietary rights of such parties, there can be no
assurance that infringement claims will not be asserted against the Company in
the future or that any such claims will not require the Company to enter into
costly litigation. Irrespective of the validity or the successful assertion of
such claims, any such litigation could result in substantial costs and a
significant diversion of managements attention and resources, and these
results as well as any adverse judgment that might be rendered could have a
material adverse effect on the Companys business, financial condition and
results of operations. In addition, if any claims or actions are asserted
against the Company, the Company may choose or be required to obtain a license
under a third partys intellectual property rights. There can be no assurance
that under such circumstances a license would be available upon reasonable
terms or at all.

Certain technology used by the Companys products is licensed from third
parties, generally on a nonexclusive basis. The Company believes there are
alternative sources for each of the material components of technology licensed
by the Company from third parties. However, the termination of any such
licenses, the failure of the third parties to adequately maintain or update
their products, or a substantial increase in the license fee associated with
such licenses could result in a delay in the Companys ability to deliver
certain of its products while it seeks to implement technology offered by
alternative sources and may adversely affect the Companys business, financial
condition and results of operations. Any required replacement licenses could
prove costly. Also, any such delay, to the extent it occurs at or near the end
of a quarter, could result in a material adverse effect on the Companys
quarterly results of operations. While it may be necessary or desirable in the
future to obtain other licenses relating to one or more of the Companys
products or relating to current or future technologies, there can be no
assurance that the Company will be able to do so on reasonable terms or at all.
Further, increased merger and acquisition activity in the technology industry
could affect the Companys relationships with other third-party developers, and
thus adversely affect the Companys results of operations.

Employees

As of December 31, 2001, the Company had 360 employees, consisting of 150
in engineering services, 118 in sales and marketing, 58 in research and
development and 34 in general and administrative capacities. Of these, 142 are
located at the Companys headquarters in Ann Arbor, Michigan, 24 are located at
the Companys domestic offices in Arizona, California, Georgia, Illinois, New
Jersey, Ohio, Texas, Washington, and Wisconsin, 23 are located at the Companys
Canadian subsidiary, 98 are located at the Companys European subsidiaries, 58
are located at the Companys Asian subsidiaries, and 15 are located at the
Companys foreign branch offices in China and India. None of the Companys
employees is represented by a labor union or is subject to a collective
bargaining agreement. The Company believes that its relations with its
employees are good.

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The Companys success depends in large part upon the continued service of
its key technical and senior management personnel. The Companys success also
depends on its continuing ability to attract and retain highly qualified
technical, sales and marketing, and managerial personnel. Competition for such
personnel is intense, and there can be no assurance that the Company can retain
its key managerial and technical employees or that it can attract, assimilate
or retain other highly qualified personnel in the future. If the Company is
unable to hire the necessary technical personnel, the development of new
products could be impaired. The Companys inability to attract, assimilate or
retain personnel in the future on a timely basis could have a material adverse
effect on the Companys business, financial condition and results of
operations.

Acquisitions

The Company periodically acquires or invests in businesses, software
products and technologies which are complementary to the Companys business.
The risks associated with such acquisitions or investments include, among
others, the difficulty of assimilating the operations and personnel of the
companies, the failure to realize anticipated synergies and the diversion of
managements time and attention. In addition, such investments and
acquisitions may contribute to fluctuations in quarterly results of operations
due to merger-related costs and charges associated with eliminating redundant
expenses or write-offs of impaired assets or in-process research and
development recorded in connection with the acquisitions, any of which could
negatively impact results of operations for a given period. There can be no
assurance that the Company will be successful in overcoming such risks or that
such investments and acquisitions will not have a material adverse effect upon
on the Companys business, financial condition or results of operations.

Potential Fluctuations in Quarterly Results

The Companys quarterly operating results have in the past varied and may
vary in the future depending on factors such as mix of direct and indirect
sales, product mix, service mix, increased competition, size and timing of
significant orders, seasonal factors and budgeting cycles of customers, product
releases and pricing changes by the Company or its competitors, timing of new
product announcements, market acceptance or delays in the introduction of new
or enhanced versions of the Companys products and general economic conditions.
A significant portion of the Companys revenue in previous quarters has been
derived from sales to a limited number of customers, and the Company currently
anticipates that future quarters will continue to reflect this trend. In
addition, like many software companies, the Company has generally recognized a
substantial portion of its revenue in the last month of each quarter, with this
revenue concentrated in the last weeks of the quarter. Accordingly, the
cancellation or deferral of even a small number of purchases of the Companys
products could have a material adverse effect on the Companys business,
results of operations and financial condition in any particular quarter. To
the extent that significant sales occur earlier than expected, operating
results for subsequent quarters may fail to keep pace or even decline. The
Companys quarterly operating results have also fluctuated as a result of
seasonality of customer buying patterns. Revenue is typically lower or
constant in the first quarter of the year in relation to the previous years
last quarter due primarily to budgeting cycles of customers. Revenue from
quarter to quarter is difficult to forecast, as minimal order backlog exists at
the end of any quarter because the Companys products typically are shipped and
revenue recognized promptly after receipt of the customers orders.

The Companys expense levels are based, in part, on its expectations as to
future revenue. If revenue levels are below expectations, operating results
are likely to be adversely affected. In particular, net income may be
disproportionately affected by a reduction in revenue because only a small
portion of the Companys expenses varies with its revenue. There can be no
assurance that the Company will be able to grow in future periods, that it will
be able to sustain its historical rate of revenue growth or that its operations
will remain profitable. As a result of the foregoing and other 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 indications of
future performance. Fluctuations in operating results may also result in
volatility in the price of the shares of the Companys common stock.

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Stock Price Volatility

The trading price of the Companys common stock could be subject to wide
fluctuations in response to quarterly variations in operating results,
announcements of technological innovations, the introduction of new products or
pricing changes by the Company or its competitors, proprietary rights or
litigation, changes in earnings estimates by analysts and other events or
factors. In addition, the stock market has from time to time experienced
extreme price and volume fluctuations that have been unrelated to the operating
performance of particular companies. These broad market fluctuations may
adversely affect the market price of the Companys common stock. In the past,
following periods of volatility in the market price of a companys securities,
securities class action litigation has sometimes occurred against companies.
There can be no assurance that such litigation will not occur in the future
with respect to the Company. Such litigation could result in substantial costs
and a significant diversion of managements attention and resources, and could
have a material adverse effect on the Companys business, financial condition
and results of operations. Any adverse determination in such litigation could
also subject the Company to significant liabilities.




Item 2. Properties

During the fourth quarter of 2000, the Company leased office space in a
new headquarters facility in Ann Arbor, Michigan. The Company occupies
approximately 70,500 square feet of space at the new facility. The initial
lease term is ten years expiring in December 2010. The Company also leases
sales offices in Texas, California, Canada, France, Sweden, England, Germany,
Italy, Czech Republic, Japan, China, Singapore and India.




Item 3. Legal Proceedings

From time to time, the Company is party to routine litigation arising in
the normal course of business. In the opinion of management, the liabilities
resulting from these proceedings, if any, will not be material to the Companys
consolidated financial position or results of operations.




Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of shareholders during the last
quarter of the year ended December 31, 2001.

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PART II




Item 5. Market for Registrants Common Equity and Related Stockholder Matters

The Companys common stock trades on The Nasdaq Stock Market under the
symbol MDII. The range of high and low sale prices for the Companys common
stock on that market for each of the quarters in the last two years are as
follows:

|                              |                |  |               |       |  |     |   |      | 
|----------------------------- | -------------- |  | ------------- | ----- |  | --- | - | ---- | 
|                              |                |  | Market prices |      
|                              |                |  |               |      
|                              |                |  | High          |       |  | Low |  
|                              |                |  |               |       |  |     |  
|Year ended December 31, 2001: |                |  |               |       |  |     |   |     
|                              | Fourth quarter |  | $             | 10.90 |  |     | $ | 6.75 | 
|                              | Third quarter  |  |               | 12.25 |  |     |   | 7.74 | 
|                              | Second quarter |  |               | 11.80 |  |     |   | 6.94 | 
|                              | First quarter  |  |               | 10.00 |  |     |   | 5.50 | 
|Year ended December 31, 2000: |                |  |               |       |  |     |   |     
|                              | Fourth quarter |  | $             | 6.88  |  |     | $ | 5.00 | 
|                              | Third quarter  |  |               | 6.13  |  |     |   | 4.63 | 
|                              | Second quarter |  |               | 6.25  |  |     |   | 4.81 | 
|                              | First quarter  |  |               | 7.38  |  |     |   | 4.63 | 

As of December 31, 2001, there were 154 shareholders of record of the
Companys common stock. This may not be an accurate indication of the total
shareholders of the Company as of December 31, 2001, since many nominees hold
the Companys shares in street name for the beneficial owners.

The Company has never declared or paid cash dividends on its capital stock
and anticipates that, for the foreseeable future, it will continue to retain
any earnings for use in the operation of its business.

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Item 6. Selected Consolidated Financial Data

The consolidated statement of income data for the years ended December 31,
2001, 2000, 1999, 1998 and 1997 and the consolidated balance sheet data as of
December 31, 2001, 2000, 1999, 1998 and 1997 presented below are derived from
the Companys consolidated financial statements audited by Arthur Andersen LLP
and should be read in conjunction with those statements.

|                                       |                                            |      |                                  |        |      |  |   |        |  |  |      |        |  |      |   |        |      |  |   |        |    
|-------------------------------------- | ------------------------------------------ | ---- | -------------------------------- | ------ | ---- |  | - | ------ |  |  | ---- | ------ |  | ---- | - | ------ | ---- |  | - | ------ | ---
|                                       |                                            |      | For the years ended December 31, |       
|                                       |                                            |      |                                  |       
|In thousands, except per share data    |                                            | 2001 |                                  |        | 2000 |  |   | 1999   |  |  | 1998 |        |  | 1997 |  
|                                       |                                            |      |                                  |        |      |  |   |        |  |  |      |        |  |      |  
|Consolidated statement of income data: |                                            |      |                                  |        |      |  |   |        |  |  |      |        |  |      |   |        |      |  |   |       
|                                       | Revenue                                    |      | $                                | 57,503 |      |  | $ | 46,577 |  |  | $    | 40,255 |  |      | $ | 36,575 |      |  | $ | 30,191 |    
|                                       | Operating income (loss)                    |      |                                  | 3,408  |      |  |   | 2,499  |  |  |      | 340    |  |      |   | (556   | )(1) |  |   | 965    | (2)
|                                       | Net income (loss)                          |      |                                  | 2,540  |      |  |   | 2,168  |  |  |      | 1,095  |  |      |   | (217   | )    |  |   | 744    |    
|                                       | Diluted net income (loss) per common
share |      |                                  | 0.40   |      |  |   | 0.35   |  |  |      | 0.18   |  |      |   | (0.04  | )    |  |   | 0.13   |    

|                                     |                           |      |                    |        |      |  |   |        |  |  |      |        |  |      |   |        |  |  |   |        | 
|------------------------------------ | ------------------------- | ---- | ------------------ | ------ | ---- |  | - | ------ |  |  | ---- | ------ |  | ---- | - | ------ |  |  | - | ------ | 
|                                     |                           |      | As of December 31, |       
|                                     |                           |      |                    |       
|In thousands                         |                           | 2001 |                    |        | 2000 |  |   | 1999   |  |  | 1998 |        |  | 1997 |  
|                                     |                           |      |                    |        |      |  |   |        |  |  |      |        |  |      |  
|Consolidated balance sheet data (3): |                           |      |                    |        |      |  |   |        |  |  |      |        |  |      |   |        |  |  |   |       
|                                     | Cash and cash equivalents |      | $                  | 18,125 |      |  | $ | 17,961 |  |  | $    | 17,741 |  |      | $ | 16,843 |  |  | $ | 20,261 | 
|                                     | Total assets              |      |                    | 46,923 |      |  |   | 45,869 |  |  |      | 38,189 |  |      |   | 36,247 |  |  |   | 34,147 | 
|                                     | Shareholders equity      |      |                    | 29,431 |      |  |   | 27,663 |  |  |      | 27,171 |  |      |   | 25,600 |  |  |   | 23,970 | 

Notes:



|(1) |  | For the year ended December 31, 1998, the Company recorded approximately
$1.7 million in charges to operations for acquisition and related costs
resulting primarily from the acquisitions of DTI Asia Pte. Ltd., certain
assets of H.G.E. Inc., and technology from the University of Iowa.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | For the year ended December 31, 1997, the Company recorded a $1.7 million
charge to operations for acquisition and related costs resulting from the
acquisition of StatDesign, Inc.                                                                                                         
|   
|(3) |  | The Company has never declared or paid cash dividends on its capital
stock and anticipates that, for the foreseeable future, it will continue
to retain any earnings for use in the operation of its business.                                                                              

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Item 7. 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 8 of
this Form 10-K.

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 the performance of
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 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 and included in Item 1 of this Form 10-K entitled
Business.

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.

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Results of Operations

Revenue

|                                |                    |      |        |      |          |  |      |      |  |   |          |      |   |      |      |    |  |   |        |      |  
|------------------------------- | ------------------ | ---- | ------ | ---- | -------- |  | ---- | ---- |  | - | -------- | ---- | - | ---- | ---- | -- |  | - | ------ | ---- | -
|In thousands                    |                    | 2001 |        |      | % Change |  |      | 2000 |  |   | % Change |      |   | 1999 |     
|                                |                    |      |        |      |          |  |      |      |  |   |          |      |   |      |     
|Software licenses               |                    | $    | 24,701 |      |          |  | 3.9  | %    |  | $ | 23,784   |      |   |      | 24.1 | %  |  | $ | 19,159 |     
|                                | % of total revenue |      |        | 43.0 | %        |  |      |      |  |   |          | 51.1 | % |      |      |    |  |   |        | 47.6 | %
|Software maintenance services   |                    | $    | 13,555 |      |          |  | 25.8 | %    |  | $ | 10,775   |      |   |      | 35.7 | %  |  | $ | 7,941  |     
|                                | % of total revenue |      |        | 23.6 | %        |  |      |      |  |   |          | 23.1 | % |      |      |    |  |   |        | 19.7 | %
|Professional services and other |                    | $    | 19,247 |      |          |  | 60.2 | %    |  | $ | 12,018   |      |   |      | (8.6 | %) |  | $ | 13,155 |     
|                                | % of total revenue |      |        | 33.5 | %        |  |      |      |  |   |          | 25.8 | % |      |      |    |  |   |        | 32.7 | %
|Total revenue                   |                    | $    | 57,503 |      |          |  | 23.5 | %    |  | $ | 46,577   |      |   |      | 15.7 | %  |  | $ | 40,255 |     

The Companys total revenue increased 23.5% to $57.5 million in 2001 from
$46.6 million in 2000. During 2000, total revenue increased 15.7% from $40.3
million in 1999. The growth in revenue during 2001 resulted primarily from
increased professional services revenue generated in Japan as a result of the
Companys acquisition of ESTECH Corporation (ESTECH) in December 2000, and
increased software maintenance services and software license sales of the
Companys software products. The growth in revenue during 2000 resulted from
increased sales of the Companys software products, including related
maintenance services, as well as from increased sales of third-party software
products licensed through the Companys European and Canadian subsidiaries.
These increases in software revenue were partially offset by a decrease in
professional services provided to the Companys customers in 2000. During 2001
and 2000, the Company achieved revenue growth in North America, Europe and
Asia. A summary of the Companys revenue by geographic location is presented in
Note 7 of Notes to Consolidated Financial Statements.

Revenue from international customers accounted for approximately 69.8%,
64.2% and 61.7% of the Companys total revenue in 2001, 2000 and 1999,
respectively. The increase in international revenue as a percent of total
revenue in 2001 was due primarily to increased professional services revenue
generated in Japan as a result of the Companys acquisition of ESTECH in
December 2000, and, to a lesser extent, increased sales of the Companys
software products in Asia. The accounting for the ESTECH acquisition is
summarized in Note 2 of Notes to Consolidated Financial Statements. The
increase in international revenue in 2001 was partially offset by the
strengthening of the U.S. dollar, which, relative to the European, Canadian and
Japanese currencies, negatively impacted the Companys revenue by approximately
$3.8 million. The increase in international revenue as a percent of total
revenue in 2000, as compared to 1999, was due primarily to increased sales of
the Companys software products in Asia. This increase was partially offset by
a decline in the percent of total revenue derived from European customers. The
strengthening of the dollar relative to the European currencies negatively
impacted the Companys revenue by approximately $2.2 million during 2000. This
negative impact was partially offset by the strengthening of the Japanese yen,
which positively affected revenue by $446,000 in 2000. Since most of the
Companys international operating expenses were incurred in local 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 2002 relative to the European, Canadian or 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 relies primarily on a direct sales force in North America and
Europe. Outside of North America and Europe, the Company relies primarily on
distributors and sales representatives for the licensing and support of its
products. Distributors and sales representatives accounted for approximately
19.2%, 24.4% and 20.4% of the Companys total revenue in 2001, 2000 and 1999,
respectively. The decrease in revenue from distributors and sales
representatives as a percentage of total revenue in 2001, as compared to 2000,
resulted primarily from an increase in professional services provided to the
Companys customers as a percentage of total revenue in 2001. The increase in
revenue from distributors and sales representatives as a percentage of total
revenue in 2000, as compared to 1999,

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resulted primarily from increased revenue from sales of the Companys
software products in Japan. The Companys largest distributor, Information
Services International-Dentsu, Ltd. (ISI-Dentsu) of Japan, accounted for
approximately 12.0%, 16.4% and 12.6% of the Companys total revenue in 2001,
2000 and 1999, respectively.

Revenue from automotive-related customers accounted for approximately
52.7%, 56.6% and 54.0% of the Companys total revenue in 2001, 2000 and 1999,
respectively. No customer accounted for greater than 10% of the Companys
total revenue in 2001, 2000 or 1999.

Software licenses revenue consists primarily of license fees for the
Companys software products and, to a lesser extent, license fees from
third-party software products licensed through the Companys European and
Canadian subsidiaries. Software licenses revenue increased 3.9% from 2000 to
approximately $24.7 million in 2001. This growth in revenue resulted primarily
from an increase in sales of the Companys software products in Asia. Software
licenses revenue increased 24.1% from 1999 to approximately $23.8 million in
2000. This increase resulted primarily from an increase in sales of the
Companys software products, and to a lesser extent, increased sales of third
party software licenses sold worldwide. Revenue from third-party products
accounted for $4.6 million in 2001, or 8.0% of total revenue, $4.7 million in
2000, or 10.0 % of total revenue, and $3.9 million in 1999, or 9.7% of total
revenue.

Software maintenance services revenue consists of revenue generated from
maintenance and support agreements on the Companys software products. Software
maintenance services revenue increased 25.8% during 2001 to approximately $13.6
million. In 2000, software maintenance services revenue grew 35.7% over 1999 to
approximately $10.8 million. The increases realized in 2001 and 2000 reflect
the continuing growth of the Companys customer base, as well as the strong
maintenance renewal rate the Company has historically experienced with respect
to software maintenance agreements. In addition, during 2001, the Companys
maintenance services revenue benefited from a price increase implemented in the
second half of 2001, whereby fees for the Companys maintenance services
increased from 18% to 20% of paid-up license fees. During 2000, the Companys
maintenance services revenue benefited from a price increase implemented in the
second half of 1999, whereby fees for the Companys maintenance services
increased from 15% to 18% of paid-up license fees.

Professional services and other revenue consists primarily of revenue from
consulting, training and funded research and development projects. Professional
services revenue grew 60.2% over 2000 to approximately $19.2 million in 2001.
The increase in revenue was primarily due to consulting revenue generated in
Japan as a result of the Companys acquisition of ESTECH in December 2000. The
8.6% decrease in professional services revenue in 2000 was due to a combination
of several factors, including: (1) a shift in spending during 2000 on the part
of certain large Japanese customers, whereby they invested less in consulting
services and more in software licenses, (2) a decline in the number of
employees deployed by the Company toward consulting services in the United
States during 2000, as compared to 1999, and (3) a decrease in funded
development activities during 2000.

Cost of Revenue

|                          |                                                  |      |        |      |          |  |      |      |  |   |          |      |   |      |      |   |  |   |        |      |  
|------------------------- | ------------------------------------------------ | ---- | ------ | ---- | -------- |  | ---- | ---- |  | - | -------- | ---- | - | ---- | ---- | - |  | - | ------ | ---- | -
|In thousands              |                                                  | 2001 |        |      | % Change |  |      | 2000 |  |   | % Change |      |   | 1999 |     
|                          |                                                  |      |        |      |          |  |      |      |  |   |          |      |   |      |     
|Cost of software licenses |                                                  | $    | 4,198  |      |          |  | (0.4 | %)   |  | $ | 4,214    |      |   |      | 21.3 | % |  | $ | 3,473  |     
|                          | Gross profit margin on
software licenses
revenue |      |        | 83.0 | %        |  |      |      |  |   |          | 82.3 | % |      |      |   |  |   |        | 81.9 | %
|Cost of services          |                                                  | $    | 16,779 |      |          |  | 47.6 | %    |  | $ | 11,369   |      |   |      | 0.6  | % |  | $ | 11,306 |     
|                          | Gross profit margin on
services revenue          |      |        | 48.8 | %        |  |      |      |  |   |          | 50.1 | % |      |      |   |  |   |        | 46.4 | %

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 decreased 0.4%
from 2000 to approximately $4.2 million in 2001. In 2000, cost of software
licenses increased 21.3% from 1999 to approximately $4.2 million. During 2001,
the decrease was due to lower royalties paid to third parties whose products
were licensed through the Companys

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Canadian and European subsidiaries, which is consistent with the decline
in revenue from third-party software products during 2001. During 2000, the
increase was due to higher royalties paid to third parties whose products were
licensed through the Companys Canadian and European subsidiaries, which is
consistent with the increase in revenue from third-party software products
during 2000. Gross profit margin on software licenses revenue was 83.0%, 82.3%
and 81.9% during 2001, 2000 and 1999, respectively.

Cost of services includes payroll and overhead expenses attributable to
hotline support, consulting, training, and funded research and development.
Cost of services revenue grew 47.6% over 2000 to approximately $16.8 million in
2001. In 2000, cost of services revenue grew 0.6% over 1999 to approximately
$11.4 million. The increase in cost of services in 2001 was primarily due to
the costs associated with professional services revenue generated by ESTECH in
2001. Gross profit margin on services revenue was 48.8%, 50.1% and 46.4% during
2001, 2000 and 1999, respectively. Historically, software maintenance services
revenue has generated higher profit margins than revenue from professional
services. The decrease in gross profit margin during 2001 was due to an
increase in professional services revenue as a percent of total service
revenue. The increase in gross profit margin during 2000 was primarily due to
the increase in software maintenance services revenue as a percentage of total
services revenue.

Operating Expenses

|                            |                    |      |        |      |          |  |      |      |  |   |          |      |   |      |      |   |  |   |        |      |  
|--------------------------- | ------------------ | ---- | ------ | ---- | -------- |  | ---- | ---- |  | - | -------- | ---- | - | ---- | ---- | - |  | - | ------ | ---- | -
|In thousands                |                    | 2001 |        |      | % Change |  |      | 2000 |  |   | % Change |      |   | 1999 |     
|                            |                    |      |        |      |          |  |      |      |  |   |          |      |   |      |     
|Sales and marketing         |                    | $    | 20,629 |      |          |  | 17.2 | %    |  | $ | 17,599   |      |   |      | 14.3 | % |  | $ | 15,394 |     
|                            | % of total revenue |      |        | 35.9 | %        |  |      |      |  |   |          | 37.8 | % |      |      |   |  |   |        | 38.2 | %
|Research and development    |                    | $    | 6,921  |      |          |  | 13.1 | %    |  | $ | 6,118    |      |   |      | 9.2  | % |  | $ | 5,603  |     
|                            | % of total revenue |      |        | 12.0 | %        |  |      |      |  |   |          | 13.1 | % |      |      |   |  |   |        | 13.9 | %
|General and administrative  |                    | $    | 4,855  |      |          |  | 12.8 | %    |  | $ | 4,304    |      |   |      | 16.8 | % |  | $ | 3,685  |     
|                            | % of total revenue |      |        | 8.4  | %        |  |      |      |  |   |          | 9.2  | % |      |      |   |  |   |        | 9.2  | %
|Amortization of intangibles |                    | $    | 713    |      |          |  | 50.4 | %    |  | $ | 474      |      |   |      | 4.4  | % |  | $ | 454    |     
|                            | % of total revenue |      |        | 1.2  | %        |  |      |      |  |   |          | 1.0  | % |      |      |   |  |   |        | 1.1  | %

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 in
2001 resulted from the Companys continued expansion of its worldwide sales and
marketing organization, as well as the increase in commissions paid on the
higher level of revenue. The absolute dollar increase in sales and marketing
expenses during 2000 primarily resulted from increased sales commissions paid
to the distributor of the Companys software in Japan, based on the higher
revenue realized from the region. During 2001, the number of employees in sales
and marketing increased from 103 to 118. The Company expects to continue to
invest significant resources in sales and marketing, and will expand its sales
and marketing organization as necessary to meet a growing demand for its
products and services.

Research and development expenses include all payroll costs attributable
to research and development activities, as well as an allocation of overhead
expenses incurred by the Company. The absolute dollar increases in research
and development expenses in 2001 and 2000 resulted from an increase in costs in
support of expanded product development efforts. Funded research and
development expenses, which are not included in research and development
expenses but are included in cost of services revenue, represented 0.4%, 0.8%,
and 0.9%, of total revenue in 2001, 2000, and 1999, respectively. The majority
of the revenue received and expenses incurred for funded research and
development was directly related to projects associated with the ongoing
development of the Companys vertical software products, including ADAMS/Car,
ADAMS/Engineand ADAMS/Rail. The Company intends to continue to invest
significant resources in research and development in the future.

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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
grew 12.8% over 2000 to approximately $4.9 million in 2001. General and
administrative expenses grew 16.8% over 1999 to approximately $4.3 million in
2000. 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.

Amortization of intangibles includes the amortization of goodwill, or the
purchase price in excess of net assets on the Companys acquisitions. Goodwill
amortization increased during 2001 and 2000, due to increased goodwill
associated with the Companys acquisition of ESTECH in December 2000. 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.

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible
Assets, which primarily addresses the accounting for goodwill and intangible
assets subsequent to their acquisition. The provisions for SFAS 142 will be
effective for the Companys fiscal year beginning January 1, 2002. Pursuant to
SFAS 142, the Companys goodwill will no longer be amortized in future periods.
However, goodwill will be subject to an annual test for impairment based on an
estimated fair market value. Should a units goodwill exceed its fair market
value, an impairment charge would result. Management has not yet assessed the
impact of SFAS 142 in regard to the impairment of goodwill. See Note 1 of
Notes to Condensed Consolidated Financial Statements.

Other Income, Net

|                  |                    |      |     |     |          |  |       |      |  |   |          |     |   |      |      |   |  |   |     |     |  
|----------------- | ------------------ | ---- | --- | --- | -------- |  | ----- | ---- |  | - | -------- | --- | - | ---- | ---- | - |  | - | --- | --- | -
|In thousands      |                    | 2001 |     |     | % Change |  |       | 2000 |  |   | % Change |     |   | 1999 |     
|                  |                    |      |     |     |          |  |       |      |  |   |          |     |   |      |     
|Other income, net |                    | $    | 392 |     |          |  | (42.4 | %)   |  | $ | 680      |     |   |      | 32.3 | % |  | $ | 514 |    
|                  | % of total revenue |      |     | 0.7 | %        |  |       |      |  |   |          | 1.5 | % |      |      |   |  |   |     | 1.3 | %

Other income, net consists of net interest income, net foreign currency
transaction loss, and loss on the disposal of property and equipment. Net
interest income was $522,000, $998,000, and $679,000 in 2001, 2000, and 1999,
respectively. The decrease in net interest income in 2001 compared to 2000
primarily resulted from a decline in interest rates. The increase in net
interest income during 2000 compared to 1999 primarily resulted from additional
interest earned given the Companys higher cash and cash equivalents balance.
Net foreign currency transaction loss amounted to $73,000, $309,000, and
$74,000 in 2001, 2000 and 1999, respectively. The loss on the disposal of
property and equipment was $57,000, $9,000 and $91,000 in 2001, 2000, and 1999,
respectively.

Provision for Income Taxes

The Companys effective income tax rates were 29.9%, 29.9% and (29.2%) for
2001, 2000 and 1999, respectively. The difference between the Companys
effective rate and statutory federal rate during 2001 and 2000 resulted
primarily from the recognition of certain tax credits, tax-exempt interest
income earned by the Company, and tax benefits gained from the Companys
foreign sales corporation. In 1999, the difference between the effective and
statutory federal rate resulted primarily from U.S. research and development
tax credits recognized by the Company, and to a lesser extent, benefits
realized from the Companys foreign sales corporation and tax-exempt interest
income earned during the year. Excluding the tax credits, the Companys
effective tax rate for 1999 would have been 29.9%. See Note 4 of Notes to
Consolidated Financial Statements.

Minority Interest in Net Income of Subsidiary

The Company owns a 66% interest in its Japanese subsidiary, Mechanical
Dynamics Japan K.K. (MDI-Japan), through a joint venture agreement with
ISI-Dentsu of Tokyo, Japan, the largest distributor of the Companys software
in Japan. Minority interest in net income of subsidiary of $123,000 in 2001,
$60,000 in 2000 and $8,000 in 1999 represents ISI-Dentsus 34% interest in the
net income of MDI-Japan.

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Off Balance Sheet Commitments

The Company and its subsidiaries lease office space and certain
equipment under noncancellable lease agreements which expire at various dates through December 2010.
Operating leases are expensed over the term of the lease agreement and are not capitalized. In addition, the
Company has assets held under capital leases that are included in property and equipment and are charged to
depreciation and interest over the life of the leases. See Note 6 of Notes to Consolidated Financial Statements.

Employees

The number of the Companys worldwide employees increased 8.4% to 360 at
December 31, 2001, compared with 332 at December 31, 2000.

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
was a transition period from January 1, 1999 to January 1, 2002 during which
the old currencies remained legal tender in the participating countries as
denominations of the Euro.

The Companys subsidiaries in Germany, France and Italy are currently
reporting in Euros. The Company does not expect that the Euros introduction
will have a material adverse effect on its consolidated results of operations.

Liquidity and Capital Resources

Cash and cash equivalents were $18.1 million at December 31, 2001,
compared to $18.0 million at December 31, 2000. During 2001, cash and cash
equivalents increased primarily as a result of the $3.8 million in cash
provided by operations and $488,000 in proceeds from the issuance of common
stock. These increases were offset by $2.4 million used to purchase property
and equipment (net of proceeds from disposals), $495,000 used to repurchase
62,400 shares of the Companys common stock, and $488,000 used for payments on
capital lease obligations.

Cash and cash equivalents were $18.0 million at December 31, 2000,
compared to $17.7 million at December 31, 1999. During 2000, cash and cash
equivalents increased primarily as a result of the $7.3 million in cash
provided by operations. This increase was offset by $3.5 million in cash used
in the acquisition of ESTECH in December 2000, $2.1 million used to purchase
property and equipment, and $1.3 million used to repurchase 218,948 shares of
the Companys common stock.

At December 31, 2001, the Companys principal commitments consisted of
obligations under capital and operating leases for facilities and equipment,
including approximately $3.1 million in payments due under noncancellable
leases during 2002. The Company had $921,000 in capital lease obligations
outstanding as of December 31, 2001, of which $515,000 is long-term. The
Company had no other borrowings under long-term debt arrangements at December
31, 2001.

The Company has an agreement with its principal bank for an unsecured $6.0
million line of credit. No borrowings were outstanding under this agreement as
of December 31, 2001. The Companys subsidiaries in Germany and Italy also
have line of credit and overdraft facilities that provide for aggregate
borrowing availability of approximately $335,000. No borrowings were
outstanding under these facilities as of December 31, 2001.

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 1999
through 2001 and intends to continue its policy of retaining earnings to
finance future growth.

New Accounting Pronouncements

In accordance with recently issued accounting pronouncements, the Company
will be required to comply with certain changes in accounting rules and
regulations. See Note 1 of Notes to Consolidated Financial Statements.

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Critical Accounting Policies

The Companys consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States, which
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts
of revenue and expenses during the reporting period. Actual results may differ
from these estimates which could have a material impact on the Companys
financial statements. The Companys significant accounting policies are
described in Note 1 of Notes to Consolidated Financial Statements. The Company
believes that its most critical accounting policies include revenue
recognition, accounting for income taxes and foreign currency.

The Company follows the provisions of AICPA Statements of Provision 97-2,
Software Revenue Recognition. Revenue under paid-up software licensing
agreements, including licenses generated through distributors, is recognized
when a customer contract is fully executed, the software is delivered, the fee
is fixed and determinable and collectability is reasonably assured. Revenue
under annual software licensing arrangements is deferred and amortized over the
terms of the agreements. Revenue related to advance payments received under
software maintenance agreements is deferred and amortized over the terms of the
agreements. Revenue from professional services is recognized upon performance
of the service.

Significant judgment is required in determining the Companys provision
for income taxes, deferred tax assets and liabilities and any valuation
allowance recorded against the net deferred tax assets. Management believes the
Company will obtain the full benefit of the net deferred tax asset on the basis
of its evaluation of the Companys anticipated profitability over the period of
years that the temporary differences are expected to become tax deductions. It
believes that sufficient taxable income will be generated to realize the
benefit of these tax assets. This assessment of profitability takes into
account the Companys present and anticipated split of domestic and
international earnings.

The financial statements of international subsidiaries are translated
using exchange rates in effect at period end for assets and liabilities and at
average rates during the period for results of operations. The resulting
foreign currency translation adjustments are reflected as a separate component
of shareholders equity. Net foreign currency transaction gains and losses are
included in other income, net in the consolidated statements of income.




Item 7a. Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed to market risk from changes in foreign exchange and
interest rates. To reduce the risk from changes in foreign exchange rates, the
Company selectively uses financial instruments. The Company does not hold or
issue financial instruments for trading purposes.

Foreign Currency

The Company, at various times, enters into forward exchange contracts to
hedge certain exposures related to identifiable foreign currency transactions
that are relatively certain as to both timing and amount. The Company does not
use any other types of derivative financial instruments to hedge such
exposures, nor does it use derivatives for speculative purposes. In general,
the Company uses forward exchange contracts to hedge against large, selective
transactions that present the most exposure to exchange rate fluctuations. At
December 31, 2001, the Company had forward foreign currency exchange contracts
of $255,000 (notional amounts). The contracts outstanding at December 31, 2001
mature through March 8, 2002 and are intended to hedge various foreign currency
commitments due from foreign subsidiaries and the Companys distributors. Due
to the short-term nature of these financial instruments, the fair value of
these contracts is not materially different than their notional amount at
December 31, 2001.

Gains and losses on the forward contracts are largely offset by gains and
losses on the underlying exposures. The Company conducts business in seven
foreign currencies, predominantly Japanese yen, German marks, Euros and British
pounds. A hypothetical 10% appreciation of the U.S. dollar from December 31,
2001 market rates would

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increase the unrealized value of the Companys existing forward contracts
at December 31, 2001 by $25,000. Conversely, a hypothetical 10% depreciation
of the U.S. dollar from December 31, 2001 market rates would decrease the
unrealized value of the Companys forward contracts by $25,000. In either
scenario, the gains and losses on the forward contracts are largely offset by
the gains or losses on the underlying transactions.

Interest Rates

The Company maintains its cash and cash equivalents in highly liquid
investments with maturities of 90 days or less. The Company has the ability to
hold its fixed income investments to maturity, and therefore would not expect
its operating results or cash flows to be affected to any significant degree by
the effect of a hypothetical 10% change in market interest rates on its cash
and cash equivalents.

International Sales

The Company expects that international sales will continue to account for
a significant portion of its total revenue in future periods. The Company
intends to continue to expand its operations outside of the United States,
which will require significant management attention and financial resources.
International operations are subject to inherent risks, including unexpected
changes in regulatory requirements, tariffs and taxes, difficulties in staffing
and managing foreign operations, longer payment cycles, greater difficulty in
accounts receivable collection, compliance with applicable export licensing
requirements and other trade barriers and political and economic instability.
Moreover, gains and losses on the conversion to U.S. dollars of receivables and
payables arising from international operations may contribute to fluctuations
in the Companys results of operations. As more fully described in Note 1 of
Notes to Consolidated Financial Statements, the Companys risk management
strategy uses derivative financial instruments in the form of forward foreign
exchange contracts for the purpose of hedging foreign currency market exposures
of its ongoing business operations. The Company does not enter into derivative
contracts for the purpose of trading or speculative transactions. If for any
reason exchange or price controls or other restrictions on foreign currencies
were imposed, the Companys business, financial condition and results of
operations could be materially adversely affected. Currency exchange
fluctuations in countries in which the Company licenses its products in U.S.
dollars could have a material adverse effect on the Companys business,
financial condition and results of operations by resulting in pricing that is
not competitive with products priced in local currencies. In addition, the laws
of certain countries do not protect the Companys products and intellectual
property rights to the same extent as do the laws of the United States. There
can be no assurance that any of these factors will not have a material adverse
effect on the Companys future international operations and sales and,
consequently, on the Companys business, financial condition and results of
operations.

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Item 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Shareholders of Mechanical Dynamics, Inc.:

We have audited the accompanying consolidated balance sheets of MECHANICAL
DYNAMICS, INC. (a Michigan corporation) and subsidiaries as of December 31,
2001 and 2000, and the related consolidated statements of income, shareholders
equity and comprehensive income, and cash flows for each of the three years in
the period ended December 31, 2001. These financial statements are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Mechanical Dynamics, Inc.
and subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted
in the United States.



| | ARTHUR ANDERSEN LLP
| | -------------------

Detroit, Michigan,
      January 30, 2002.

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MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2001 AND 2000

|                                                                             |                                                                                                                                                |                            |                                      |        |        |   |        |        |        |  |  | 
|---------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ------------------------------------ | ------ | ------ | - | ------ | ------ | ------ |  |  | 
|In thousands                                                                 |                                                                                                                                                | 2001                       |                                      |        | 2000   |  
|                                                                             |                                                                                                                                                |                            |                                      |        |        |  
|                                                                             |                                                                                                                                                |                            |                                      | Assets |        |   |        |        |        |  |  | 
|Current assets:                                                              |                                                                                                                                                |                            |                                      |        |        |   |        |       
|                                                                             | Cash and cash equivalents                                                                                                                      |                            | $                                    | 18,125 |        |   | $      | 17,961 |       
|                                                                             | Accounts receivable, net of allowance for doubtful accounts of $380 and $374                                                                   |                            |                                      | 11,030 |        |   |        | 11,442 |       
|                                                                             | Prepaid and deferred expenses                                                                                                                  |                            |                                      | 3,412  |        |   |        | 3,255  |       
|                                                                             |                                                                                                                                                |                            |                                      |        |        |  
|                                                                             |                                                                                                                                                | Total current assets       |                                      |        | 32,567 |   |        |        | 32,658 | 
|                                                                             |                                                                                                                                                |                            |                                      |        |        |  
|Property and equipment, net of accumulated depreciation of $5,625 and $4,578 |                                                                                                                                                |                            | 5,155                                |        |        |   | 4,462  |       
|Goodwill, net of accumulated amortization of $2,376 and $1,663               |                                                                                                                                                |                            | 6,185                                |        |        |   | 6,768  |       
|Other assets                                                                 |                                                                                                                                                |                            | 3,016                                |        |        |   | 1,981  |       
|                                                                             |                                                                                                                                                |                            |                                      |        |        |  
|                                                                             |                                                                                                                                                | $                          | 46,923                               |        |        | $ | 45,869 |       
|                                                                             |                                                                                                                                                |                            |                                      |        |        |   |       
|                                                                             |                                                                                                                                                |                            | Liabilities and Shareholders Equity |        |        |   |        |        |        |  | 
|Current liabilities:                                                         |                                                                                                                                                |                            |                                      |        |        |   |        |       
|                                                                             | Borrowings under lines of credit                                                                                                               |                            | $                                    |       |        |   | $      | 49     |       
|                                                                             | Current portion of capital leases                                                                                                              |                            |                                      | 406    |        |   |        | 406    |       
|                                                                             | Accounts payable                                                                                                                               |                            |                                      | 2,078  |        |   |        | 2,466  |       
|                                                                             | Accrued compensation                                                                                                                           |                            |                                      | 2,749  |        |   |        | 2,960  |       
|                                                                             | Other accrued expenses                                                                                                                         |                            |                                      | 4,043  |        |   |        | 4,192  |       
|                                                                             | Deferred revenue                                                                                                                               |                            |                                      | 7,039  |        |   |        | 6,936  |       
|                                                                             |                                                                                                                                                |                            |                                      |        |        |  
|                                                                             |                                                                                                                                                | Total current liabilities  |                                      |        | 16,315 |   |        |        | 17,009 | 
|                                                                             |                                                                                                                                                |                            |                                      |        |        |  
|Capital lease obligation, less current portion                               |                                                                                                                                                |                            | 515                                  |        |        |   | 658    |       
|                                                                             |                                                                                                                                                |                            |                                      |        |        |  
|Minority interest                                                            |                                                                                                                                                |                            | 662                                  |        |        |   | 539    |       
|                                                                             |                                                                                                                                                |                            |                                      |        |        |  
|Commitments and contingencies (Note 6)                                       |                                                                                                                                                |                            |                                      |        |        |   |        |       
|Shareholders equity:                                                        |                                                                                                                                                |                            |                                      |        |        |   |        |       
|                                                                             | Common stock, no par value, 15,000,000 shares authorized, 6,112,524 and
6,103,041 shares issued and outstanding in 2001 and 2000, respectively |                            |                                      | 22,261 |        |   |        | 21,998 |       
|                                                                             | Preferred stock, no par value, 1,000,000 shares authorized, no shares
issued and outstanding                                                   |                            |                                      |       |        |   |        |       |       
|                                                                             | Retained earnings                                                                                                                              |                            |                                      | 8,089  |        |   |        | 5,819  |       
|                                                                             | Accumulated other comprehensive loss                                                                                                           |                            |                                      | (919   | )      |   |        | (154   | )     
|                                                                             |                                                                                                                                                |                            |                                      |        |        |  
|                                                                             |                                                                                                                                                | Total shareholders equity |                                      |        | 29,431 |   |        |        | 27,663 | 
|                                                                             |                                                                                                                                                |                            |                                      |        |        |  
|                                                                             |                                                                                                                                                | $                          | 46,923                               |        |        | $ | 45,869 |       
|                                                                             |                                                                                                                                                |                            |                                      |        |        |   |       

The accompanying notes are an integral part of these consolidated statements.

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MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999

|                                                     |                                 |                          |           |        |        |   |           |        |        |   |           |        |        | 
|---------------------------------------------------- | ------------------------------- | ------------------------ | --------- | ------ | ------ | - | --------- | ------ | ------ | - | --------- | ------ | ------ | 
|In thousands, except share and per share data        |                                 | 2001                     |           |        | 2000   |   |           | 1999   |       
|                                                     |                                 |                          |           |        |        |   |           |        |       
|Revenue:                                             |                                 |                          |           |        |        |   |           |        |        |   |           |       
|                                                     | Software licenses               |                          | $         | 24,701 |        |   | $         | 23,784 |        |   | $         | 19,159 |       
|                                                     | Software maintenance services   |                          |           | 13,555 |        |   |           | 10,775 |        |   |           | 7,941  |       
|                                                     | Professional services and other |                          |           | 19,247 |        |   |           | 12,018 |        |   |           | 13,155 |       
|                                                     |                                 |                          |           |        |        |   |           |        |       
|                                                     |                                 | Total revenue            |           |        | 57,503 |   |           |        | 46,577 |   |           |        | 40,255 | 
|                                                     |                                 |                          |           |        |        |   |           |        |       
|Cost of revenue:                                     |                                 |                          |           |        |        |   |           |        |        |   |           |       
|                                                     | Software licenses               |                          |           | 4,198  |        |   |           | 4,214  |        |   |           | 3,473  |       
|                                                     | Services                        |                          |           | 16,779 |        |   |           | 11,369 |        |   |           | 11,306 |       
|                                                     |                                 |                          |           |        |        |   |           |        |       
|                                                     |                                 | Total cost of revenue    |           |        | 20,977 |   |           |        | 15,583 |   |           |        | 14,779 | 
|                                                     |                                 |                          |           |        |        |   |           |        |       
|Gross profit                                         |                                 |                          | 36,526    |        |        |   | 30,994    |        |        |   | 25,476    |       
|                                                     |                                 |                          |           |        |        |   |           |        |       
|Operating expenses:                                  |                                 |                          |           |        |        |   |           |        |        |   |           |       
|                                                     | Sales and marketing             |                          |           | 20,629 |        |   |           | 17,599 |        |   |           | 15,394 |       
|                                                     | Research and development        |                          |           | 6,921  |        |   |           | 6,118  |        |   |           | 5,603  |       
|                                                     | General and administrative      |                          |           | 4,855  |        |   |           | 4,304  |        |   |           | 3,685  |       
|                                                     | Amortization of intangibles     |                          |           | 713    |        |   |           | 474    |        |   |           | 454    |       
|                                                     |                                 |                          |           |        |        |   |           |        |       
|                                                     |                                 | Total operating expenses |           |        | 33,118 |   |           |        | 28,495 |   |           |        | 25,136 | 
|                                                     |                                 |                          |           |        |        |   |           |        |       
|Operating income                                     |                                 |                          | 3,408     |        |        |   | 2,499     |        |        |   | 340       |       
|Other income, net                                    |                                 |                          | 392       |        |        |   | 680       |        |        |   | 514       |       
|                                                     |                                 |                          |           |        |        |   |           |        |       
|Income before income taxes and minority interest     |                                 |                          | 3,800     |        |        |   | 3,179     |        |        |   | 854       |       
|Provision (credit) for income taxes                  |                                 |                          | 1,137     |        |        |   | 951       |        |        |   | (249      | )     
|                                                     |                                 |                          |           |        |        |   |           |        |       
|Income before minority interest                      |                                 |                          | 2,663     |        |        |   | 2,228     |        |        |   | 1,103     |       
|Minority interest in net income of subsidiary        |                                 |                          | 123       |        |        |   | 60        |        |        |   | 8         |       
|                                                     |                                 |                          |           |        |        |   |           |        |       
|Net income                                           |                                 | $                        | 2,540     |        |        | $ | 2,168     |        |        | $ | 1,095     |       
|                                                     |                                 |                          |           |        |        |   |           |        |        |  
|Basic net income per common share                    |                                 | $                        | 0.42      |        |        | $ | 0.35      |        |        | $ | 0.18      |       
|                                                     |                                 |                          |           |        |        |   |           |        |        |  
|Weighted average common shares                       |                                 |                          | 6,083,311 |        |        |   | 6,225,970 |        |        |   | 6,254,308 |       
|                                                     |                                 |                          |           |        |        |   |           |        |       
|Diluted net income per common share                  |                                 | $                        | 0.40      |        |        | $ | 0.35      |        |        | $ | 0.18      |       
|                                                     |                                 |                          |           |        |        |   |           |        |        |  
|Weighted average common and common equivalent shares |                                 |                          | 6,313,862 |        |        |   | 6,229,750 |        |        |   | 6,254,376 |       
|                                                     |                                 |                          |           |        |        |   |           |        |       

The accompanying notes are an integral part of these consolidated statements.

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MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999

|                                               |                           |                                                          |                      |        |       |   |        |        |       |   |        |        |       |  | 
|---------------------------------------------- | ------------------------- | -------------------------------------------------------- | -------------------- | ------ | ----- | - | ------ | ------ | ----- | - | ------ | ------ | ----- |  | 
|In thousands                                   |                           | 2001                                                     |                      |        | 2000  |   |        | 1999   |      
|                                               |                           |                                                          |                      |        |       |   |        |        |      
|                                               |                           |                                                          | Shareholders Equity |        |       |   |        |        |       |   |        |        |       |  | 
|Common stock:                                  |                           |                                                          |                      |        |       |   |        |        |       |   |        |       
|                                               | Balance beginning of year |                                                          | $                    | 21,998 |       |   | $      | 22,586 |       |   | $      | 22,332 |      
|                                               |                           | Stock issued under the Employee Stock Purchase Plan      |                      |        | 177   |   |        |        | 200   |   |        |        | 254   | 
|                                               |                           | Stock issued upon the exercise of employee stock options |                      |        | 311   |   |        |        |      |   |        |        |      | 
|                                               |                           | Repurchases of Company common stock                      |                      |        | (225  | ) |        |        | (788  | ) |        |        |      | 
|                                               |                           |                                                          |                      |        |       |   |        |        |      
|                                               | Balance end of year       |                                                          |                      | 22,261 |       |   |        | 21,998 |       |   |        | 22,586 |      
|                                               |                           |                                                          |                      |        |       |   |        |        |      
|Retained earnings:                             |                           |                                                          |                      |        |       |   |        |        |       |   |        |       
|                                               | Balance beginning of year |                                                          |                      | 5,819  |       |   |        | 4,168  |       |   |        | 3,073  |      
|                                               |                           | Net income                                               |                      |        | 2,540 |   |        |        | 2,168 |   |        |        | 1,095 | 
|                                               |                           | Repurchases of Company common stock                      |                      |        | (270  | ) |        |        | (517  | ) |        |        |      | 
|                                               |                           |                                                          |                      |        |       |   |        |        |      
|                                               | Balance end of year       |                                                          |                      | 8,089  |       |   |        | 5,819  |       |   |        | 4,168  |      
|                                               |                           |                                                          |                      |        |       |   |        |        |      
|Accumulated other comprehensive income (loss): |                           |                                                          |                      |        |       |   |        |        |       |   |        |       
|                                               | Balance beginning of year |                                                          |                      | (154   | )     |   |        | 417    |       |   |        | 195    |      
|                                               |                           | Foreign currency translation adjustment                  |                      |        | (765  | ) |        |        | (571  | ) |        |        | 222   | 
|                                               |                           |                                                          |                      |        |       |   |        |        |      
|                                               | Balance end of year       |                                                          |                      | (919   | )     |   |        | (154   | )     |   |        | 417    |      
|                                               |                           |                                                          |                      |        |       |   |        |        |      
|Total shareholders equity                     |                           | $                                                        | 29,431               |        |       | $ | 27,663 |        |       | $ | 27,171 |       
|                                               |                           |                                                          |                      |        |       |   |        |        |       |  
|                                               |                           |                                                          | Comprehensive Income |        |       |   |        |        |       |   |        |        |       |  | 
|Net income                                     |                           | $                                                        | 2,540                |        |       | $ | 2,168  |        |       | $ | 1,095  |       
|Foreign currency translation adjustment        |                           |                                                          | (765                 | )      |       |   | (571   | )      |       |   | 222    |       
|                                               |                           |                                                          |                      |        |       |   |        |        |      
|Comprehensive income                           |                           | $                                                        | 1,775                |        |       | $ | 1,597  |        |       | $ | 1,317  |       
|                                               |                           |                                                          |                      |        |       |   |        |        |       |  

The accompanying notes are an integral part of these consolidated statements.

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MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999

|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |        |       |        |        |       |        |        |  
|--------------------------------------------------------------------- | --------------------------------------------------------------------------------- | ----------------------------------------------------------------- | ----------------------------- | --------------------------------------------------- | ----- | ------ | ------ | ------ | ------ | ----- | ------ | ------ | ----- | ------ | ------ | -
|In thousands                                                          |                                                                                   | 2001                                                              |                               |                                                     | 2000  |        |        | 1999   |       
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |       
|Cash flows from operating activities:                                 |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |        |       |        |       
|                                                                      | Net income                                                                        |                                                                   | $                             | 2,540                                               |       |        | $      | 2,168  |        |       | $      | 1,095  |      
|                                                                      | Adjustments to reconcile net income to net cash provided by
operating activities: |                                                                   |                               |                                                     |       |        |        |        |        |       |        |        |      
|                                                                      |                                                                                   | Provision for doubtful accounts                                   |                               |                                                     | 20    |        |        |        | 32     |       |        |        | 111   |       
|                                                                      |                                                                                   | Depreciation and amortization                                     |                               |                                                     | 2,558 |        |        |        | 1,748  |       |        |        | 2,003 |       
|                                                                      |                                                                                   | Loss on disposal of assets                                        |                               |                                                     | 57    |        |        |        | 9      |       |        |        | 91    |       
|                                                                      |                                                                                   | Minority interest in net income of subsidiary                     |                               |                                                     | 123   |        |        |        | 60     |       |        |        | 8     |       
|                                                                      |                                                                                   | Deferred income taxes                                             |                               |                                                     | (964  | )      |        |        | (830   | )     |        |        | (421  | )     
|                                                                      |                                                                                   | Changes in assets and liabilities, net of effect of acquisitions: |                               |                                                     |       |        |        |        |        |       |        |        |       |       
|                                                                      |                                                                                   |                                                                   | Accounts receivable           |                                                     |       | (109   | )      |        |        | 6     |        |        |       | (1,056 | )     
|                                                                      |                                                                                   |                                                                   | Prepaid and deferred expenses |                                                     |       | (130   | )      |        |        | (564  | )      |        |       | (888   | )     
|                                                                      |                                                                                   |                                                                   | Other assets                  |                                                     |       | (232   | )      |        |        | 1,082 |        |        |       | (192   | )     
|                                                                      |                                                                                   |                                                                   | Accounts payable              |                                                     |       | (205   | )      |        |        | 1,287 |        |        |       | 29     |       
|                                                                      |                                                                                   |                                                                   | Accrued expenses              |                                                     |       | (107   | )      |        |        | 1,469 |        |        |       | (153   | )     
|                                                                      |                                                                                   |                                                                   | Deferred revenue              |                                                     |       | 279    |        |        |        | 824   |        |        |       | 1,179  |       
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |       
|                                                                      |                                                                                   |                                                                   |                               | Net cash provided by operating activities           |       |        | 3,830  |        |        |       | 7,291  |        |       |        | 1,806  |  
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |       
|Cash flows from investing activities:                                 |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |        |       |        |       
|                                                                      | Purchases of property and equipment                                               |                                                                   |                               | (2,442                                              | )     |        |        | (2,059 | )      |       |        | (1,093 | )    
|                                                                      | Acquisition of ESTECH Corporation, net of cash acquired                           |                                                                   |                               |                                                    |       |        |        | (3,492 | )      |       |        |       |      
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |       
|                                                                      |                                                                                   |                                                                   |                               | Net cash used in investing activities               |       |        | (2,442 | )      |        |       | (5,551 | )      |       |        | (1,093 | )
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |       
|Cash flows from financing activities:                                 |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |        |       |        |       
|                                                                      | Proceeds from issuance of common stock                                            |                                                                   |                               | 488                                                 |       |        |        | 200    |        |       |        | 254    |      
|                                                                      | Net borrowings (payments) under line of credit agreements                         |                                                                   |                               | (49                                                 | )     |        |        | 35     |        |       |        | (91    | )    
|                                                                      | Payments on capital lease obligations                                             |                                                                   |                               | (488                                                | )     |        |        |       |        |       |        |       |      
|                                                                      | Repurchases of Company common stock                                               |                                                                   |                               | (495                                                | )     |        |        | (1,305 | )      |       |        |       |      
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |       
|                                                                      |                                                                                   |                                                                   |                               | Net cash provided by (used in) financing activities |       |        | (544   | )      |        |       | (1,070 | )      |       |        | 163    |  
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |       
|Effect of exchange rate changes on cash                               |                                                                                   |                                                                   | (680                          | )                                                   |       |        | (450   | )      |        |       | 22     |       
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |       
|Net increase in cash and cash equivalents                             |                                                                                   |                                                                   | 164                           |                                                     |       |        | 220    |        |        |       | 898    |       
|Cash and cash equivalents at beginning of year                        |                                                                                   |                                                                   | 17,961                        |                                                     |       |        | 17,741 |        |        |       | 16,843 |       
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |       
|Cash and cash equivalents at end of year                              |                                                                                   | $                                                                 | 18,125                        |                                                     |       | $      | 17,961 |        |        | $     | 17,741 |       
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |        |      
|Supplemental disclosures of cash flow information:                    |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |        |       |        |       
|                                                                      | Cash paid during the year for:                                                    |                                                                   |                               |                                                     |       |        |        |        |        |       |        |        |      
|                                                                      |                                                                                   | Interest                                                          |                               | $                                                   | 51    |        |        | $      | 9      |       |        | $      | 15    |       
|                                                                      |                                                                                   | Income taxes                                                      |                               | $                                                   | 1,869 |        |        | $      | 1,338  |       |        | $      | 607   |       
|Supplemental schedule of non-cash investing and financing activities: |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |        |       |        |       
|                                                                      | Details of acquisitions:                                                          |                                                                   |                               |                                                     |       |        |        |        |        |       |        |        |      
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       | ESTECH |        |        |        |       |       
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |        |       |       
|                                                                      |                                                                                   | Net assets, excluding cash acquired                               |                               |                                                     |       |        |        | $      | 894    |       |        |        |       |       
|                                                                      |                                                                                   | Purchase price in excess of net assets acquired                   |                               |                                                     |       |        |        |        | 3,841  |       |        |        |       |       
|                                                                      |                                                                                   | Accrued acquisition costs                                         |                               |                                                     |       |        |        |        | (1,243 | )     |        |        |       |       
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |        |       |       
|                                                                      |                                                                                   |                                                                   |                               | Net cash used                                       |       |        |        |        |        | $     | 3,492  |        |       |        |        |  
|                                                                      |                                                                                   |                                                                   |                               |                                                     |       |        |        |        |        |       |       

The accompanying notes are an integral part of these consolidated statements.

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MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) Summary Of Significant Accounting Policies

Description of Business

Mechanical Dynamics, Inc. (the Company) and its subsidiaries develop,
market and support virtual prototyping software and provide consulting,
training, and maintenance services to the automotive, aerospace, defense, rail,
general machinery and other industries on a worldwide basis.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company
and its majority-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.

Minority Interest in Net Income of Subsidiary

The Company owns a 66% interest in its Japanese subsidiary, Mechanical
Dynamics Japan K.K. (MDI-Japan), through a joint venture agreement with
ISI-Dentsu of Tokyo, Japan, the largest distributor of the Companys software
in Japan. Minority interest in net income of subsidiary of $123,000 in 2001,
$60,000 in 2000 and $8,000 in 1999 represents ISI-Dentsus 34% interest in the
net income of MDI-Japan.

Foreign Currency

The financial statements of international subsidiaries are translated
using exchange rates in effect at period end for assets and liabilities and at
average rates during the period for results of operations. The resulting
foreign currency translation adjustments are reflected as a separate component
of shareholders equity. Net foreign currency transaction loss amounted to
$73,000, $309,000 and $74,000 in 2001, 2000 and 1999, respectively, and is
included in other income, net in the accompanying consolidated statements of
income.

Revenue

Software licenses revenue consists primarily of license fees for the
Companys software products and, to a lesser extent, license fees from
third-party software products licensed through the Companys European and
Canadian subsidiaries. Revenue under paid-up software licensing agreements,
including licenses generated through distributors, is recognized when a
customer contract is fully executed, the software is delivered, the fee is
fixed and determinable and collectability is reasonably assured. Revenue under
annual software licensing arrangements is deferred and amortized over the terms
of the agreements. In either instance, revenue is recognized only when no
significant remaining obligations to the customer exist.

Software maintenance services revenue consists of revenue generated from
maintenance and support agreements on the Companys software products. Revenue
related to advance payments received under software maintenance agreements is
deferred and amortized over the terms of the agreements.

Professional services and other revenue consists primarily of revenue from
consulting, training, and funded research and development projects. Revenue
from professional services is recognized upon performance of the service.

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Cost of Revenue

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 services includes payroll and overhead expenses attributable to
hotline support, consulting, training, and funded research and development.

Research and Development Expenses

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.

Under the criteria set forth in Statement of Financial Accounting
Standards (SFAS) No. 86, Accounting for the Costs of Computer Software to be
Sold, Leased or Otherwise Marketed, capitalization of software development
costs begins upon the establishment of technological feasibility of the product
(defined as a working program model). The establishment of technological
feasibility and the ongoing assessment of the recoverability of these costs
require considerable judgment by management with respect to certain external
factors, including, but not limited to, anticipated future gross product
revenue, estimated economic product lives, and changes in software and hardware
technology. Amounts that would have been capitalized under this statement after
establishment of technological feasibility were immaterial, and therefore no
software development costs have been capitalized by the Company.

Cash and Cash Equivalents

The Company considers all highly liquid investments with initial
maturities of 90 days or less to be cash equivalents.

Property and Equipment

Property and equipment is stated at cost. Office furniture and equipment
is depreciated using accelerated or straight-line methods over estimated useful
lives of three to seven years. Leasehold improvements are amortized using the
straight-line method over the lesser of the respective assets life or the life
of the related lease, generally ten years. Property and equipment consists
primarily of office furniture and equipment.

|                               |  |      |        |   |      |   |        |  
|------------------------------ |  | ---- | ------ | - | ---- | - | ------ | -
|In thousands                   |  | 2001 |        |   | 2000 |  
|                               |  |      |        |   |      |  
|Furniture and equipment        |  | $    | 10,112 |   |      | $ | 8,758  |  
|Leasehold improvements         |  |      | 668    |   |      |   | 282    |  
|                               |  |      |        |   |      |  
|                               |  |      | 10,780 |   |      |   | 9,040  |  
|Less: Accumulated depreciation |  |      | (5,625 | ) |      |   | (4,578 | )
|                               |  |      |        |   |      |  
|Net property and equipment     |  | $    | 5,155  |   |      | $ | 4,462  |  
|                               |  |      |        |   |      |  

Depreciation expense was approximately $1.8 million, $1.3 million and $1.5
million in 2001, 2000, and 1999, respectively.

Goodwill

Goodwill represents the unamortized cost in excess of fair value of net
assets acquired and is amortized on a straight-line basis over five to fifteen
years. On an ongoing basis, management reviews the valuation and amortization
of goodwill and other long-lived assets. As part of this review, the Company
considers the value of projected future undiscounted cash flows attributable to
the acquired operations in evaluating potential impairment.

Amortization of intangibles was $713,000, $474,000 and $454,000 in 2001,
2000, and 1999, respectively.

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Fair Value of Financial Instruments and Concentration of Credit Risk

The Company adopted SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities in the first quarter of 2001. Derivatives are
financial instruments whose value is derived from one or more underlying
financial instruments, such as foreign currency. The Company enters into
derivative transactions, specifically foreign exchange forward contracts, to
manage the Companys exposure to fluctuations in foreign exchange rates. The
contracts are primarily in European currencies and Japanese yen and have
maturities less than one year. Any derivative the Company enters into is
designated at inception as a hedge of risks associated with specific assets,
liabilities, or future commitments, and is monitored to determine if it remains
an effective hedge. The effectiveness of the derivative as a hedge is based on
changes in its market value being highly correlated with changes in market
value of the underlying hedged items. The Company does not enter into or hold
derivatives for trading or speculative purposes.

The Company uses forward exchange contracts to hedge specific foreign
currency denominated receivables. These contracts, which are one year or less
in length, require the Company to exchange foreign currencies for U.S. dollars
at maturity at rates agreed to at inception of the contracts. The Company
enters into transactions denominated in foreign currencies and includes the
exchange gain or loss arising from such transactions in other income, net. As
of December 31, 2001 and 2000, the Company had approximately $255,000 and
$60,000, respectively, of foreign exchange forward contracts outstanding. Net
unrealized and realized gains and losses associated with exchange rate
fluctuations on forward contracts and the underlying foreign currency exposure
being hedged were immaterial for all periods presented. Cash flows from
forward contracts are classified with the related receivables.

Other financial instruments which potentially expose the Company to
concentrations of credit risk, as defined by SFAS No. 105, Disclosure of
Information about Financial Instruments with Off-Balance-Sheet Risk and
Financial Instruments with Concentrations of Credit Risk, consist primarily of
accounts receivable. The Companys accounts receivable are concentrated in
global automotive-related companies, other manufacturers, and the Companys
international distributor network. The Company generally does not require
collateral upon delivery of its products. Additionally, the difference between the carrying value and fair
value of the Company's capital leases would not be materially different.

Net Income Per Common Share

The following table reconciles the weighted average number of shares in
the basic net income per common share calculation to the number of shares in
the diluted net income per common share calculation:

|                                                                                                 |                         |  |                         |         |  |      |           |       |      |  |           |    | 
|------------------------------------------------------------------------------------------------ | ----------------------- |  | ----------------------- | ------- |  | ---- | --------- | ----- | ---- |  | --------- | -- | 
|                                                                                                 |                         |  | Year Ended December 31, |        
|                                                                                                 |                         |  |                         |        
|                                                                                                 |                         |  | 2001                    |         |  | 2000 |           |       | 1999 | 
|                                                                                                 |                         |  |                         |         |  |      |           |       |      | 
|Weighted average common
shares used in basic net
income per common share                         |                         |  | 6,083,311               |         |  |      | 6,225,970 |       |      |  | 6,254,308 |   
|                                                                                                 | Effect of stock options |  |                         | 230,551 |  |      |           | 3,780 |      |  |           | 68 | 
|                                                                                                 |                         |  |                         |         |  |      |           |       |     
|Weighted average common
and common equivalent
shares used in diluted
net income per common
share |                         |  | 6,313,862               |         |  |      | 6,229,750 |       |      |  | 6,254,376 |   
|                                                                                                 |                         |  |                         |         |  |      |           |       |     

For the years ended December 31, 2001, 2000, and 1999, options to purchase
shares of the Companys common stock of 122,592, 657,374, and 676,214,
respectively, were outstanding but were not included in the computations of
diluted earnings per share because the price of the options was greater than
the average market price of the common stock for the period reported.

Comprehensive Income

Comprehensive income is the total of net income and all other non-owner
changes in equity. The difference between net income, as reported in the
accompanying consolidated statements of income, and comprehensive income is the
foreign currency translation adjustment for the respective periods. The
accumulated other comprehensive loss

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consists solely of the cumulative translation adjustment as presented in
the accompanying consolidated balance sheets.

Stock-Based Compensation

The Company has elected to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, and related interpretations.
Accordingly, compensation cost for stock options in the accompanying
consolidated statements of income is measured as the excess, if any, of the
quoted market price of the Companys stock at the date of grant over the amount
the employee must pay to acquire the stock. As supplemental information, the
Company has provided pro forma disclosure of the fair value at the date of
grant of stock options granted during 2001 and 2000 in Note 5, in accordance
with the requirements of SFAS No. 123, Accounting for Stock-Based
Compensation.

Use of Estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those estimates.

New Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board issued SFAS No.
141, Business Combinations, SFAS No. 142, Goodwill and Other Intangible
Assets, and SFAS No. 143, Accounting for Asset Retirement Obligations. In
August 2001, the Financial Accounting Standards Board issued SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets.

SFAS 141 supersedes Accounting Principles Board Opinion No. 16, Business
Combinations. The most significant changes made by SFAS 141 are: (1)
requiring that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001, (2) establishing specific criteria
for the recognition of intangible assets separately from goodwill, and (3)
requiring unallocated negative goodwill to be written off immediately as an
extraordinary gain (rather than being deferred and amortized).

SFAS 142 supersedes Accounting Principles Board Opinion No. 17,
Intangible Assets, and primarily addresses the accounting for goodwill and
intangible assets subsequent to their acquisition. The most significant
changes made by SFAS 142 are: (1) goodwill and indefinite lived intangible
assets will no longer be amortized, (2) goodwill will be tested for impairment
at least annually at the reporting unit level, (3) intangible assets deemed to
have an indefinite life will be tested for impairment at least annually, and
(4) the amortization period of intangible assets with finite lives will no
longer be limited to forty years. SFAS 142 also specifies that certain
intangible assets that were previously identified as separate from goodwill
(ie. assembled workforce) are not considered separately identifiable for
purposes of this standard and should be included as part of goodwill and
subject to the non-amortization provisions for SFAS 142. The provisions for
SFAS 142 will be effective for the Companys fiscal year beginning January 1,
2002. At adoption, an evaluation of goodwill and intangible assets will be
required, and any impairment of goodwill or intangible assets at that time will
be recognized as a cumulative effect of adoption. Pursuant to SFAS 142, the
Companys goodwill will no longer be amortized in future periods. Management
has not yet assessed the impact of SFAS 142 in regard to the impairment of
goodwill.

SFAS 143 clarifies the rules on retirements of tangible long-lived assets
and methodologies to be used to record and accrue retirement and closure costs.
SFAS 144 addresses the financial accounting and reporting for the impairment or
disposal of long-lived assets. Management expects that the adoption of SFAS 143
and SFAS 144 will not have a material impact on the Companys consolidated
financial position or results of operations.

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(2) Acquisitions

In December 2000, the Company acquired 100% of the capital stock of ESTECH
Corporation (ESTECH), a computer-aided engineering service provider based in
Yokohama, Japan, from Nissan Motor of Japan and Structural Dynamics Research
Corporation. The aggregate purchase price was paid entirely in cash and
approximated $8.8 million. The cash required for this transaction was provided
from the Companys existing cash balances. Pursuant to the agreement, the
Company assumed the cash and cash equivalents of ESTECH, which totaled $4.1
million as of the closing balance sheet. The acquisition has been accounted
for under the purchase method of accounting. The excess of the aggregate
purchase price over the fair value of the net assets acquired resulted in
goodwill of approximately $4.0 million. The operating results of ESTECH are
included in the Companys consolidated results of operations from the date of
acquisition.

The unaudited pro forma condensed consolidated results of operations are
presented below, for the respective twelve-month periods, as though ESTECH had
been acquired as of January 1, 1999:

|                                    |  |                     |        |  |      |   |        | 
|----------------------------------- |  | ------------------- | ------ |  | ---- | - | ------ | 
|                                    |  | Twelve months Ended |       
|                                    |  | December 31,        |       
|                                    |  |                     |       
|In thousands, except per share data |  | 2000                |        |  | 1999 |  
|                                    |  |                     |        |  |      |  
|Revenue                             |  | $                   | 52,778 |  |      | $ | 46,473 | 
|Net income                          |  | $                   | 2,205  |  |      | $ | 1,097  | 
|Earnings per share (diluted)        |  | $                   | 0.35   |  |      | $ | 0.18   | 

(3) Financing Arrangements

The Company has an agreement with its principal bank for a $6.0 million
line of credit facility. Borrowings on the line of credit bear interest at
1.0% below the banks prime rate of interest. No borrowings were outstanding at
any time during 2001 and 2000. The agreement expires on June 30, 2002.

The Companys subsidiaries in Germany and Italy also have line of credit
and overdraft facilities that provide for aggregate borrowing availability of
approximately $335,000, at various fixed and variable interest rates as of
December 31, 2001. Borrowings are primarily due on demand and are
collateralized by certain assets of the subsidiaries. No borrowings were
outstanding under these agreements as of December 31, 2001. Borrowings of
$49,000 were outstanding as of December 31, 2000. The weighted average
interest rate on these borrowings during 2000 was 8.5%.

The Company had $921,000 and $1,064,000 in capital lease obligations
outstanding as of December 31, 2001 and December 31, 2000, respectively, of
which $515,000 and $658,000 were classified as long-term, respectively. No
other borrowings were outstanding under long-term debt arrangements at December
31, 2001 and 2000. Cash paid for interest was $51,000, $9,000 and $15,000 in
2001, 2000, and 1999, respectively.

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(4) Income Taxes

A summary of income before provision (credit) for income taxes and
components of the provision (credit) for income taxes is as follows:

|                                               |          |      |                         |       |      |   |       |       |   |   |      |      |  
|---------------------------------------------- | -------- | ---- | ----------------------- | ----- | ---- | - | ----- | ----- | - | - | ---- | ---- | -
|                                               |          |      | Year Ended December 31, |      
|                                               |          |      |                         |      
|In thousands                                   |          | 2001 |                         |       | 2000 |   |       | 1999  |  
|                                               |          |      |                         |       |      |   |       |       |  
|Income before provision for income taxes:      |          |      |                         |       |      |   |       |       |   |   |      |     
|                                               | Domestic |      | $                       | 700   |      |   | $     | 1,472 |   |   | $    | 133  |  
|                                               | Foreign  |      |                         | 3,100 |      |   |       | 1,707 |   |   |      | 721  |  
|                                               |          |      |                         |       |      |   |       |       |  
|                                               |          | $    | 3,800                   |       |      | $ | 3,179 |       |   | $ | 854  |     
|                                               |          |      |                         |       |      |   |       |       |   |  
|Domestic provision (benefit) for income taxes: |          |      |                         |       |      |   |       |       |   |   |      |     
|                                               | Current  |      | $                       | 167   |      |   | $     | 187   |   |   | $    | (164 | )
|                                               | Deferred |      |                         | (420  | )    |   |       | (97   | ) |   |      | (421 | )
|Foreign provision for income taxes:            |          |      |                         |       |      |   |       |       |   |   |      |     
|                                               | Current  |      |                         | 1,390 |      |   |       | 861   |   |   |      | 336  |  
|                                               |          |      |                         |       |      |   |       |       |  
|Provision (credit) for income taxes            |          | $    | 1,137                   |       |      | $ | 951   |       |   | $ | (249 | )   
|                                               |          |      |                         |       |      |   |       |       |   |  

The differences between the provision (credit) for income taxes calculated
at the United States federal statutory rate and the consolidated income tax
provision are summarized as follows:

|                                    |                                                          |      |                         |      |      |   |       |      |   |   |      |        |  
|----------------------------------- | -------------------------------------------------------- | ---- | ----------------------- | ---- | ---- | - | ----- | ---- | - | - | ---- | ------ | -
|                                    |                                                          |      | Year Ended December 31, |     
|                                    |                                                          |      |                         |     
|In thousands                        |                                                          | 2001 |                         |      | 2000 |   |       | 1999 |  
|                                    |                                                          |      |                         |      |      |   |       |      |  
|Federal statutory provision         |                                                          | $    | 1,292                   |      |      | $ | 1,081 |      |   | $ | 290  |       
|                                    | Goodwill amortization                                    |      |                         | 149  |      |   |       | 66   |   |   |      | 37     |  
|                                    | Recognition of tax credits                               |      |                         | (116 | )    |   |       | (561 | ) |   |      | (1,237 | )
|                                    | Foreign losses without tax benefit                       |      |                         | 62   |      |   |       | 75   |   |   |      |       |  
|                                    | Effect of differences between U.S. and foreign tax rates |      |                         | 166  |      |   |       | 102  |   |   |      | 65     |  
|                                    | Increase (decrease) in valuation allowance               |      |                         | (600 | )    |   |       | 340  |   |   |      | 600    |  
|                                    | Other, net                                               |      |                         | 184  |      |   |       | (152 | ) |   |      | (4     | )
|                                    |                                                          |      |                         |      |      |   |       |      |  
|Provision (credit) for income taxes |                                                          | $    | 1,137                   |      |      | $ | 951   |      |   | $ | (249 | )     
|                                    |                                                          |      |                         |      |      |   |       |      |  

Deferred income taxes represent temporary differences in the recognition
of certain items for income tax and financial reporting purposes. The
components of the net deferred income tax asset are summarized as follows:

|                                                        |                          |      |              |       |      |  |       |       |  
|------------------------------------------------------- | ------------------------ | ---- | ------------ | ----- | ---- |  | ----- | ----- | -
|                                                        |                          |      | As of        |      
|                                                        |                          |      | December 31, |      
|                                                        |                          |      |              |      
|In thousands                                            |                          | 2001 |              |       | 2000 | 
|                                                        |                          |      |              |       |      | 
|Current deferred tax asset (liability):                 |                          |      |              |       |      |  |       |      
|                                                        | Accounts receivable      |      | $            | 298   |      |  | $     | 158   |  
|                                                        | Accrued expenses         |      |              | 285   |      |  |       | 264   |  
|                                                        | Other                    |      |              | (22   | )    |  |       | (8    | )
|                                                        |                          |      |              |       |      | 
|Net current deferred tax asset                          |                          |      | 561          |       |      |  | 414   |      
|                                                        |                          |      |              |       |      | 
|Long-term deferred tax asset:                           |                          |      |              |       |      |  |       |      
|                                                        | Tax credits              |      |              | 1,996 |      |  |       | 1,702 |  
|                                                        | Property and equipment   |      |              | 116   |      |  |       | 169   |  
|                                                        | Accrued expenses         |      |              | 87    |      |  |       | 122   |  
|                                                        | Other                    |      |              | 38    |      |  |       | 27    |  
|                                                        | Less valuation allowance |      |              | (340  | )    |  |       | (940  | )
|                                                        |                          |      |              |       |      | 
|Net long-term deferred tax asset Net deferred tax
asset |                          |      | 1,897        |       |      |  | 1,080 |      
|                                                        |                          |      |              |       |      | 
|                                                        | Net deferred tax asset   |      | $            | 2,458 |      |  | $     | 1,494 |  
|                                                        |                          |      |              |       |      |  |      

Management believes the Company will obtain the full benefit of the net
deferred tax asset on the basis of its evaluation of the Companys anticipated
profitability over the period of years that the temporary differences are
expected to become tax deductions. It believes that sufficient taxable income
will be generated to realize the benefit of these tax assets. This assessment
of profitability takes into account the Companys present and anticipated split
of

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domestic and international earnings. Valuation allowances recorded
against the Companys tax credits were $340,000 in 2001 and $940,000 in 2000.
The tax credits expire in 2005 through 2021.

Income taxes have been provided on all undistributed earnings of foreign
subsidiaries. Cash paid for income taxes was $1.9 million, $1.3 million and
$607,000 in 2001, 2000 and 1999, respectively.

(5) Common Stock and Shareholders Equity

Common Stock

Holders of shares of common stock are entitled to one vote per share on
all matters submitted to a vote of holders of shares of common stock, and do
not have any cumulative voting rights. In the event of a liquidation,
dissolution, or winding-up of the Company, the holders of shares of common
stock are entitled to share equally and ratably in the assets of the Company,
if any, remaining after the payment of debts and liabilities of the Company,
subject to prior liquidation rights of any outstanding shares of preferred
stock.

Preferred Stock

The Board of Directors is authorized to issue up to 1,000,000 shares of
preferred stock in one or more series. Under each issuance of a series of
preferred stock, the Board of Directors is permitted to fix the designations,
preferences, powers, and relative rights and restrictions thereof, including
without limitation, the dividend rate, conversion rights, voting rights,
redemption price, and liquidation preference.

Stock Repurchases

In 2000, the Companys Board of Directors authorized the repurchase of up
to 1,000,000 shares of the Companys common stock through April 2001. In 2001,
the Companys Board of Directors extended this authorization through April
2002. The Company repurchased 62,400 and 218,948 shares of its common stock
during 2001 and 2000, respectively, at a cost of $495,000 in 2001 and $1.3
million in 2000.

Employee Stock Purchase Plan

The Companys Employee Stock Purchase Plan (the Purchase Plan) was
adopted by the Companys Board of Directors in March 1996. A total of 300,000
shares of common stock have been reserved for issuance under the Purchase Plan.
The Purchase Plan provides that the Company will sell shares to employees who
elect to participate in the Purchase Plan at a price equal to 85% of the lesser
of the fair market value of the common stock on the first trading day of an
offering period or the last trading day of such offering period.

Under the Purchase Plan, the Company issued 30,830, 46,626 and 50,157
shares of common stock in 2001, 2000 and 1999, respectively, to various
employees. These shares were issued with a weighted average price per share of
$5.76, $4.30 and $5.07 in 2001, 2000 and 1999, respectively. As of December
31, 2001, there were 77,935 shares of common stock remaining to be issued under
this plan.

1996 Stock Incentive Plan for Key Employees

The Companys 1996 Stock Incentive Plan for Key Employees (the Stock
Option Plan) was adopted by the Companys Board of Directors in March 1996.
Under the Stock Option Plan, options will be granted or restricted stock will
be awarded for the purpose of attracting and motivating key employees of the
Company. The Stock Option Plan provides for (1) the grant of incentive stock
options within the meaning of Section 422 of the Internal Revenue Code, (2)
the grant of nonqualified stock options (options which do not meet the
requirements of Section 422), and (3) the award of restricted stock. Subject to
certain provisions outlined in the Stock Option Plan, the Compensation
Committee of the Board of Directors will determine which key employees will be
granted options or awarded restricted stock, the number of options granted or
shares awarded, and other terms and conditions applicable to each award or
grant. A total of 1,050,000 shares of common stock have been reserved for
issuance under the Stock Option Plan.

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Stock option activity for this plan is summarized below:

|                                 |           |  |           |          |   |           |               |               |          |   |           |      | 
|-------------------------------- | --------- |  | --------- | -------- | - | --------- | ------------- | ------------- | -------- | - | --------- | ---- | 
|                                 |           |  |           |          |   |           |               |               |          |   | Wtd. Avg. |     
|                                 |           |  | Number    |          |   | Price     |               |               | Exercise |  
|                                 |           |  | Of Shares |          |   | Per Share |               |               | Price    |  
|                                 |           |  |           |          |   |           |               |               |          |  
|Outstanding at December 31, 1998 |           |  | 589,525   |          |   | $         | 6.69 - $11.50 |               |          | $ | 7.38      |     
|                                 | Granted   |  |           | 37,000   |   |           | $             | 4.50 -  $6.75 |          |   | $         | 6.51 | 
|                                 | Canceled  |  |           | (51,405  | ) |           | $             | 6.63 - $11.50 |          |   | $         | 7.82 | 
|                                 |           |  |           |          |   |           |               |               |         
|Outstanding at December 31, 1999 |           |  | 575,120   |          |   | $         | 4.50 - $10.88 |               |          | $ | 7.28      |     
|                                 | Granted   |  |           | 254,190  |   |           | $             | 4.81 - $6.13  |          |   | $         | 5.68 | 
|                                 | Canceled  |  |           | (106,114 | ) |           | $             | 5.50 - $9.00  |          |   | $         | 6.62 | 
|                                 |           |  |           |          |   |           |               |               |         
|Outstanding at December 31, 2000 |           |  | 723,196   |          |   | $         | 4.50 - $10.88 |               |          | $ | 6.82      |     
|                                 | Granted   |  |           | 203,450  |   |           | $             | 5.63 - $10.90 |          |   | $         | 7.28 | 
|                                 | Exercised |  |           | (41,053  | ) |           | $             | 5.50 - $8.00  |          |   | $         | 7.58 | 
|                                 | Canceled  |  |           | (52,150  | ) |           | $             | 4.50 - $10.88 |          |   | $         | 7.15 | 
|                                 |           |  |           |          |   |           |               |               |         
|Outstanding at December 31, 2001 |           |  | 833,443   |          |   | $         | 4.81 - $10.90 |               |          | $ | 6.87      |     
|                                 |           |  |           |          |   |           |               |               |         

There were 457,876 and 155,627 options exercisable under the Stock Option
Plan as of December 31, 2001 and 2000, respectively, with a weighted average
exercise price of $7.05 and $8.07 per share, respectively. The remaining
options vest over a three- or four-year period beginning on the date of grant
at 33% or 25% per year, respectively, and expire five or ten years from the
date they are granted. As of December 31, 2001, there were 169,379 shares of
common stock available for grant under the Stock Option Plan. Options
outstanding under the Stock Option Plan had a weighted average remaining
contractual life of 6.9 and 6.8 years as of December 31, 2001 and 2000,
respectively.

Non-Employee Director Stock Option Plan

The Companys Non-Employee Director Stock Option Plan (the Director Stock
Option Plan) was adopted by the Companys Board of Directors in March 1996.
The Director Stock Option Plan provides for the grant of nonqualified stock
options to purchase shares of common stock. Upon appointment to the Board of
Directors, each newly appointed non-employee director will receive an option to
purchase 5,000 shares of common stock of the Company. Furthermore, immediately
following each annual meeting of shareholders of the Company, each non-employee
director who has served as a director for at least six months will
automatically be granted an option to purchase 5,000 shares of common stock of
the Company. The exercise price of any option will be equal to the market price
of the common stock at the time of grant. Each option, if not terminated sooner
as provided in the Director Stock Option Plan, will have a five-year term from
the date of grant and will vest and become exercisable in full on the first
anniversary of the date of grant. A total of 200,000 shares of common stock
have been reserved for issuance under the Director Stock Option Plan.

Stock option activity for this plan is summarized below:

|                                 |          |  |           |         |   |           |               |       |          |   |           |      | 
|-------------------------------- | -------- |  | --------- | ------- | - | --------- | ------------- | ----- | -------- | - | --------- | ---- | 
|                                 |          |  |           |         |   |           |               |       |          |   | Wtd. Avg. |     
|                                 |          |  | Number    |         |   | Price     |               |       | Exercise |  
|                                 |          |  | of Shares |         |   | Per Share |               |       | Price    |  
|                                 |          |  |           |         |   |           |               |       |          |  
|Outstanding at December 31, 1998 |          |  | 60,000    |         |   | $         | 9.13 - $13.00 |       |          | $ | 11.04     |     
|                                 | Granted  |  |           | 20,000  |   |           | $             | 6.56  |          |   | $         | 6.56 | 
|                                 |          |  |           |         |   |           |               |       |         
|Outstanding at December 31, 1999 |          |  | 80,000    |         |   | $         | 6.56 - $13.00 |       |          | $ | 9.92      |     
|                                 | Granted  |  |           | 20,000  |   |           | $             | 5.94  |          |   | $         | 5.94 | 
|                                 |          |  |           |         |   |           |               |       |         
|Outstanding at December 31, 2000 |          |  | 100,000   |         |   | $         | 5.94 - $13.00 |       |          | $ | 9.13      |     
|                                 | Granted  |  |           | 20,000  |   |           | $             | 9.70  |          |   | $         | 9.70 | 
|                                 | Canceled |  |           | (20,000 | ) |           | $             | 11.00 |          |   | $         | 5.94 | 
|                                 |          |  |           |         |   |           |               |       |         
|Outstanding at December 31, 2001 |          |  | 100,000   |         |   | $         | 5.94 - $13.00 |       |          | $ | 8.87      |     

There were 80,000 options exercisable under the Director Stock Option Plan
as of December 31, 2001 and December 31, 2000, with a weighted average exercise
price of $8.66 per share in 2001 and $9.92 per share in 2000. Options
outstanding under the Director Stock Option Plan had a weighted average
remaining contractual life of 2.4 years as of December 31, 2001 and December
31, 2000.

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For various price ranges, information for options outstanding and
exercisable for all option plans at December 31, 2001 was as follows:

|                |  |        |         |  |                     |                     |      |                     |           |   |        |  |  |                |         |           |  |   |       |  |  |  | 
|--------------- |  | ------ | ------- |  | ------------------- | ------------------- | ---- | ------------------- | --------- | - | ------ |  |  | -------------- | ------- | --------- |  | - | ----- |  |  |  | 
|                |  |        |         |  | Outstanding Options |                     |      | Exercisable Options |          
|                |  |        |         |  |                     |                     |      |                     |          
|Range of        |  |        |         |  |                     | Wtd. Avg. Remaining |      |                     | Wtd. Avg. |   |        |  |  |                |         | Wtd. Avg. | 
|Exercise Prices |  | Shares |         |  | Life (Years)        |                     |      | Exercise Price      |           |   | Shares |  |  | Exercise Price |        
|                |  |        |         |  |                     |                     |      |                     |           |   |        |  |  |                |        
|$4.81 - $6.63   |  |        | 371,813 |  |                     |                     | 7.89 |                     |           | $ | 5.75   |  |  |                | 104,470 |           |  | $ | 5.96  | 
|$6.75           |  |        | 262,380 |  |                     |                     | 6.67 |                     |           | $ | 6.75   |  |  |                | 260,880 |           |  | $ | 6.75  | 
|$6.90 - $8.00   |  |        | 138,500 |  |                     |                     | 2.99 |                     |           | $ | 7.80   |  |  |                | 96,000  |           |  | $ | 7.89  | 
|$8.50 - $10.90  |  |        | 140,750 |  |                     |                     | 6.18 |                     |           | $ | 9.70   |  |  |                | 56,526  |           |  | $ | 9.19  | 
|$13.00          |  |        | 20,000  |  |                     |                     | 1.37 |                     |           | $ | 13.00  |  |  |                | 20,000  |           |  | $ | 13.00 | 

Stock-Based Compensation

Using the intrinsic value method of accounting for the value of stock
options granted during 2001, 2000 and 1999, no compensation cost was recorded
in the accompanying consolidated statements of income. Had compensation cost
been determined based on the fair value at the date of grant for awards in
2001, 2000 and 1999 consistent with the provisions of SFAS 123, net income and
net income per share would have been reduced to the pro forma amounts indicated
below:

|                                           |  |      |       |  |      |   |       |      |  |   |       | 
|------------------------------------------ |  | ---- | ----- |  | ---- | - | ----- | ---- |  | - | ----- | 
|In thousands, except per share data        |  | 2001 |       |  | 2000 |   |       | 1999 | 
|                                           |  |      |       |  |      |   |       |      | 
|Net income  as reported                   |  | $    | 2,540 |  |      | $ | 2,168 |      |  | $ | 1,095 | 
|Net income  pro forma                     |  | $    | 1,983 |  |      | $ | 1,650 |      |  | $ | 545   | 
|Diluted net income per share  as reported |  | $    | 0.40  |  |      | $ | 0.35  |      |  | $ | 0.18  | 
|Diluted net income per share  pro forma   |  | $    | 0.31  |  |      | $ | 0.26  |      |  | $ | 0.09  | 

The weighted average estimated fair value of stock options granted during
2001, 2000 and 1999 was $4.19, $3.26 and $3.72, respectively. The fair value
of each option grant was estimated on the date of grant using the Black-Scholes
option-pricing model. The following weighted average assumptions were used in
valuing the option grants:

|                      |  |      |     |   |      |  |     |      |  |  |     |  
|--------------------- |  | ---- | --- | - | ---- |  | --- | ---- |  |  | --- | -
|                      |  | 2001 |     |   | 2000 |  |     | 1999 | 
|                      |  |      |     |   |      |  |     |      | 
|Expected life (years) |  |      | 5.0 |   |      |  | 5.0 |      |  |  | 5.0 |  
|Interest rate         |  |      | 4.4 | % |      |  | 5.2 | %    |  |  | 6.2 | %
|Volatility            |  |      | 0.6 |   |      |  | 0.6 |      |  |  | 0.6 |  
|Dividend yield        |  |      | 0.0 | % |      |  | 0.0 | %    |  |  | 0.0 | %

(6) Commitments and Contingencies

Employee Benefit Plans

The Company maintains a 401(k) plan covering substantially all of its
domestic employees. During 2001, 2000 and 1999, the Company matched 40% of
qualified employee contributions, up to a maximum of 2.4% of eligible
compensation. In 2001, 2000, and 1999, the Company contributed $231,000,
$249,000 and $233,000, respectively, to the plan.

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Lease Commitments

The Company and its subsidiaries lease office space and certain equipment
under noncancellable lease agreements which expire at various dates through
December 2010. Assets held under capital leases are included in property and
equipment and are charged to depreciation and interest over the life of the
lease. Operating leases are expensed over the term of the lease agreement and
are not capitalized. Future minimum lease payments at December 31, 2001 are as
follows:

|                                 |  |                |      |   |                  |   |        | 
|-------------------------------- |  | -------------- | ---- | - | ---------------- | - | ------ | 
|In thousands                     |  | Capital leases |      |   | Operating leases |  
|                                 |  |                |      |   |                  |  
|2002                             |  | $              | 440  |   |                  | $ | 2,636  | 
|2003                             |  |                | 304  |   |                  |   | 2,038  | 
|2004                             |  |                | 158  |   |                  |   | 1,627  | 
|2005                             |  |                | 40   |   |                  |   | 1,568  | 
|2006                             |  |                | 20   |   |                  |   | 1,593  | 
|Thereafter                       |  |                | 10   |   |                  |   | 6,775  | 
|                                 |  |                |      |   |                  |  
|Total minimum lease payments     |  | $              | 972  |   |                  | $ | 16,237 | 
|Less interest                    |  |                | (51  | ) |                  |   |        | 
|                                 |  |                |      |   |                  |   |       
|Total minimum lease payments     |  |                | 921  |   |                  |   |        | 
|Less current portion             |  |                | (406 | ) |                  |   |        | 
|                                 |  |                |      |   |                  |   |       
|Long-term minimum lease payments |  | $              | 515  |   |                  |   |        | 
|                                 |  |                |      |   |                  |   |       

Total lease expense amounted to approximately $3.1 million, $1.9 million,
and $1.9 million in 2001, 2000, and 1999, respectively.

In the fourth quarter of 2000, the Company moved into a new headquarters
facility in Ann Arbor, Michigan. The initial lease term is 10 years expiring
in December 2010. The future minimum lease payment table above includes the
lease payments required under this lease agreement.

Royalty Agreements

The Company has entered into various agreements which generally provide
for royalty payments by the Company based on a percentage of revenue derived
through the licensing of certain software products. Royalty expense under these
agreements amounted to approximately $3.9 million, $3.8 million, and $3.2
million in 2001, 2000, and 1999, respectively.

Litigation

From time to time, the Company is party to routine litigation arising in
the normal course of business. In the opinion of management, the liabilities
resulting from these proceedings, if any, will not be material to the Companys
consolidated financial position or results of operations.

(7) Geographic Operations and Segment Information

The Company operates in one segment  the development, marketing and
support of software products and services for the mechanical segment of the
computer-aided engineering industry. The Company licenses products to
customers on a worldwide basis. Revenue is attributed to the country in which
the sale originates. Sales and marketing operations outside the United States
are conducted principally through the Companys foreign subsidiaries and
international distributors. Intercompany sales and transfers between
geographic areas are accounted for at prices which are designed to be
representative of third-party transactions.

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The following table summarizes selected financial information of the
Companys operations by geographic location:

|                     |               |                          |                           |       |                         |        |  |       |        |        |  |       |        |        | 
|-------------------- | ------------- | ------------------------ | ------------------------- | ----- | ----------------------- | ------ |  | ----- | ------ | ------ |  | ----- | ------ | ------ | 
|                     |               |                          |                           |       | Year Ended December 31, |       
|                     |               |                          |                           |       |                         |       
|In thousands         |               | 2001                     |                           |       | 2000                    |        |  | 1999  |       
|                     |               |                          |                           |       |                         |        |  |       |       
|Revenue:             |               |                          |                           |       |                         |        |  |       |        |        |  |      
|                     | North America |                          |                           |       |                         |        |  |       |        |        |  |       |       
|                     |               | United States            |                           | $     | 13,364                  |        |  | $     | 12,052 |        |  | $     | 11,613 |       
|                     |               | Canada and Mexico        |                           |       | 4,006                   |        |  |       | 4,607  |        |  |       | 3,820  |       
|                     | Europe        |                          |                           |       |                         |        |  |       |        |        |  |       |       
|                     |               | Germany                  |                           |       | 5,488                   |        |  |       | 4,824  |        |  |       | 5,473  |       
|                     |               | Other European countries |                           |       | 10,547                  |        |  |       | 10,767 |        |  |       | 9,573  |       
|                     | Asia/Pacific  |                          |                           |       |                         |        |  |       |        |        |  |       |       
|                     |               | Japan                    |                           |       | 20,273                  |        |  |       | 11,297 |        |  |       | 7,706  |       
|                     |               | Other Asian countries    |                           |       | 3,825                   |        |  |       | 3,030  |        |  |       | 2,070  |       
|                     |               |                          |                           |       |                         |        |  |       |       
|                     |               |                          | Total revenue             |       | $                       | 57,503 |  |       | $      | 46,577 |  |       | $      | 40,255 | 
|                     |               |                          |                           |       |                         |        |  |       |        |        | 
|Identifiable assets: |               |                          |                           |       |                         |        |  |       |        |        |  |      
|                     | North America |                          |                           |       |                         |        |  |       |        |        |  |       |       
|                     |               | United States            |                           | $     | 21,816                  |        |  | $     | 20,335 |        |  | $     | 23,550 |       
|                     |               | Canada                   |                           |       | 2,616                   |        |  |       | 2,837  |        |  |       | 2,287  |       
|                     | Europe        |                          |                           |       |                         |        |  |       |        |        |  |       |       
|                     |               | Germany                  |                           |       | 1,730                   |        |  |       | 1,780  |        |  |       | 2,384  |       
|                     |               | Other European countries |                           |       | 5,944                   |        |  |       | 5,232  |        |  |       | 4,466  |       
|                     | Asia/Pacific  |                          |                           |       |                         |        |  |       |        |        |  |       |       
|                     |               | Japan                    |                           |       | 8,182                   |        |  |       | 8,484  |        |  |       | 1,917  |       
|                     |               | Other Asian countries    |                           |       | 450                     |        |  |       | 433    |        |  |       | 149    |       
|                     |               |                          |                           |       |                         |        |  |       |       
|                     |               |                          | Total identifiable assets |       |                         | 40,738 |  |       |        | 39,101 |  |       |        | 34,753 | 
|                     | Goodwill      |                          |                           | 6,185 |                         |        |  | 6,768 |        |        |  | 3,436 |       
|                     |               |                          |                           |       |                         |        |  |       |       
|                     |               |                          | Total assets              |       | $                       | 46,923 |  |       | $      | 45,869 |  |       | $      | 38,189 | 
|                     |               |                          |                           |       |                         |        |  |       |        |        | 

No customer accounted for greater than 10% of total revenue in 2001, 2000
or 1999. The Companys largest distributor, ISI-Dentsu, is located in Japan and
accounted for approximately 12.0%, 16.4% and 12.6% of the Companys total
revenue in 2001, 2000 and 1999, respectively.

(8) Quarterly Results of Operations (Unaudited)

The following table summarizes selected unaudited quarterly financial
information for 2001 and 2000. The Company believes all adjustments, consisting
of normal recurring adjustments considered necessary for a fair presentation,
have been included in the selected quarterly information:

|                                    |  |                    |        |  |            |   |        |               |  |   |              |  |  |              |        |  |  |   |        | 
|----------------------------------- |  | ------------------ | ------ |  | ---------- | - | ------ | ------------- |  | - | ------------ |  |  | ------------ | ------ |  |  | - | ------ | 
|                                    |  | Three months ended |        |  | Year ended |  
|                                    |  |                    |        |  |            |  
|                                    |  | March 31,          |        |  | June 30,   |   |        | September 30, |  |   | December 31, |  |  | December 31, |       
|In thousands, except per share data |  | 2001               |        |  | 2001       |   |        | 2001          |  |   | 2001         |  |  | 2001         |       
|                                    |  |                    |        |  |            |   |        |               |  |   |              |  |  |              |       
|Revenue                             |  | $                  | 13,841 |  |            | $ | 14,240 |               |  | $ | 14,436       |  |  | $            | 14,986 |  |  | $ | 57,503 | 
|Gross profit                        |  |                    | 8,796  |  |            |   | 8,951  |               |  |   | 9,303        |  |  |              | 9,476  |  |  |   | 36,526 | 
|Operating income                    |  |                    | 668    |  |            |   | 995    |               |  |   | 1,099        |  |  |              | 646    |  |  |   | 3,408  | 
|Net income                          |  |                    | 491    |  |            |   | 678    |               |  |   | 815          |  |  |              | 556    |  |  |   | 2,540  | 
|Basic net income
per common share   |  | $                  | 0.08   |  |            | $ | 0.11   |               |  | $ | 0.13         |  |  | $            | 0.09   |  |  | $ | 0.42   | 
|Diluted net income
per common share |  | $                  | 0.08   |  |            | $ | 0.11   |               |  | $ | 0.13         |  |  | $            | 0.09   |  |  | $ | 0.40   | 

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|                                    |  |                    |        |  |            |   |        |               |  |   |              |  |  |              |        |  |  |   |        | 
|----------------------------------- |  | ------------------ | ------ |  | ---------- | - | ------ | ------------- |  | - | ------------ |  |  | ------------ | ------ |  |  | - | ------ | 
|                                    |  | Three months ended |        |  | Year ended |  
|                                    |  |                    |        |  |            |  
|                                    |  | March 31,          |        |  | June 30,   |   |        | September 30, |  |   | December 31, |  |  | December 31, |       
|In thousands, except per share data |  | 2000               |        |  | 2000       |   |        | 2000          |  |   | 2000         |  |  | 2000         |       
|                                    |  |                    |        |  |            |   |        |               |  |   |              |  |  |              |       
|Revenue                             |  | $                  | 10,739 |  |            | $ | 11,081 |               |  | $ | 11,581       |  |  | $            | 13,176 |  |  | $ | 46,577 | 
|Gross profit                        |  |                    | 7,086  |  |            |   | 7,310  |               |  |   | 7,833        |  |  |              | 8,765  |  |  |   | 30,994 | 
|Operating income                    |  |                    | 297    |  |            |   | 554    |               |  |   | 810          |  |  |              | 838    |  |  |   | 2,499  | 
|Net income                          |  |                    | 241    |  |            |   | 479    |               |  |   | 668          |  |  |              | 780    |  |  |   | 2,168  | 
|Basic net income
per common share   |  | $                  | 0.04   |  |            | $ | 0.08   |               |  | $ | 0.11         |  |  | $            | 0.13   |  |  | $ | 0.35   | 
|Diluted net income
per common share |  | $                  | 0.04   |  |            | $ | 0.08   |               |  | $ | 0.11         |  |  | $            | 0.13   |  |  | $ | 0.35   | 

40



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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.




PART III

Certain information required by Part III is omitted from this report in
that the Registrant will file a definitive proxy statement pursuant to
Regulation 14A (the Proxy Statement) not later than 120 days after the end of
the fiscal year covered by this report and certain information included therein
is incorporated herein by reference. Only those sections of the Proxy
Statement that specifically address the items set forth herein are incorporated
by reference.




Item 10. Directors and Executive Officers of the Registrant

Information with respect to the directors of the Company is incorporated
by reference to the Companys Proxy Statement for the 2002 Annual Meeting of
Shareholders.

The executive officers of the Company as of March 1, 2002 are listed
below:

|                      |  |     |    |  |          |                                                            
|--------------------- |  | --- | -- |  | -------- | -----------------------------------------------------------
|Name                  |  | Age |    |  | Position
|                      |  |     |    |  |         
|Michael E. Korybalski |  |     | 55 |  |          | Chief Executive Officer, Chairman of the Board
and Director
|Robert R. Ryan        |  |     | 44 |  |          | President, Chief Operating Officer and Director            
|Michael Hoffmann      |  |     | 45 |  |          | Senior Vice President  Worldwide Sales & Service          
|David Peralta         |  |     | 34 |  |          | Vice President, Chief Financial Officer and
Treasurer      
|Douglas M. Peterson   |  |     | 36 |  |          | Vice President, Chief Technical Officer                    

Michael E. Korybalski, a co-founder of MDI, is currently Chief Executive
Officer, Chairman of the Board and a director of the Company. From 1984 to
February 1997, Mr. Korybalski served as President of the Company. From 1977 to
1984, Mr. Korybalski served as Vice President and General Manager of the
Company. From 1973 to 1977, he was employed as a product engineer with Ford
Motor Company. Mr. Korybalski holds B.S.E. and M.S.E. degrees in mechanical
engineering, as well as an M.B.A., from the University of Michigan.

Robert R. Ryan became the President of the Company in February 1997 and
since 1991 has served as the Chief Operating Officer of the Company. Mr. Ryan
was elected a director of the Company in May 1997. Mr. Ryan served as the
Companys Executive Vice President from 1991 to February 1997. From 1988
through 1991, Mr. Ryan served as the Companys Vice President of Product
Development. Before joining the Company, Mr. Ryan held various positions in
sales and engineering services at Structural Dynamics Research Corporation, and
served briefly on the engineering faculty at the University of Michigan. Mr.
Ryan holds a B.S. degree from the University of Cincinnati and M.S. and Ph.D.
degrees in applied mechanics from Stanford University.

Michael Hoffmann became the Companys Senior Vice President  Worldwide
Sales and Service in November 1997. Dr. Hoffmann served as the Companys Vice
President  European Operations from November 1996 to November 1997. Dr.
Hoffmann served as the Companys Managing Director  European Operations from
1994 to November 1996. From 1993 through 1994, Dr. Hoffmann served as Managing
Director of TEDAS Mechanical Systems GmbH, a shareholder of the Company. From
1991 through 1992, he served as Technical Director of TEDAS GmbH. Dr. Hoffmann
holds masters and doctorate degrees in civil engineering from the Technological
University of Darmstadt.

David Peralta became the Companys Vice President, Chief Financial Officer
and Treasurer in February 1997, and served as Controller of the Company from
1993 to February 1997. From 1992 to 1993, Mr. Peralta served as Assistant
Corporate Controller at OVAKO Ajax, Inc. From 1989 through 1992, he served as
an auditor at Coopers & Lybrand. Mr. Peralta is a licensed Certified Public
Accountant in the State of Michigan. Mr. Peralta holds a bachelors degree in
accounting from the University of Michigan.

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Douglas M. Peterson became the Companys Vice President, Chief Technical
Officer in March 2001, and served as the Companys Vice President of Product
Development from November 1997 to March 2001. Before joining the Company, Mr.
Peterson was co-founder and president of StatDesign, Inc. from 1992 through
1997, at which time StatDesign, Inc. was acquired by the Company. Mr. Peterson
holds B.S. and M.S. degrees in mechanical engineering from Brigham Young
University.




Item 11. Executive Compensation

The information required by this Item is incorporated by reference to the
Companys Proxy Statement for the 2002 Annual Meeting of Shareholders.




Item 12. Security Ownership of Certain Beneficial Owners and Management

The information required by this Item is incorporated by reference to the
Companys Proxy Statement for the 2002 Annual Meeting of Shareholders.




Item 13. Certain Relationships and Related Transactions

None.

42



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##### Table of Contents






PART IV




Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

Item 14(a)1. Financial Statements

None.

Item 14(a)2. Financial Statement Schedules

None.

43



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Item 14(a) 3. Exhibits

|        |  |                                                                                                                                                                                                                                                                                                               
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number  |  | Exhibit                                                                                                                                                                                                                                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                               
|(2.1)   |  | Joint Venture Agreement between Mechanical Dynamics, Inc. and Information
Services International-Dentsu, Ltd., incorporated herein by reference to
Exhibit 2.1 to the Companys previously filed Form 10-Q for the quarter ended
March 31, 1997                                                               
|       
|(2.2)   |  | Share Transfer Agreement dated November 17, 2000 by and among Mechanical
Dynamics, Inc., Nissan Motor Co., Ltd., and Structural Dynamics Research
Corporation, incorporated herein by reference to Exhibit 2.2 to the Companys
previously filed Form 8-K on December 28, 2000 and From 8-K/A on March 5, 2001
|       
|(3.1)   |  | Restated Articles of Incorporation, incorporated herein by reference to Exhibit
3.2 to the Companys previously filed Registration Statement on Form S-1,
Registration No. 333-2900                                                                                                                           
|       
|(3.2)   |  | Restated Bylaws, incorporated herein by reference to Exhibit 3.4 to the
Companys previously filed Registration Statement on Form S-1, Registration No.
333-2900                                                                                                                                              
|       
|(4.2)   |  | Line of Credit Demand Note between the Company and KeyBank National Association
dated July 6, 2001, incorporated herein by reference to Exhibit 4.2 to the
Companys previously filed Form 10-Q for the quarter ended September 30, 2001                                                                      
|       
|(10.1)  |  | Amended and Restated Employment Agreement between the Company and Michael E.
Korybalski                                                                                                                                                                                                                       
|       
|(10.2)  |  | Amended and Restated Employment Agreement between the Company and Robert R. Ryan                                                                                                                                                                                                                              
|       
|(10.3)  |  | Amended and Restated Employment Agreement between the Company and David Peralta                                                                                                                                                                                                                               
|       
|(10.4)  |  | Amended and Restated Employment Agreement between the Company and Douglas M.
Peterson                                                                                                                                                                                                                         
|       
|(10.18) |  | Lease Agreement between the Company and First Martin Corporation dated August
5, 1999, incorporated herein by reference to Exhibit 10.18 to the Companys
previously filed Form 10-Q for the quarter ended September 30, 1999                                                                                 
|       
|(11)    |  | Statement Re Computation Of Per Share Earnings Per Share                                                                                                                                                                                                                                                      
|       
|(21)    |  | Subsidiaries Of The Registrant                                                                                                                                                                                                                                                                                
|       
|(23.1)  |  | Consent Of Independent Public Accountants                                                                                                                                                                                                                                                                     

Item 14(b). Reports on Form 8-K

None.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

|                     |  |     |  |                          
|-------------------- |  | --- |  | -------------------------
|Dated: March 8, 2002 |  |     |  | MECHANICAL DYNAMICS, INC.
|                     |  |     |  | (Registrant)             
|                    
|                    
|                     |  | By: |  | /s/ Michael E. Korybalski
|                     |  |     | 
|                     |  |     |  | Michael E. Korybalski    
|                     |  |     |  | Chairman of the Board    

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

|                                               |  |                                                                                            |  |              
|---------------------------------------------- |  | ------------------------------------------------------------------------------------------ |  | -------------
|Signatures                                     |  | Title                                                                                      |  | Date         
|                                               |  |                                                                                            |  |              
|/s/ Michael E. KorybalskiMichael E. Korybalski |  | Chairman of the Board,
Chief Executive Officer,
and Director
(Principal Executive Officer) |  | March 8, 2002
|                                              
|/s/ Robert R. RyanRobert R. Ryan               |  | President, Chief Operating Officer
and Director                                            |  | March 8, 2002
|                                              
|/s/ David PeraltaDavid Peralta                 |  | Chief Financial Officer
(Principal Financial and
Accounting Officer)                       |  | March 8, 2002
|                                              
|/s/ Herbert S. AmsterHerbert S. Amster         |  | Director                                                                                   |  | March 8, 2002
|                                              
|/s/ David E. ColeDavid E. Cole                 |  | Director                                                                                   |  | March 8, 2002
|                                              
|/s/ Joseph F. GloudemanJoseph F. Gloudeman     |  | Director                                                                                   |  | March 8, 2002
|                                              
|/s/ Mitchell I. QuainMitchell I. Quain         |  | Director                                                                                   |  | March 8, 2002

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INDEX TO EXHIBITS

|        |  |                                                                                                                                                                                                                                                                                                               
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number  |  | Exhibit                                                                                                                                                                                                                                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                               
|(2.1)   |  | Joint Venture Agreement between Mechanical Dynamics, Inc. and Information
Services International-Dentsu, Ltd., incorporated herein by reference to
Exhibit 2.1 to the Companys previously filed Form 10-Q for the quarter ended
March 31, 1997                                                               
|       
|(2.2)   |  | Share Transfer Agreement dated November 17, 2000 by and among Mechanical
Dynamics, Inc., Nissan Motor Co., Ltd., and Structural Dynamics Research
Corporation, incorporated herein by reference to Exhibit 2.2 to the Companys
previously filed Form 8-K on December 28, 2000 and From 8-K/A on March 5, 2001
|       
|(3.1)   |  | Restated Articles of Incorporation, incorporated herein by reference to Exhibit
3.2 to the Companys previously filed Registration Statement on Form S-1,
Registration No. 333-2900                                                                                                                           
|       
|(3.2)   |  | Restated Bylaws, incorporated herein by reference to Exhibit 3.4 to the
Companys previously filed Registration Statement on Form S-1, Registration No.
333-2900                                                                                                                                              
|       
|(4.2)   |  | Line of Credit Demand Note between the Company and KeyBank National Association
dated July 6, 2001, incorporated herein by reference to Exhibit 4.2 to the
Companys previously filed Form 10-Q for the quarter ended September 30, 2001                                                                      
|       
|(10.1)  |  | Amended and Restated Employment Agreement between the Company and Michael E.
Korybalski                                                                                                                                                                                                                       
|       
|(10.2)  |  | Amended and Restated Employment Agreement between the Company and Robert R. Ryan                                                                                                                                                                                                                              
|       
|(10.3)  |  | Amended and Restated Employment Agreement between the Company and David Peralta                                                                                                                                                                                                                               
|       
|(10.4)  |  | Amended and Restated Employment Agreement between the Company and Douglas M.
Peterson                                                                                                                                                                                                                         
|       
|(10.18) |  | Lease Agreement between the Company and First Martin Corporation dated August
5, 1999, incorporated herein by reference to Exhibit 10.18 to the Companys
previously filed Form 10-Q for the quarter ended September 30, 1999                                                                                 
|       
|(11)    |  | Statement Re Computation Of Per Share Earnings Per Share                                                                                                                                                                                                                                                      
|       
|(21)    |  | Subsidiaries Of The Registrant                                                                                                                                                                                                                                                                                
|       
|(23.1)  |  | Consent Of Independent Public Accountants                                                                                                                                                                                                                                                                     

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