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

                                    FORM 10-K

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
    OF 1934
    For the fiscal year ended:  DECEMBER 31, 2000, OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934
    For the transition period from ____________ to ____________

                         Commission file number: 0-20679

                            MECHANICAL DYNAMICS, INC.
             (Exact name of registrant as specified in its charter)

           MICHIGAN                                    38-2163045
   (State of incorporation)                (I.R.S. Employer Identification No.)

                              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] Yes                     [ ] 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]

    The aggregate market value of the voting stock of the Registrant held by
non-affiliates of the Registrant as of March 15, 2001, computed by reference to
The Nasdaq Stock Market closing price on such date, was approximately
$45,205,000.

      The number of outstanding shares of the Registrant's common stock, as of
March 15, 2001, was 6,050,198.

                       DOCUMENTS INCORPORATED BY REFERENCE
    Portions of the Proxy Statement for the 2001 Annual Meeting of Shareholders,
scheduled to be held on May 10, 2001, are incorporated by reference into Part
III.



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                            MECHANICAL DYNAMICS, INC.

                                    FORM 10-K
                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                                             PAGE
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<S>        <C>                                                                                               <C>
                                                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...............................           23
Item 8.    Financial Statements and Supplementary Data..............................................           24
Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.....           42

                                               PART III
                                               --------
Item 10.   Directors and Executive Officers of the Registrant.......................................           42
Item 11.   Executive Compensation...................................................................           43
Item 12.   Security Ownership of Certain Beneficial Owners and Management...........................           43
Item 13.   Certain Relationships and Related Transactions...........................................           43

                                                PART IV
                                                -------
Item 14.   Exhibits, Financial Statement Schedules and Reports on Form 8-K..........................           44

SIGNATURES. ........................................................................................           46

INDEX TO EXHIBITS...................................................................................           47
</TABLE>



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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 ADAMS mechanical 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.

    ADAMS makes 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. Leading manufacturers from
nearly every industry today use the Company's software and consulting services.

    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. The aggregate purchase price of approximately $1.7 million
consisted of $563,000 in cash and 142,540 shares of the Company's common stock
valued at approximately $1.1 million. Subsequent to the closing of the
acquisition, the operations of DTI were integrated within the Company. See Note
2 of Notes to Consolidated Financial Statements.

    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. The aggregate purchase price of
approximately $2.2 million consisted principally of cash. Subsequent to the
closing of the acquisition, the operations of HGE were integrated within the
Company. See Note 2 of Notes to Consolidated Financial Statements.

    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 will be integrated with the Company's
ADAMS virtual prototyping software to provide system-level durability design
sensitivity analysis capabilities. The Company paid $400,000 to the University
for the ability to jointly develop and market this technology. See Note 2 of
Notes to Consolidated Financial Statements.

    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. The aggregate purchase price
approximated $8.8 million and was paid entirely in cash. See Note 2 of Notes to
Consolidated Financial Statements.


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    ADAMS(R) and the Company's logo are registered trademarks of the Company.
ADAMS/Animation, ADAMS/Car, ADAMS/Controls, ADAMS/Driver, ADAMS/Engine,
ADAMS/Exchange, ADAMS/Flex, ADAMS/Hydraulics, ADAMS/Insight, ADAMS/Linear,
ADAMS/PostProcessor, ADAMS/Pre, ADAMS/Rail, ADAMS/Solver, ADAMS/Tire,
ADAMS/View, CAT/ADAMS, Dynamic Designer and MECHANISM/Pro are 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.

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 Package is approximately $24,000 per license depending
upon configuration. The U.S. list prices for the Company's additional software
products typically range from $3,000 to $27,000. 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 Series
product line, a decline in the demand for ADAMS software and services would have
a material adverse effect on the Company's business, financial condition and
results of operations.

    ADAMS software is available on a number of platforms, including Intel
Pentium-based PCs running the Microsoft Windows NT operating system and
UNIX-based workstations and servers from Silicon Graphics, Hewlett-Packard, Sun
Microsystems, IBM and Digital Equipment.

ADAMS PROFESSIONAL SERIES

   Full Simulation Package

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

   Industry-specific software

    - ADAMS/Car was developed by the Company in collaboration with a consortium
of major automotive manufacturers. ADAMS/Car is a special version of ADAMS
designed 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 ADAMS/Car with little formal training.

    - ADAMS/Driver allows the user to add the element of human driver response
to vehicle simulations. ADAMS/Driver can simulate the actions and reactions of a
vehicle's operator under a variety of driving conditions.

    - ADAMS/Engine is 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.



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    - ADAMS/Pre is a pre-processing environment for ADAMS designed specifically
for the automotive environment.

    - ADAMS/Rail was 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/Tire is 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/Animation allows a user to see the complete system in motion -- in
real time, fully shaded and rendered. ADAMS/Animation checks and reports
potential collision of parts and components and shows important measurements on
screen. ADAMS/Animation also allows for multiple light sources, texture mapping,
detailed color specifications and multiple perspectives. These enhance the
understanding of the design and can result in more successful design reviews.

    - ADAMS/Insight provides 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/PostProcessor is a high-performance tool for visualizing ADAMS
simulation results. Used as a standalone or integrated with ADAMS/View,
ADAMS/PostProcessor simplifies and speeds the steps required to view, study, and
understand ADAMS simulation results.

ADAMS INTERFACE PRODUCTS

    Interface Products are products specifically designed for the CAD/CAM/CAE
environments. Assemblies created within the Company's partners' software
environments are converted into realistic, fully three-dimensional mechanical
system models. These software environments then verify and evaluate motion
paths, locate lock-up positions, detect interferences, establish work-space
envelopes and calculate joint reaction forces.

   ADAMS CAE Interface Products

    - ADAMS/Controls simplifies the integration of non-linear ADAMS mechanical
models with control and hydraulic systems developed in leading control system
design packages including MATLAB, MATRIXx and EASY5. The product allows the user
to test how control systems will affect their mechanical system, and visualize
the effects of both controls and mechanics in a virtual system test environment.

    - ADAMS/Flex automates the exchange of data between ADAMS and finite element
analysis ("FEA") software, including ANSYS and MSC/NASTRAN. This two-way
interface provides for accurate loading conditions for FEA and a more complete
understanding of flexible effects on mechanical systems.

    - ADAMS/Hydraulics is an add-on module for the simulation of complex
mechanical systems powered by hydraulic elements. Static, linear, transient, and
dynamic analyses are all supported for combined mechanical and hydraulic models.

    - ADAMS/Linear simplifies the non-linear equations of motion calculated 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/Linear can also provide an easy link to popular control system design
packages such as MATRIXx and MATLAB.


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    ADAMS CAD/CAM Interface Products

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

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

    - Dynamic Designer was purchased by the Company in conjunction with its
acquisition of DTI in January 1998. Dynamic Designer is 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/Pro is a program specifically designed for Parametric Technology
Corp.'s ("PTC") Pro/ENGINEER environment. MECHANISM/Pro converts assemblies
created within PTC's Pro/ASSEMBLY software into realistic, fully
three-dimensional mechanical system models. MECHANISM/Pro can verify and
evaluate motion paths, locate lock-up positions, detect interferences, establish
work-space envelopes and calculate joint reaction forces.

ADAMS OEM PRODUCTS

    OEM Products are 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., 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 23.1%, 19.7%
and 16.3% of the Company's total revenue was realized from maintenance contracts
in 2000, 1999 and 1998, 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 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.




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    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 2000,
1999 or 1998.

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 2000, 1999 and 1998, automotive-related customers accounted for
approximately 56.6%, 54.0% and 54.7% of the Company's total revenue,
respectively. No customer accounted for greater than 10% of the Company's total
revenue in 2000, 1999 or 1998.

    Segments within the auto industry, in each of the United States, Europe and
Japan, have, from time to time, 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 Atlanta,
GA; Austin, TX; Chicago, IL; Cleveland, OH; Los Angeles, CA; Irvine, CA;
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., MSC Software Corp., MTS
Systems Corp., The Mathworks, Inc., nCode International Ltd., Cosin, Structural
Research & Analysis Corp., and Wind River Systems, Inc. These relationships
entail collaborative development to support interfaces between the products of
the Company and each partner, as well as cooperative 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, 2000 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.
Throughout Sweden, the Company distributes MATRIXx, a



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product of Wind River Systems, Inc. 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 10.0%,
9.7% and 7.1% of the Company's total revenue in 2000, 1999 and 1998,
respectively.

    The Company has formed relationships with several CAD/CAM companies,
including Autodesk, Inc., Dassault Systemes, Engineering Animation, Inc.,
Parametric Technology Corp., SolidWorks Corp., Structural Dynamics Research
Corporation, and Unigraphics Solutions Inc. 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 ADAMS product 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 64.2%, 61.7% and 62.4% of the Company's total
revenue in 2000, 1999 and 1998, respectively. A summary of the Company's revenue
by geographic area is presented in Note 7 of Notes to Consolidated Financial
Statements. In December 2000, the Company acquired ESTECH Corporation
("ESTECH"), a computer-aided engineering service provider based in Yokohama,
Japan. During its fiscal year ended March 31, 2000, ESTECH had approximately
$6.6 million in revenue. As a result of this acquisition, the Company expects
international revenue as a percentage of total revenue to increase in 2001. This
acquisition is summarized in Note 2 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 primarily on
distributors and sales representatives for the licensing and support of its
products. Distributors and sales representatives accounted for approximately
24.4%, 20.4% and 21.3% of the Company's total revenue in 2000, 1999 and 1998,
respectively. The Company's largest Japanese distributor, Information Services
International-Dentsu, Ltd. ("ISI-Dentsu"), accounted for approximately 16.4%,
12.6% and 13.2% of the Company's total revenue in 2000, 1999 and 1998,
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 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. In 1999, the net impact of exchange rate fluctuations
positively affected the Company's international revenue by approximately
$432,000. Since most of the Company's international operating expenses were
incurred in foreign currencies, the net impact of exchange rate fluctuations on
income from operations in 2000 and 1999 was considerably less than the impact on
revenue. If the U.S. dollar strengthens in 2001 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 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



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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
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.


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    As of December 31, 2000, the Company's research and development group
consisted of 55 full-time employees. During 2000, 1999 and 1998, the Company's
research and development expenses were approximately $6.1 million, $5.6 million
and $5.3 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 Parametric
Technology Corp. and MSC Software Corp., 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 ADAMS products 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.

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


                                       10

<PAGE>   11

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 Designer software
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, 2000, the Company had 332 employees, consisting of 143 in
engineering services, 103 in sales and marketing, 55 in research and development
and 31 in general and administrative capacities. Of these, 129 are located at
the Company's headquarters in Ann Arbor, Michigan, 21 are located at the
Company's domestic offices in Arizona, California, Georgia, Illinois, Maryland,
Ohio, Texas, Washington, and Wisconsin, 20 are located at the Company's Canadian
subsidiary, 91 are located at the Company's European subsidiaries, 56 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.

    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


                                       11

<PAGE>   12

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.

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


                                       12

<PAGE>   13

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
Michigan, Texas, California, Maryland, 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, 2000.






                                       13


<PAGE>   14

                                     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:

<TABLE>
<CAPTION>
                                                                                          MARKET PRICES
                                                                               -------------------------------------
                                                                                     HIGH                LOW
--------------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>                <C>
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
Year ended December 31, 1999:
  Fourth quarter..........................................................          $  5.38            $  4.25
  Third quarter...........................................................             6.00               4.38
  Second quarter..........................................................             7.38               4.75
  First quarter...........................................................             8.13               6.00
</TABLE>

    As of December 31, 2000, there were 172 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, 2000, 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.







                                       14

<PAGE>   15

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

    The consolidated statement of income data for the years ended December 31,
2000, 1999, 1998, 1997 and 1996 and the consolidated balance sheet data as of
December 31, 2000, 1999, 1998, 1997 and 1996 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.

<TABLE>
<CAPTION>
                                                                      FOR THE YEARS ENDED DECEMBER 31,
                                                   -----------------------------------------------------------------------
In thousands, except per share data                    2000         1999           1998           1997           1996
-------------------------------------------------- ------------ ------------ ---------------- ------------- --------------
<S>                                                <C>          <C>          <C>              <C>           <C>
CONSOLIDATED STATEMENT OF INCOME DATA:
  Revenue........................................   $  46,577    $  40,255    $  36,575        $ 30,191      $ 25,383
  Operating income (loss) .......................       2,499          340         (556) (1)        965 (2)     2,503
  Net income (loss) .............................       2,168        1,095         (217)            744         2,071
  Diluted net income (loss) per common share.....        0.35         0.18        (0.04)           0.13          0.41
</TABLE>

<TABLE>
<CAPTION>

                                                   -----------------------------------------------------------------------
                                                                             AS OF DECEMBER 31,
                                                   -----------------------------------------------------------------------
In thousands                                           2000         1999           1998           1997           1996
-------------------------------------------------- ------------ ------------ ---------------- ------------- --------------
<S>                                                <C>          <C>          <C>              <C>           <C>
CONSOLIDATED BALANCE SHEET DATA (3):
  Cash and cash equivalents......................   $  17,961    $  17,741    $  16,843        $ 20,261      $ 20,570 (4)
  Total assets...................................      45,869       38,189       36,247          34,147        29,812
  Redeemable common stock........................          --           --           --              --           167
  Shareholders' equity...........................      27,663       27,171       25,600          23,970        22,185 (4)
</TABLE>

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.

(4)  For the year ended December 31, 1996, the Company completed an initial
     public offering of its stock, which resulted in the issuance of 1,500,000
     shares at $11.00 per share. An additional 354,750 shares were sold by the
     Company at $11.00 per share to cover over-allotments. The offering,
     including the over-allotments, raised $17.8 million in net proceeds.




                                       15

<PAGE>   16


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 mechanical systems. The
Company's revenue has in the past been, and is expected to be in the future,
derived primarily from its ADAMS Full Simulation Package and related software
products and services.

FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY

    Except for the historical information contained in this report, the matters
herein contain "forward-looking" statements (as defined in the Private
Securities Litigation Reform Act of 1995) that involve risk and uncertainty.
These forward-looking statements include, but are not limited to, revenue
levels, including the level of international revenue, certain costs and
operating expense levels, the level of other income, the Company's liquidity and
capital needs, and various business environment and trend information. Actual
future results and trends may differ materially depending on a variety of
factors, including:

     -    the volume and timing of orders received during the quarter;
     -    the mix of and changes in distribution channels through which the
          Company's products are sold;
     -    the timing and acceptance of new products and product enhancements by
          the Company or its competitors;
     -    changes in pricing;
     -    the level of the Company's sales of third-party products;
     -    purchasing patterns of distributors and customers;
     -    competitive conditions in the industry;
     -    business cycles affecting the markets in which the Company's products
          are sold;
     -    extraordinary events, such as litigation;
     -    risks inherent in seeking and consummating acquisitions, including the
          diversion of management attention to the assimilation of the
          operations and personnel of the acquired business;
     -    fluctuations in foreign exchange rates;
     -    the impact of undetected errors or defects, including those associated
          with Year 2000 date functions, on the Company's current products,
          vendors and internal systems; and
     -    economic conditions generally or in various geographic areas.

    All of the foregoing factors are difficult to forecast. The future operating
results of the Company may fluctuate as a result of these and other risk factors
detailed from time to time in the Company's Securities and Exchange Commission
reports 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.




                                       16

<PAGE>   17

RESULTS OF OPERATIONS

   REVENUE

<TABLE>
<CAPTION>
In thousands                                 2000        % CHANGE         1999         % CHANGE         1998
---------------------------------------- ------------- -------------- -------------- -------------- -------------
<S>                                      <C>           <C>            <C>            <C>            <C>
Software licenses...................     $  23,784          24.1%     $  19,159           (2.5%)      $ 19,659
  % of total revenue................          51.1%                        47.6%                          53.7%

Software maintenance services.......     $  10,775          35.7%     $   7,941           33.5%       $  5,949
  % of total revenue................          23.1%                        19.7%                          16.3%

Professional services and other.....     $  12,018          (8.6%)    $  13,155           20.0%       $ 10,967
  % of total revenue................          25.8%                        32.7%                          30.0%

Total revenue.......................     $  46,577          15.7%     $  40,255           10.1%       $ 36,575
</TABLE>

    The Company's total revenue increased 15.7% to $46.6 million in 2000 from
$40.3 million in 1999. During 1999, total revenue increased 10.1% from $36.6
million in 1998. 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. The growth in revenue during 1999 resulted
primarily from increased software maintenance services on the Company's software
products and increased professional services provided to the Company's
customers. During 2000, the Company achieved revenue growth in North America,
Europe and Asia. During 1999, the Company achieved revenue growth in North
America and Europe, and experienced a slight decline in revenue from 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 64.2%,
61.7% and 62.4% of the Company's total revenue in 2000, 1999 and 1998,
respectively. In December 2000, the Company acquired ESTECH Corporation
("ESTECH"), a computer-aided engineering service provider based in Yokohama,
Japan. During its fiscal year ended March 31, 2000, ESTECH had approximately
$6.6 million in revenue. As a result of this acquisition, the Company expects
international revenue as a percentage of total revenue to increase in 2001. This
acquisition is summarized in Note 2 of Notes to Consolidated Financial
Statements.

    The increase in international revenue as a percent of total revenue in 2000
was due primarily to increased sales of ADAMS software licenses in Japan and the
rest of Asia compared to the corresponding periods in 1999. 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 2001 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 decrease in international revenue as a percent of total revenue during
1999 as compared to 1998, was due primarily to weakness experienced in certain
countries in Asia, as well as an increase in revenue from North America, due in
part to the Company's August 1998 acquisition of the Design Analysis Group of
H.G.E. Inc. ("HGE"), an engineering software and services firm based in Toronto,
Ontario, Canada. If the economies in Asia deteriorate in 2001, the Company's
overall Asian revenue could be adversely impacted, which could have a material
adverse effect on the Company's consolidated results of operations.



                                       17

<PAGE>   18

    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
24.4%, 20.4% and 21.3% of the Company's total revenue in 2000, 1999 and 1998,
respectively. The increase in revenue from distributors and sales
representatives in 2000, as compared to 1999, resulted primarily from increased
revenue from sales of ADAMS software licenses in Japan. Alternatively, the
decrease in revenue from distributors and sales representatives in 1999, as
compared to 1998, resulted primarily from decreased revenue from sales of ADAMS
software licenses in Japan. The Company's largest Japanese distributor,
Information Services International-Dentsu, Ltd. ("ISI-Dentsu"), accounted for
approximately 16.4%, 12.6% and 13.2% of the Company's total revenue in 2000,
1999 and 1998, respectively.

    Revenue from automotive-related customers accounted for approximately 56.6%,
54.0% and 54.7% of the Company's total revenue in 2000, 1999 and 1998,
respectively. No customer accounted for greater than 10% of the Company's total
revenue in 2000, 1999 and 1998.

    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 24.1% from 1999 to
approximately $23.8 million in 2000. This increase resulted primarily from a
higher volume of the Company's ADAMS and Dynamic Designer products, as well as
increased sales of third party software licenses sold worldwide. Software
licenses revenue decreased 2.5% from 1998 to approximately $19.2 million in
1999. The decrease resulted from a lower volume of the Company's software
licenses sold in North America and Asia, partially offset by a higher volume of
software licenses sold in Europe. Revenue from third-party products accounted
for $4.7 million in 2000, or 10.0% of total revenue, $3.9 million in 1999, or
9.7% of total revenue, and $2.6 million in 1998, or 7.1% 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 35.7% during 2000 to approximately $10.8
million. In 1999, software maintenance services revenue grew 33.5% over 1998 to
approximately $7.9 million. The increases realized in 2000 and 1999 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 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. The 8.6%
decrease in professional services revenue in 2000 was due to a combination of
several factors, including: (i) 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, (ii) 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 (iii) a decrease in funded
development activities during 2000. Professional services revenue grew 20.0%
over 1998 to approximately $13.2 million in 1999. The increase in professional
services revenue during 1999 was due largely to consulting revenue generated by
the Company's Canadian subsidiary, which was acquired in August 1998.


   COST OF REVENUE

<TABLE>
<CAPTION>
In thousands                                 2000        % CHANGE         1999         % CHANGE         1998
---------------------------------------- ------------- -------------- -------------- -------------- -------------
<S>                                      <C>           <C>            <C>            <C>            <C>
Cost of software licenses...........       $   4,214        21.3%       $   3,473         40.1%       $   2,479
  Gross profit margin on software
    licenses revenue................           82.3%                        81.9%                         87.4%

Cost of services....................       $  11,369         0.6%       $  11,306         18.0%       $   9,581
  Gross profit margin on services
    revenue.........................            50.1%                       46.4%                         43.4%
</TABLE>



                                       18

<PAGE>   19

    Cost of software licenses includes software royalty fees, media costs,
payroll and other costs attributable to software documentation and distribution,
and an allocation of depreciation, utilities and other overhead expenses
incurred by the Company. Cost of software licenses increased 21.3% from 1999 to
approximately $4.2 million in 2000. In 1999, cost of software licenses increased
40.1% from 1998 to approximately $3.5 million. During both years, the increases
were due to higher royalties paid to third parties whose products were licensed
through the Company's Canadian and European subsidiaries, as well as additional
royalties paid to third parties whose products are embedded in the Company's
ADAMS software. Gross profit margin on software licenses revenue was 82.3%,
81.9% and 87.4% during 2000, 1999 and 1998, 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 0.6% over 1999 to approximately $11.4 million in 2000.
In 1999, cost of services revenue grew 18.0% over 1998 to approximately $11.3
million. The increase in 1999 resulted from the hiring of additional employees
to support the growth in software maintenance services revenue and professional
services revenue. Gross profit margin on services revenue was 50.1%, 46.4% and
43.4% during 2000, 1999 and 1998, respectively. The increase in gross profit
margin during 2000 and 1999 was primarily due to the increase in software
maintenance services revenue as a percentage of total services revenue.
Historically, software maintenance services revenue has generated higher profit
margins than revenue from professional services.

   OPERATING EXPENSES

<TABLE>
<CAPTION>
In thousands                                 2000        % CHANGE         1999         % CHANGE         1998
---------------------------------------- ------------- -------------- -------------- -------------- -------------
<S>                                      <C>           <C>            <C>            <C>            <C>
Sales and marketing.................       $  17,599        14.3%       $  15,394          8.1%       $  14,245
  % of total revenue................           37.8%                        38.2%                         38.9%

Research and development............       $   6,118         9.2%       $   5,603          6.4%       $   5,265
  % of total revenue................           13.1%                        13.9%                         14.4%

General and administrative..........       $   4,304        16.8%       $   3,685          6.1%       $   3,472
  % of total revenue................            9.2%                         9.2%                          9.5%

Goodwill amortization...............       $     474         4.4%       $     454         33.1%       $     341
  % of total revenue................            1.0%                         1.1%                          0.9%

Acquisition-related costs and
  non-recurring charges.............       $      --                    $      --                     $   1,748
  % of total revenue................            0.0%                         0.0%                          4.8%
</TABLE>

    Sales and marketing expenses include costs associated with the Company's
sales channels, such as personnel, commissions, sales office costs, travel,
promotional events, sales order processing, including license administration and
order fulfillment, and advertising and public relations programs. Sales and
marketing expenses also include an allocation of overhead expenses incurred by
the Company. The absolute dollar increase in sales and marketing expenses during
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. The absolute dollar increase in sales and marketing expenses in 1999
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. During 2000, the number of employees in sales and
marketing increased from 94 to 103. 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 increase in research and
development expenses in 2000 and 1999 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 0.8%, 0.9%, and 0.7%, of total


                                       19

<PAGE>   20

revenue in 2000, 1999, and 1998, 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/Engine and ADAMS/Rail.
The Company intends to continue to invest significant resources in research and
development in the future.

    General and administrative expenses include the cost of salaries, employee
benefits and other payroll costs associated with the Company's finance,
accounting, human resources, information systems, and executive management
functions. General and administrative expenses also include an allocation of
overhead expenses incurred by the Company. General and administrative expenses
grew 16.8% over 1999 to approximately $4.3 million in 2000. General and
administrative expenses grew 6.1% over 1998 to approximately $3.7 million in
1999. The absolute dollar increase in these expenses was primarily due to
additional expenses incurred to support the Company's worldwide growth. The
Company expects general and administrative expenses to increase in absolute
dollars in the future. However, these expenses may vary as a percentage of total
revenue from period to period.

    Goodwill amortization includes the amortization of purchase price in excess
of net assets on the Company's acquisitions. Goodwill amortization increased
4.4% in 2000, as compared to 1999, due to increased goodwill associated with the
Company's acquisition of ESTECH in December 2000. Goodwill amortization
increased 33.1% in 1999, as compared to 1998, due to increased goodwill
associated with the Company's acquisition of the Design Analysis Group and
certain other assets of H.G.E. Inc. in August 1998. The Company amortizes
goodwill over the periods estimated to be benefited from the acquisitions, after
considering such factors as demand, competition, service lives of employees, and
expected actions of competitors.


    Acquisition-related costs and non-recurring charges were approximately $1.7
million in 1998, and consist primarily of the write-off of purchased in-process
research and development ("R&D") associated with the Company's acquisitions in
this year. In each acquisition, the value assigned to purchased in-process R&D
was determined by an independent appraisal of the acquired company's assets,
both tangible and intangible. The portion of the aggregate purchase price
assigned to in-process R&D was determined by identifying research projects for
which technological feasibility had not yet been established. The appraisals
considered such factors as the estimated percent complete of each project in
process at the date of acquisition, the estimated remaining costs to develop the
in-process R&D into commercially viable products, and the estimated discounted
net future cash flows from such products. If the Company were unable to complete
the R&D projects in a timely manner or lost key personnel from the acquired
companies, revenue and operating income in future periods could be adversely
impacted. These acquisitions and the related accounting treatment are summarized
in Note 2 of Notes to Consolidated Financial Statements.


   OTHER INCOME, NET

<TABLE>
<CAPTION>
In thousands                                 2000        % CHANGE         1999         % CHANGE         1998
---------------------------------------- ------------- -------------- -------------- -------------- -------------
<S>                                      <C>           <C>            <C>            <C>            <C>
Other income, net.....................        $ 680          32.3%         $ 514          (37.9%)        $ 828
  % of total revenue..................          1.5%                         1.3%                          2.3%
</TABLE>

    Other income, net consists of net interest income (expense), net foreign
currency transaction gain (loss), and gain (loss) on the disposal of property
and equipment. Net interest income was $998,000, $679,000, and $828,000 in 2000,
1999, and 1998, respectively. The increase in net interest income during 2000
compared to 1999 primarily resulted from an increase in interest earned given
the Company's higher cash and cash equivalents balance. The decline in interest
income in 1999 compared to 1998 resulted from a higher percentage of the
Company's cash and cash equivalents being invested in tax-exempt securities
which return a lower yield on a pre-tax basis. Net foreign currency transaction
gain (loss) amounted to ($309,000), ($74,000), and $64,000 in 2000, 1999 and
1998, respectively. The gain (loss) on the disposal of property and equipment
was ($9,000), ($91,000) and ($64,000) in 2000, 1999, and 1998, respectively.


                                       20

<PAGE>   21

   PROVISION FOR INCOME TAXES

    The Company's effective income tax rates were 29.9%, (29.2%) and 176.1% for
2000, 1999 and 1998, respectively. The differences between the consolidated tax
provision and the income tax provision calculated at the United States federal
statutory rate are summarized in Note 4 of Notes to Consolidated Financial
Statements. In 2000, the difference between the effective and statutory federal
rate resulted primarily from benefits realized from the Company's foreign sales
corporation and tax-exempt interest income earned during the year. 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%. In
1998, the difference between the effective and statutory federal rate was
primarily due to the non-deductibility of the expense associated with purchased
in-process research and development incurred with certain of the Company's
acquisitions. These unfavorable differences were partially offset by benefits
realized from the Company's foreign sales corporation and tax-exempt interest
income. Excluding acquisition-related charges, the Company's effective tax rate
for 1998 would have been 29.6%.

   MINORITY INTEREST IN NET INCOME OF SUBSIDIARY

    In April 1997, the Company established a Japanese subsidiary, Mechanical
Dynamics Japan K.K. ("MDI-Japan"), through a joint venture agreement with
ISI-Dentsu of Tokyo, Japan, the largest distributor of the Company's software in
Japan. Minority interest in net income of subsidiary of $60,000 in 2000, $8,000
in 1999 and $10,000 in 1998 represents ISI-Dentsu's 34% interest in the net
income of MDI-Japan.

   EMPLOYEES

    The number of the Company's worldwide employees increased 16.9% to 332 at
December 31, 2000, compared with 284 at December 31, 1999. Reflected in this
increase are 43 new employees who joined the Company as a result of the
Company's acquisition of ESTECH in December 2000.

   YEAR 2000 COMPLIANCE

    The Year 2000 issue is the result of computer programs using a two-digit
format, as opposed to four digits, to indicate the year. Such computer programs
are unable to interpret dates beyond the year 1999, which could cause a system
failure or other computer errors. The Company assessed and identified risks in
four areas of its business: (1) the Company's products, including third-party
software embedded in the Company's products, (2) business management and
accounting systems, (3) computing and communications infrastructure, and (4) the
Company's suppliers.

    The Company has not experienced any significant effects resulting from Year
2000 issues to date. While the Company believes that its efforts to address Year
2000 issues for which it is responsible were successful, it is possible that
there could still be undetected errors or defects associated with Year 2000 date
functions in the Company's products and internal systems or those of its key
suppliers. If a problem does still arise, it is possible that the Company could
be involved in litigation. Further, although the Company does not believe that
it has any obligation to continue to support prior versions of its products
after the termination of maintenance contracts covering those products, nor any
obligation to make prior versions of its products, including custom applications
written by the Company, Year-2000 compliant, it is possible that its customers
may take a contrary position and initiate litigation. In the event of such
litigation or the occurrence of one or more problems associated with Year 2000
compliance, the Company's business, financial condition, or results of
operations could be materially adversely affected.

   EURO CONVERSION

    In January 1999, 11 of the 15 member countries of the European Union
established fixed conversion rates between their existing sovereign currencies
and the Euro, making the Euro their common legal currency on that date.


                                       21


<PAGE>   22

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

    The Company's subsidiaries in France and Italy are currently reporting in
Euros. The Company's German subsidiary does not expect any interruptions or
adverse effects as a result of its future conversion to Euros. The Company is
also evaluating any other business implications of conversion to the Euro,
including technical adaptation of information technology and other systems to
accommodate Euro-denominated transactions, long-term competitive implications of
the conversion, and the effect on market risk with respect to financial
instruments. At this time, the Company does not expect that the Euro's
introduction will have a material adverse effect on its consolidated results of
operations during or after the transition period.


LIQUIDITY AND CAPITAL RESOURCES

    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.

    Cash and cash equivalents were $17.7 million at December 31, 1999, compared
to $16.8 million at December 31, 1998. The increase in cash and cash equivalents
during 1999 of $898,000 was primarily due to the $1.8 million in cash generated
from operations and the $254,000 in proceeds from stock issued by the Company,
partially offset by the $1.1 million used for capital expenditures.

    At December 31, 2000, the Company's principal commitments consisted of
obligations under capital and operating leases for facilities and equipment,
including approximately $2.0 million in payments due under noncancellable leases
during 2001. The Company had $1,064,000 in capital lease obligations outstanding
as of December 31, 2000, of which $658,000 is long-term. The Company had no
other borrowings under long-term debt arrangements at December 31, 2000.

    The Company has an agreement with its principal bank for an unsecured $4.0
million line of credit. No borrowings were outstanding under this agreement as
of December 31, 2000. The Company's subsidiaries in Germany, Italy, Sweden, and
France also have line of credit and overdraft facilities that provide for
aggregate borrowing availability of approximately $400,000. Approximately
$49,000 in borrowings were outstanding under these facilities as of December 31,
2000.

    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 1998
through 2000 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.


                                       22

<PAGE>   23

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,
2000, the Company had forward foreign currency exchange contracts of $60,000
(notional amounts). The contracts outstanding at December 31, 2000 mature
through January 4, 2001 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,
2000.

    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,
2000 market rates would increase the unrealized value of the Company's existing
forward contracts at December 31, 2000 by $5,000. Conversely, a hypothetical 10%
depreciation of the U.S. dollar from December 31, 2000 market rates would
decrease the unrealized value of the Company's forward contracts by $6,000. 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.



                                       23

<PAGE>   24


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, 2000
and 1999, 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, 2000. 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, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000 in conformity with accounting principles generally accepted in
the United States.



                                                  ARTHUR ANDERSEN LLP

Detroit, Michigan,
January 29, 2001


                                       24
<PAGE>   25




                   MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
                        AS OF DECEMBER 31, 2000 AND 1999


<TABLE>
<CAPTION>
In thousands                                                                                    2000          1999
------------------------------------------------------------------------------------------- -------------- -----------
<S>                                                                                         <C>            <C>
                                          ASSETS
                                          ------
Current assets:
   Cash and cash equivalents............................................................    $   17,961     $   17,741
   Accounts receivable, net of allowance for doubtful accounts of $374 and $342.........        11,442         10,454
   Prepaid and deferred expenses........................................................         3,255          2,755
                                                                                            ----------     ----------
       Total current assets.............................................................        32,658         30,950
                                                                                            ----------     ----------
Property and equipment, net of accumulated depreciation of $4,578 and $4,387............         4,462          3,118
Goodwill, net of accumulated amortization of $1,663 and $1,154..........................         6,768          3,436
Other assets............................................................................         1,981            685
                                                                                            ----------     ----------
                                                                                            $   45,869     $   38,189
                                                                                            ==========     ==========
                           LIABILITIES AND SHAREHOLDERS' EQUITY
                           ------------------------------------
Current liabilities:
   Borrowings under lines of credit.....................................................    $       49    $        14
   Current portion of capital leases....................................................           406             --
   Accounts payable.....................................................................         2,466          1,447
   Accrued compensation.................................................................         2,960          1,246
   Other accrued expenses...............................................................         4,192          2,000
   Deferred revenue.....................................................................         6,936          5,832
                                                                                            ----------     ----------
       Total current liabilities........................................................        17,009         10,539
                                                                                            ----------     ----------
Capital lease obligation, less current portion..........................................           658             --
                                                                                            ----------     ----------
Minority interest.......................................................................           539            479
                                                                                            ----------     ----------
Shareholders' equity:
   Common stock, no par value, 15,000,000 shares authorized, 6,103,041 and 6,275,363
     shares issued and outstanding in 2000 and 1999, respectively.......................        21,998         22,586
   Preferred stock, no par value, 1,000,000 shares authorized, no shares issued and
     outstanding........................................................................            --             --
   Retained earnings....................................................................         5,819          4,168
   Accumulated other comprehensive income (loss)........................................          (154)           417
                                                                                            -----------    ----------
       Total shareholders' equity.......................................................        27,663         27,171
                                                                                            ----------     ----------
                                                                                            $   45,869     $   38,189
                                                                                            ==========     ==========
</TABLE>

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



                                       25
<PAGE>   26



                   MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES

                        CONSOLIDATED STATEMENTS OF INCOME
              FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998


<TABLE>
<CAPTION>
In thousands, except share and per share data                               2000           1999            1998
----------------------------------------------------------------------- -------------- -------------- ---------------
<S>                                                                     <C>            <C>            <C>
Revenue:
   Software licenses...............................................     $    23,784    $    19,159    $    19,659
   Software maintenance services...................................          10,775          7,941          5,949
   Professional services and other.................................          12,018         13,155         10,967
                                                                        -----------    -----------    -----------
       Total revenue...............................................          46,577         40,255         36,575
                                                                        -----------    -----------    -----------
Cost of revenue:
   Software licenses...............................................           4,214          3,473          2,479
   Services........................................................          11,369         11,306          9,581
                                                                        -----------    -----------    -----------
       Total cost of revenue.......................................          15,583         14,779         12,060
                                                                        -----------    -----------    -----------
Gross profit.......................................................          30,994         25,476         24,515
                                                                        -----------    -----------    -----------
Operating expenses:
   Sales and marketing.............................................          17,599         15,394         14,245
   Research and development........................................           6,118          5,603          5,265
   General and administrative......................................           4,304          3,685          3,472
   Goodwill amortization...........................................             474            454            341
   Acquisition-related costs and non-recurring charges.............              --             --          1,748
                                                                        -----------    -----------    -----------
       Total operating expenses....................................          28,495         25,136         25,071
                                                                        -----------    -----------    -----------
Operating income (loss)............................................           2,499            340           (556)
Other income, net..................................................             680            514            828
                                                                        -----------    -----------    -----------
Income before income taxes and minority interest...................           3,179            854            272
Provision (credit) for income taxes................................             951           (249)           479
                                                                        -----------    ------------   -----------
Income (loss) before minority interest.............................           2,228          1,103           (207)
Minority interest in net income of subsidiary......................              60              8             10
                                                                        -----------    -----------    -----------
Net income (loss)..................................................     $     2,168    $     1,095    $      (217)
                                                                        ===========    ===========    ===========

Basic net income (loss) per common share...........................     $      0.35    $      0.18    $     (0.04)
                                                                        ===========    ===========    ===========
Weighted average common shares.....................................       6,225,970      6,254,308      6,186,469
                                                                        ===========    ===========    ===========

Diluted net income (loss) per common share.........................     $      0.35    $      0.18    $     (0.04)
                                                                        ===========    ===========    ===========
Weighted average common and common equivalent shares...............       6,229,750      6,254,376      6,186,469
                                                                        ===========    ===========    ===========
</TABLE>

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



                                       26
<PAGE>   27



                   MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES

    CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
              FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998


<TABLE>
<CAPTION>
In thousands                                                                2000           1999            1998
----------------------------------------------------------------------- -------------- -------------- ---------------
<S>                                                                     <C>            <C>            <C>
                         SHAREHOLDERS' EQUITY
                         --------------------
Common stock:
   Balance beginning of year.......................................     $    22,586    $    22,332    $    20,838
     Stock issued under the Employee Stock Purchase Plan...........             200            254            276
     Stock issued upon the exercise of employee stock options......              --             --             95
     Stock issued in purchase of StatDesign, Inc...................              --             --             31
     Stock issued in purchase of DTI Asia Pte. Ltd.................              --             --          1,092
     Repurchases of Company common stock...........................            (788)            --             --
                                                                        ------------   -----------    -----------
   Balance end of year.............................................          21,998         22,586         22,332
                                                                        -----------    -----------    -----------

Retained earnings:
   Balance beginning of year.......................................           4,168          3,073          3,290
     Net income (loss).............................................           2,168          1,095           (217)
     Repurchases of Company common stock...........................            (517)            --             --
                                                                        ------------   -----------    -----------
   Balance end of year.............................................           5,819          4,168          3,073
                                                                        -----------    -----------    -----------

Accumulated other comprehensive income (loss):
   Balance beginning of year.......................................             417            195           (158)
     Foreign currency translation adjustments......................            (571)           222            353
                                                                        ------------   -----------    -----------
   Balance end of year.............................................            (154)           417            195
                                                                        ------------   -----------    -----------

Total shareholders' equity.........................................     $    27,663    $    27,171    $    25,600
                                                                        ===========    ===========    ===========

                         COMPREHENSIVE INCOME
                         --------------------
Net income (loss)..................................................     $     2,168    $     1,095    $      (217)
Foreign currency translation adjustment............................            (571)           222            353
                                                                        ------------   -----------    -----------
Comprehensive income...............................................     $     1,597    $     1,317    $       136
                                                                        ===========    ===========    ===========
</TABLE>




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



                                       27
<PAGE>   28



                   MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998


<TABLE>
<CAPTION>
In thousands                                                                 2000            1999             1998
----------------------------------------------------------------------- --------------- ---------------- ---------------
<S>                                                                     <C>             <C>              <C>
Cash flows from operating activities:
   Net income (loss)...............................................       $   2,168       $   1,095        $    (217)
   Adjustments to reconcile net income (loss) to net cash provided by
     operating activities:
     Acquisition-related costs and non-recurring charges...........              --              --            1,748
     Depreciation and amortization.................................           1,748           2,003            1,726
     Loss on disposal of assets....................................               9              91               64
     Minority interest in net income of subsidiary.................              60               8               10
     Changes in assets and liabilities, net of effect of
     acquisitions:
       Accounts receivable.........................................              38            (945)          (2,245)
       Prepaid and deferred expenses...............................            (689)           (934)            (273)
       Other assets................................................             377            (567)             117
       Accounts payable............................................           1,287              29              452
       Accrued expenses............................................           1,469            (153)            (134)
       Deferred revenue............................................             824           1,179             (327)
                                                                        -----------     -----------      -----------
         Net cash provided by operating activities.................           7,291           1,806              921
                                                                        -----------     -----------      -----------

Cash flows from investing activities:
   Purchases of property and equipment.............................          (2,059)         (1,093)          (2,250)
   Acquisition of ESTECH Corporation, net of cash acquired.........          (3,492)             --               --
   Purchase of technology from the University of Iowa..............              --              --             (400)
   Acquisition of DTI Asia Pte. Ltd., net of cash acquired.........              --              --             (563)
   Acquisition of certain assets of H.G.E. Inc., net of cash acquired            --              --           (2,040)
                                                                        -----------     -----------      ------------
         Net cash used in investing activities.....................          (5,551)         (1,093)          (5,253)
                                                                        ------------    ------------     -----------

Cash flows from financing activities:
   Proceeds from issuance of common stock..........................             200             254              402
   Net borrowings (payments) under line of credit agreements.......              35             (91)              60
   Repurchases of Company common stock.............................          (1,305)             --               --
                                                                        ------------    -----------      -----------
         Net cash provided by (used in) financing activities.......          (1,070)            163              462
                                                                        ------------    -----------      -----------
Effect of exchange rate changes on cash............................            (450)             22              452
                                                                        ------------    -----------      -----------
Net increase (decrease) in cash and cash equivalents...............             220             898           (3,418)
Cash and cash equivalents at beginning of year.....................          17,741          16,843           20,261
                                                                        -----------     -----------      -----------
Cash and cash equivalents at end of year...........................       $  17,961       $  17,741        $  16,843
                                                                        ===========     ===========      ===========
</TABLE>

<TABLE>
<CAPTION>
Supplemental schedule of non-cash investing and financing activities:
   Details of acquisitions:
                                                                            ESTECH                            DTI
                                                                        ---------------                  ---------------
<S>                                                                     <C>                              <C>
     Net assets (liabilities), excluding cash acquired.............       $     894                        $     (59)
     Purchase price in excess of net assets acquired...............           3,841                              734
     Accrued acquisition costs.....................................          (1,243)                              --
     Purchased in-process research and development.................              --                              980
     Common stock issued...........................................              --                           (1,092)
                                                                        -----------                      -----------
         Net cash used.............................................       $   3,492                        $     563
                                                                        ===========                      ===========

                                                                                                          H.G.E. INC.
     Net liabilities, excluding cash acquired......................                                        $    (118)
     Purchase price in excess of net assets acquired...............                                            1,955
     Purchased in-process research and development.................                                              203
                                                                                                         -----------
         Net cash used.............................................                                        $   2,040
                                                                                                         ===========
</TABLE>

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



                                       28
<PAGE>   29



                   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

    In April 1997, the Company established a Japanese subsidiary, Mechanical
Dynamics Japan K.K. ("MDI-Japan"), through a joint venture agreement with
ISI-Dentsu of Tokyo, Japan, the largest distributor of the Company's software in
Japan. Minority interest in net income of subsidiary of $60,000 in 2000, $8,000
in 1999 and $10,000 in 1998 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 gain (loss) amounted to
($309,000), ($74,000) and $64,000 in 2000, 1999 and 1998, 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 and the software is delivered. 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.



                                       29
<PAGE>   30



   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
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.

<TABLE>
<CAPTION>
In thousands                                                                               2000         1999
-------------------------------------------------------------------------------------- ------------- ------------
<S>                                                                                    <C>           <C>
  Furniture and equipment...........................................................    $   8,758     $  6,720
  Leasehold improvements............................................................          282          785
                                                                                       ----------     --------
                                                                                            9,040        7,505
  Less:  Accumulated depreciation...................................................       (4,578)      (4,387)
                                                                                       -----------    ---------
  Net property and equipment........................................................    $   4,462     $  3,118
                                                                                       ==========     ========
</TABLE>

   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.

   Fair Value of Financial Instruments and Concentration of Credit Risk

    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




                                       30
<PAGE>   31

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, 2000 and 1999, the Company had approximately $60,000 and $108,000,
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.

    The carrying values of the Company's cash and cash equivalents and accounts
payable approximate fair value due to the short maturities of these instruments.
Management's estimate of the fair value of borrowings outstanding under lines of
credit and overdraft facilities requires judgment by management, and is not
necessarily indicative of the amounts that could be realized in a current market
exchange. The fair value of these financial instruments approximate their
recorded values. It is not practicable to estimate the fair value of the
Company's capital lease obligations.

    Other financial instruments which potentially expose the Company to
concentrations of credit risk, as defined by Statement of Financial Accounting
Standards No. 105, 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.

   Net Income (Loss) Per Common Share

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

<TABLE>
<CAPTION>
                                                                                YEAR ENDED DECEMBER 31,
                                                                       ------------------------------------------
                                                                           2000           1999          1998
---------------------------------------------------------------------- -------------- ------------- -------------
<S>                                                                    <C>            <C>           <C>
 Weighted average common shares used in basic net income (loss) per
    common share...................................................        6,225,970     6,254,308     6,186,469
   Effect of stock options.........................................            3,780            68            --
                                                                       -------------  ------------  ------------
 Weighted average common and common equivalent shares used in
    diluted net income (loss) per common share.....................        6,229,750     6,254,376     6,186,469
                                                                       =============  ============  ============
</TABLE>

For the years ended December 31, 2000, 1999, and 1998, options to purchase
shares of the Company's common stock of 657,374, 676,214, and 258,981,
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. For the year
ended December 31, 1998, the dilutive effect of an additional 95,020 shares was
excluded from the computation of diluted earnings per share, as the effect was
anti-dilutive with the net loss.

   Comprehensive Income

    Comprehensive income is the total of net income and all other non-owner
changes in equity. The difference between net income (loss), 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



                                       31
<PAGE>   32

comprehensive income (loss) 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 2000 and 1999 in Note 5, in accordance with the
requirements of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS 123").

   Use of Estimates

    The preparation of financial statements in conformity with generally
accepted accounting principles 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

    The Financial Accounting Standards Board issued Statements of Financial
Accounting Standards No. 133, 137 and 138, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133, SFAS 137 and SFAS 138"). These
statements establish accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and hedging activities. The statements require that an entity record
all derivatives as either assets or liabilities at fair value. Under certain
conditions a derivative may be designated as a hedge of (1) potential changes in
the fair value of an asset or liability or firm commitment, (2) the foreign
currency exposure of a forecasted transaction, or (3) the foreign currency
exposure of the net investment in a foreign operation. The accounting for
changes in the fair value of a derivative instrument depends on the intended use
of the derivative and the resulting designation. These statements are effective
for fiscal years beginning after June 15, 2000. The Company's derivative
activities are currently limited to entering into forward contracts to hedge
potential changes in the fair value of its receivables denominated in certain
foreign currencies.

    In September 2000, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 140").
SFAS 140 provides accounting and reporting standards for transfers and servicing
of financial assets and extinguishments of liabilities. SFAS 140 replaces SFAS
125 but it carries over most of SFAS 125's provisions. The statement is
effective for transfers and servicing of financial assets and extinguishments of
liabilities occurring after March 31, 2001.

    Additionally, the Securities and Exchange Commission has issued Staff
Accounting Bulletin No. 101, "Revenue Recognition," ("SAB 101"), which is
effective for the Company's fourth quarter, and the Financial Accounting
Standards Board has issued Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation, an interpretation of APB Opinion No.
25," ("FIN 44") which generally is effective for all periods after July 1, 2000.
Certain conclusions in FIN 44 cover specific events that occur after either
December 15, 1998, or January 12, 2000.

    The adoption of FIN 44 and SAB 101 had no impact on the Company's financial
statements and management expects that adoption of SFAS 133, SFAS 137 and SFAS
138 and SFAS 140 will have little, if any, impact on the Company's consolidated
financial position or results of operations.



                                       32
<PAGE>   33

(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 acquisition resulted in goodwill of
approximately $3.8 million, which is being amortized over 15 years. 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:

<TABLE>
<CAPTION>
                                                                                          TWELVE MONTHS ENDED
                                                                                             DECEMBER 31,
                                                                                       --------------------------
In thousands, except per share data                                                        2000         1999
-------------------------------------------------------------------------------------- ------------- ------------
<S>                                                                                    <C>           <C>
  Revenue...........................................................................    $  52,778     $ 46,473
  Net income........................................................................    $   2,205     $  1,097
  Earnings per share (diluted)......................................................    $    0.35     $   0.18
</TABLE>


    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 was acquired to be integrated with the
Company's ADAMS virtual prototyping software to provide system-level durability
design sensitivity analysis capabilities. In connection with the transaction,
the Company reported a non-recurring charge to operations in 1998 of $400,000,
associated with the write-off of in-process research and development acquired
from the University. The purchase price was allocated to in-process research and
development as the software had not reached technological feasibility and no
other tangible or intangible assets were identified.

    In August 1998, the Company acquired the Design Analysis Group and certain
other assets of H.G.E. Inc. ("HGE"), an engineering software and services firm
based in Toronto, Ontario, Canada. The aggregate purchase price of approximately
$2.2 million consisted principally of cash. In connection with the acquisition,
the Company recorded a non-recurring charge to operations in 1998 of
approximately $203,000, associated with the write-off of in-process research and
development acquired in the transaction which had not reached technological
feasibility.

    In January 1998, the Company acquired 100% of the outstanding capital stock
of DTI Asia Pte. Ltd. ("DTI"), a provider of mechanical design simulation
software embedded in the AutoCAD and Mechanical Desktop product lines from
Autodesk, Inc. The aggregate purchase price of approximately $1.7 million
consisted of $563,000 in cash and 142,540 shares of the Company's common stock
valued at approximately $1.1 million. In connection with the acquisition, the
Company recorded a non-recurring charge to operations in 1998 of approximately
$980,000, associated with the write-off of in-process research and development
acquired in the transaction which had not reached technological feasibility.

    These acquisitions have 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 has been recognized as goodwill and is being amortized
over periods ranging from five to 15 years. The operating results associated
with each acquisition have been included in the Company's consolidated results
of operations from the date of acquisition.

(3) FINANCING ARRANGEMENTS

    The Company has available an unsecured bank line of credit with a maximum
borrowing capacity of $4.0 million. Borrowings on the line of credit bear
interest at 0.75% below the bank's prime rate of interest. No



                                       33
<PAGE>   34

borrowings were outstanding at December 31, 2000 or at any time during the year.
The agreement expires on June 30, 2001.

    The Company's subsidiaries in Germany, Italy, Sweden, and France also have
line of credit and overdraft facilities that provide for aggregate borrowing
availability of approximately $400,000, at various fixed and variable interest
rates as of December 31, 2000. Borrowings are primarily due on demand and are
collateralized by certain assets of the subsidiaries. Borrowings outstanding
under these agreements were $49,000 and $14,000 at December 31, 2000 and 1999,
respectively. The weighted average interest rate on these borrowings during 2000
and 1999 were 8.5% and 7.0%, respectively.

    The Company had $1,064,000 in capital lease obligations outstanding as of
December 31, 2000, of which $658,000 is long-term. No other borrowings were
outstanding under long-term debt arrangements at December 31, 2000 and 1999.
Cash paid for interest was $9,000, $15,000 and $16,000 in 2000, 1999, and 1998,
respectively.

 (4) INCOME TAXES

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

<TABLE>
<CAPTION>
                                                                               YEAR ENDED DECEMBER 31,
                                                                       -----------------------------------------
In thousands                                                               2000           1999         1998
---------------------------------------------------------------------- -------------- ------------- ------------
<S>                                                                    <C>            <C>           <C>
Income (loss) before provision for income taxes:
  Domestic.........................................................     $  1,472       $    133      $    940
  Foreign..........................................................        1,707            721          (668)
                                                                        --------       --------      --------
                                                                        $  3,179       $    854      $    272
                                                                        ========       ========      ========
Domestic provision (benefit) for income taxes:
  Current..........................................................     $    187       $   (164)     $    241
  Deferred.........................................................          (97)          (421)           30
Foreign provision for income taxes:
  Current..........................................................          861            336           208
                                                                        --------       --------      --------
Provision (credit) for income taxes................................     $    951       $   (249)     $    479
                                                                        ========       =========     ========
</TABLE>

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

<TABLE>
<CAPTION>
                                                                                YEAR ENDED DECEMBER 31,
                                                                         ---------------------------------------
In thousands                                                                2000          1999          1998
------------------------------------------------------------------------ ------------ -------------- -----------
<S>                                                                      <C>          <C>            <C>
Federal statutory provision.........................................       $ 1,081      $   290        $    92
   Meals and entertainment..........................................            17           35             33
   Acquisition-related costs and non-recurring charges..............            --           --            402
   Goodwill amortization............................................            66           37             44
   Recognition of tax credits.......................................          (221)        (637)            --
   Foreign losses without tax benefit...............................            75           --             --
   Effect of differences between U.S. and foreign tax rates.........           102           65             37
   Tax-exempt interest income.......................................          (109)         (72)          (121)
   Other, net.......................................................           (60)          33             (8)
                                                                           --------     -------        -------
Provision (credit) for income taxes.................................       $   951      $  (249)       $   479
                                                                           =======      ========       =======
</TABLE>





                                       34
<PAGE>   35





    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:

<TABLE>
<CAPTION>
                                                                                                 AS OF
                                                                                             DECEMBER 31,
                                                                                        ------------------------
In thousands                                                                              2000         1999
--------------------------------------------------------------------------------------- ------------ -----------
<S>                                                                                     <C>          <C>
Current deferred tax asset (liability):
  Accounts receivable...............................................................     $  158       $  120
  Accrued expenses                                                                          264          202
  Other.............................................................................         (8)         (33)
                                                                                        --------     --------
Net current deferred tax asset....................................................          414          289
                                                                                        -------      -------

Long-term deferred tax asset:
  Tax credits.......................................................................        762          198
  Property and equipment............................................................        169          161
  Accrued expenses                                                                           122           --
  Other.............................................................................         27           16
                                                                                        -------      -------
Net long-term deferred tax asset....................................................      1,080          375
                                                                                        -------      -------
  Net deferred tax asset............................................................     $1,494       $  664
                                                                                         ======       ======
</TABLE>

    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 book and 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 tax credits expire
in 2005 through 2020.

    Income taxes have been provided on all undistributed earnings of foreign
subsidiaries. Cash paid for income taxes was $1.3 million, $607,000 and $1.2
million in 2000, 1999 and 1998, 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. As of
December 31, 2000, the Company had repurchased 218,948 shares of its common
stock at a cost of $1.3 million.


                                       35
<PAGE>   36



   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 46,626, 50,157 and 43,340 shares
of common stock in 2000, 1999 and 1998, respectively, to various employees.
These shares were issued with a weighted average price per share of $4.30, $5.07
and $6.37 in 2000, 1999 and 1998, respectively. As of December 31, 2000, there
were 108,765 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.

    Stock option activity for this plan is summarized below:

<TABLE>
<CAPTION>
                                                                                                    WTD. AVG.
                                                                    NUMBER           PRICE          EXERCISE
                                                                   OF SHARES       PER SHARE          PRICE
----------------------------------------------------------------- ------------ ------------------- ------------
<S>                                                               <C>          <C>                 <C>
Outstanding at December 31, 1997.................................   379,300     $ 6.69 - $ 9.13      $ 8.12
  Granted........................................................   564,150     $ 6.75 - $11.50      $ 7.76
  Exercised......................................................    (6,125)    $ 6.75 - $ 9.00      $ 8.84
  Canceled.......................................................  (347,800)    $ 6.75 - $11.50      $ 9.61
                                                                   --------      --------------      ------
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
                                                                    =======     ===============      ======
</TABLE>

    There were 155,627 and 108,913 options exercisable under the Stock Option
Plan as of December 31, 2000 and 1999, respectively, with a weighted average
exercise price of $8.07 per share in 2000 and $8.15 per share in 1999. 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 10 years from
the date they are granted. As of December 31, 2000, there were 320,679 shares of
common stock available for grant under the Stock Option Plan. Options
outstanding under the Stock Option Plan have a weighted average remaining
contractual life of 6.8 years as of December 31, 2000 and December 31, 1999.

    In November 1998, the Board of Directors approved a one-for-one stock option
exchange that provided non-director employees with the opportunity to exchange
stock options previously granted for new options with a current market price and
a new vesting period. The new options were priced at $6.75 per share based on
the closing price of the Company's common stock as reported on Nasdaq on
November 10, 1998, vest in equal installments over three years from the November
10, 1998 grant date and expire on November 10, 2008. The repriced options can
only be



                                       36
<PAGE>   37

exercised when the closing price of the Company's common stock equals or exceeds
$11.00 per share. A total of 335,950 options with prior exercise prices ranging
from $6.75 to $11.50 per share were exchanged. The weighted average prior
exercise price of options exchanged was $8.81 per share. The exchange of such
options is presented in the table above as cancellations and subsequent grants.

   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:

<TABLE>
<CAPTION>
                                                                                                    WTD. AVG.
                                                                    NUMBER           PRICE          EXERCISE
                                                                   OF SHARES       PER SHARE          PRICE
----------------------------------------------------------------- ------------ ------------------- ------------
<S>                                                               <C>          <C>                 <C>
Outstanding at December 31, 1997.................................    40,000     $ 9.13 - $11.00      $10.07
  Granted........................................................    20,000         $ 13.00          $13.00
                                                                     ------         -------          ------
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
                                                                    =======     ===============      ======
</TABLE>

    There were 80,000 and 60,000 options exercisable under the Director Stock
Option Plan as of December 31, 2000 and 1999, respectively, with a weighted
average exercise price of $9.92 per share in 2000 and $11.04 per share in 1999.
Options outstanding under the Director Stock Option Plan have a weighted average
remaining contractual life of 2.4 years and 2.9 years as of December 31, 2000
and 1999, respectively.

    For various price ranges, information for options outstanding and
exercisable for all option plans at December 31, 2000 was as follows:

<TABLE>
<CAPTION>
                                         OUTSTANDING OPTIONS                        EXERCISABLE OPTIONS
                          ---------------------------------------------------   -----------------------------
         RANGE OF                      WTD. AVG. REMAINING      WTD. AVG.                      WTD. AVG.
     EXERCISE PRICES        SHARES         LIFE (YEARS)      EXERCISE PRICE        SHARES    EXERCISE PRICE
-----------------------------------------------------------------------------   -----------------------------
<S>                         <C>        <C>                   <C>                <C>          <C>
      $4.50 - $6.63          285,511             8.42            $  5.79           28,875       $  6.42
           $6.75             285,235             7.63            $  6.75            8,400       $  6.75
       $7.25 - $8.00         127,250             1.16            $  7.90           95,625       $  7.90
      $8.50 - $11.00         105,200             3.34            $  9.51           82,727       $  9.58
          $13.00              20,000             2.37            $ 13.00           20,000       $ 13.00
</TABLE>

   Stock-Based Compensation

    Using the intrinsic value method of accounting for the value of stock
options granted during 2000, 1999 and 1998, 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 2000, 1999
and 1998 consistent with the provisions of SFAS 123, net income (loss) and net
income (loss) per share would have been reduced to the pro forma amounts
indicated below:

                                       37
<PAGE>   38

<TABLE>
<CAPTION>
In thousands, except per share data                            2000             1999            1998
--------------------------------------------------------- ---------------- --------------- ---------------
<S>                                                       <C>              <C>             <C>
Net income (loss) - as reported..........................    $  2,168         $  1,095        $   (217)
Net income (loss) - pro forma............................    $  1,650         $    545        $   (709)

Diluted net income (loss) per share - as reported........    $   0.35         $   0.18        $   (0.04)
Diluted net income (loss) per share - pro forma..........    $   0.26         $   0.09        $   (0.11)
</TABLE>

    The weighted average estimated fair value of stock options granted during
2000, 1999 and 1998 was $3.26, $3.72 and $4.69, 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:

<TABLE>
<CAPTION>
                                                               2000            1999            1998
--------------------------------------------------------- --------------- --------------- ---------------
<S>                                                             <C>             <C>             <C>
Expected life (years)....................................       5.0             5.0             5.0
Interest rate............................................       5.2%            6.2%            5.2%
Volatility...............................................       0.6             0.6             0.7
Dividend yield...........................................       0.0%            0.0%            0.0%
</TABLE>

(6) COMMITMENTS AND CONTINGENCIES

   Employee Benefit Plans

     The Company maintains a 401(k) plan covering substantially all of its
domestic employees. During 2000, 1999 and 1998, the Company matched 40% of
qualified employee contributions, up to a maximum of 2.4% of eligible
compensation. In 2000, 1999, and 1998, the Company contributed $249,000,
$233,000 and $244,000, respectively, to the plan.

    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, 2000 are as
follows:

<TABLE>
<CAPTION>
In thousands                                                                   Capital leases   Operating leases
------------------------------------------------------------------------------ ---------------- -----------------
<S>                                                                            <C>              <C>
2001..........................................................................    $    443         $  1,580
2002..........................................................................         379            1,365
2003..........................................................................         192            1,135
2004..........................................................................          88            1,037
2005..........................................................................          30            1,031
Thereafter....................................................................           0            5,010
                                                                                  --------         --------
Total minimum lease payments..................................................    $  1,132         $ 11,158
                                                                                                   ========
Less interest.................................................................         (68)
                                                                                  --------
Total minimum lease payments..................................................       1,064
Less current portion..........................................................        (406)
                                                                                  --------
Long-term minimum lease payments..............................................    $    658
                                                                                  ========
</TABLE>

    Total lease expense amounted to approximately $2.0 million in each of the
years ending 2000, 1999, and 1998.

    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.



                                       38
<PAGE>   39

   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 $3.8 million, $3.2 million, and $2.2
million in 2000, 1999, and 1998, 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

    Effective December 31, 1998, the Company adopted Statement of Financial
Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and
Related Information" ("SFAS 131"). SFAS 131 introduces a new model for segment
reporting called the "management approach." The management approach is based on
the way that the chief operating decision-maker organizes segments within a
company for making operating decisions and assessing performance.

    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.




                                       39
<PAGE>   40


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

<TABLE>
<CAPTION>
                                                                                 YEAR ENDED DECEMBER 31,
                                                                    --------------------------------------------
In thousands                                                             2000           1999           1998
------------------------------------------------------------------- --------------- -------------- -------------
<S>                                                                 <C>             <C>            <C>
Revenue:
  North America
     United States..............................................      $  12,052       $  11,613      $  12,223
     Canada and Mexico..........................................          4,607           3,820          1,514
  Europe
     Germany....................................................          4,824           5,473          5,108
     Other European countries...................................         10,767           9,573          7,769
  Asia/Pacific
     Japan......................................................         11,297           7,706          7,819
     Other Asian countries......................................          3,030           2,070          2,142
                                                                      ---------       ---------      ---------
          Total revenue.........................................      $  46,577       $  40,255      $  36,575
                                                                      =========       =========      =========

Identifiable assets:
  North America
     United States..............................................      $  20,335       $  23,550      $  23,882
     Canada.....................................................          2,837           2,287          1,698
  Europe
     Germany....................................................          1,780           2,384          1,942
     Other European countries...................................          5,232           4,466          3,430
  Asia/Pacific
     Japan......................................................          8,484           1,917          1,362
     Other Asian countries......................................            433             149            114
                                                                      ---------       ---------      ---------
          Total identifiable assets.............................         39,101          34,753         32,428
  Goodwill......................................................          6,768           3,436          3,819
                                                                      ---------       ---------      ---------
          Total assets..........................................      $  45,869       $  38,189      $  36,247
                                                                      =========       =========      =========
</TABLE>


    No customer accounted for greater than 10% of total revenue in 2000, 1999 or
1998. The Company's largest distributor, ISI-Dentsu, is located in Japan and
accounted for approximately 16.4%, 12.6% and 13.2% of the Company's total
revenue in 2000, 1999 and 1998, respectively.

(8) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

    The following table summarizes selected unaudited quarterly financial
information for 2000 and 1999. The Company believes all adjustments, consisting
of normal recurring adjustments considered necessary for a fair presentation,
have been included in the selected quarterly information:

<TABLE>
<CAPTION>
                                                       THREE MONTHS ENDED                             YEAR ENDED
                                 ---------------------------------------------------------------    ---------------
                                   MARCH 31,        JUNE 30,     SEPTEMBER 30,    DECEMBER 31,       DECEMBER 31,
In thousands, except per share       2000             2000           2000             2000               2000
data
-------------------------------- --------------- --------------- --------------- --------------- -- ---------------
<S>                                <C>             <C>             <C>             <C>                <C>
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
</TABLE>




                                       40
<PAGE>   41


<TABLE>
<CAPTION>
                                                       THREE MONTHS ENDED                             YEAR ENDED
                                 ---------------------------------------------------------------    ---------------
                                   MARCH 31,        JUNE 30,     SEPTEMBER 30,    DECEMBER 31,       DECEMBER 31,
In thousands, except per share        1999            1999            1999            1999               1999
data
-------------------------------- --------------- --------------- --------------- --------------- -- ---------------
<S>                              <C>             <C>             <C>             <C>                <C>
Revenue......................      $  10,366       $   9,158       $   9,729       $  11,002          $  40,255
Gross profit.................          6,809           5,509           6,061           7,097             25,476
Operating income (loss)......            501            (835)             69             605                340
Net income (loss)............            474            (503)            640             484              1,095
Basic net income (loss)
   per common share..........      $    0.08       $  (0.08)       $    0.10       $    0.08          $    0.18
Diluted net income (loss)
   per common share..........      $    0.08       $  (0.08)       $    0.10       $    0.08          $    0.18
</TABLE>




                                       41
<PAGE>   42


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 2001 Annual Meeting of
Shareholders scheduled to be held on May 10, 2001.

    The executive officers of the Company as of March 1, 2001 are listed below:

<TABLE>
<CAPTION>
                       NAME                           AGE                           POSITION
------------------------------------------------    -------  -------------------------------------------------------
<S>                                                 <C>      <C>
Michael E. Korybalski...........................      54     Chief Executive Officer, Chairman of the Board and
                                                                Director
Robert R. Ryan..................................      43     President, Chief Operating Officer and Director
Michael Hoffmann................................      44     Senior Vice President-- Worldwide Sales & Service
David Peralta...................................      33     Vice President, Chief Financial Officer and Treasurer
Douglas M. Peterson.............................      35     Vice President, Chief Technical Officer
</TABLE>

     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. Dr. Ryan
was elected a director of the Company in May 1997. Dr. Ryan served as the
Company's Executive Vice President from 1991 to February 1997. From 1988 through
1991, Dr. Ryan served as the Company's Vice President of Product Development.
Before joining the Company, Dr. 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. Dr. 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.



                                       42
<PAGE>   43

     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 2001 Annual Meeting of Shareholders scheduled
to be held on May 10, 2001.


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 2001 Annual Meeting of Shareholders scheduled
to be held on May 10, 2001.


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

    None.




                                       43
<PAGE>   44


                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

ITEM 14(A)1. FINANCIAL STATEMENTS

    Report of Independent Public Accountants
    Consolidated Balance Sheets as of December 31, 2000 and 1999
    Consolidated Statements of Income for the Years Ended December 31, 2000,
    1999 and 1998
    Consolidated Statements of Shareholders' Equity for the Years Ended December
    31, 2000, 1999 and 1998
    Consolidated Statements of Cash Flows for the Years Ended December 31, 2000,
    1999 and 1998
    Notes to Consolidated Financial Statements

ITEM 14(a)2. FINANCIAL STATEMENT SCHEDULES

    None.




                                       44
<PAGE>   45



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 August 6, 1999, incorporated
                     herein by reference to Exhibit 4.2 to the Company's
                     previously filed Form 10-Q for the quarter ended September
                     30, 1999

       (10.1)        Employment Agreement between the Company and Michael E.
                     Korybalski, as amended

       (10.2)        Employment Agreement between the Company and Robert R.
                     Ryan, as amended

       (10.3)        Employment Agreement between the Company and David Peralta,
                     as amended

       (10.4)        Employment Agreement between the Company and Douglas M.
                     Peterson, as amended

       (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

    A current report on Form 8-K was filed on December 28, 2000 and was amended
on March 5, 2001. The acquisition was reported under Item 2 of Form 8-K and
financial statements and pro forma financial information thereto were reported
under Item 7 of Form 8-K/A.


                                       45
<PAGE>   46

                                   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 19, 2001                            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.

<TABLE>
<CAPTION>
                     SIGNATURES                                            TITLE                         DATE
                     ----------                                            -----                         ----


<S>                                                         <C>                                  <C>
/s/ Michael E. Korybalski                                   Chairman of the Board,               March 19, 2001
------------------------------------------------------      Chief Executive Officer,
Michael E. Korybalski                                        and Director
                                                            (Principal Executive Officer)


/s/ Robert R. Ryan                                          President, Chief Operating Officer   March 19, 2001
------------------------------------------------------      and Director
Robert R. Ryan


/s/ David Peralta                                           Chief Financial Officer              March 19, 2001
------------------------------------------------------      (Principal Financial and
David Peralta                                                Accounting Officer)


/s/ Herbert S. Amster                                       Director                             March 19, 2001
------------------------------------------------------
Herbert S. Amster


/s/ David E. Cole                                           Director                             March 19, 2001
------------------------------------------------------
David E. Cole


/s/ Joseph F. Gloudeman                                     Director                             March 19, 2001
------------------------------------------------------
Joseph F. Gloudeman


/s/ Mitchell I. Quain                                       Director                             March 19, 2001
------------------------------------------------------
Mitchell I. Quain

</TABLE>



                                       46
<PAGE>   47


                               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 August 6, 1999, incorporated
                     herein by reference to Exhibit 4.2 to the Company's
                     previously filed Form 10-Q for the quarter ended September
                     30, 1999

       (10.1)        Employment Agreement between the Company and Michael E.
                     Korybalski, as amended

       (10.2)        Employment Agreement between the Company and Robert R.
                     Ryan, as amended

       (10.3)        Employment Agreement between the Company and David Peralta,
                     as amended

       (10.4)        Employment Agreement between the Company and Douglas M.
                     Peterson, as amended

      (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









                                       47