##### Table of Contents



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

FORM 10-Q

(Mark One)

| |  |                                                                                         
| |  | ----------------------------------------------------------------------------------------
| |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|
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| |  | For the fiscal period ended: September 30, 2000                                         
|
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| |  | OR                                                                                      
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| |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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| |  | For the transition period from ____________ to ____________                             

Commission file number: 0-20679

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

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

2301 Commonwealth Blvd.
Ann Arbor, Michigan 48105
(734) 994-3800

(Address of principal executive offices, including zip
code, and telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes  No

The number of outstanding shares of the Registrants common stock, as of
November 6, 2000, was 6,155,589.





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TABLE OF CONTENTS



|                                                                                                    |                                                                                               |  |  |  |  |  |  | 
|--------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION                                                                     
|Item 1. Financial Statements                                                                       
|CONDENSED CONSOLIDATED STATEMENTS OF INCOME THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 2000 AND 1999
|CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTHS
ENDED SEPTEMBER 30, 2000 AND 1999      
|NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                               
|                                                                                                    | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                                                                                    | Item 3. Quantitative and Qualitative Disclosures about Market Risk                           
|PART II  OTHER INFORMATION                                                                        
|                                                                                                    | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                                                                                         
|INDEX TO EXHIBITS                                                                                  
|Statement Re Computation of Per Share Earnings                                                     
|Financial Data Schedule                                                                            



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MECHANICAL DYNAMICS, INC.

FORM 10-Q
TABLE OF CONTENTS

|                  |                                                                                                     |  |    |      |  | 
|----------------- | --------------------------------------------------------------------------------------------------- |  | -- | ---- |  | 
|                  |                                                                                                     |  |    | Page
|                  |                                                                                                     |  |    |     
|PART I -          | FINANCIAL INFORMATION                                                                              
|                 
|                 
|                 
|                 
|Item 1.           | Financial Statements                                                                               
|                 
|                 
|                 
|                 
|                  | Condensed Consolidated Balance Sheets
September 30, 2000 and December 31, 1999                      |  |    | 3    | 
|                 
|                 
|                 
|                 
|                  | Condensed Consolidated Statements of Income
Three and Nine Months Ended September 30, 2000 and 1999 |  |    | 4    | 
|                 
|                 
|                 
|                 
|                  | Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2000 and 1999       |  |    | 5    | 
|                 
|                 
|                 
|                 
|                  | Notes to Condensed Consolidated Financial Statements                                                |  |    | 6    | 
|                 
|                 
|                 
|                 
|Item 2.           | Managements Discussion and Analysis of Financial
Condition and Results of Operations               |  |    | 8    | 
|                 
|                 
|                 
|                 
|Item 3.           | Quantitative and Qualitative Disclosures about Market
Risk                                          |  |    | 14   | 
|                 
|                 
|                 
|                 
|PART II          | OTHER INFORMATION                                                                                  
|                 
|                 
|                 
|                 
|Item 6.           | Exhibits and Reports on Form 8-K                                                                    |  |    | 15   | 
|                 
|                 
|                 
|                 
|SIGNATURES        |                                                                                                     |  | 16 |     
|                 
|                 
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|                 
|INDEX TO EXHIBITS |                                                                                                     |  | 17 |     

2



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##### Table of Contents






PART I  FINANCIAL INFORMATION




Item 1. Financial Statements

MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

|                                           |                               |                                        |                            |        |               |        |              |        |        |        | 
|------------------------------------------ | ----------------------------- | -------------------------------------- | -------------------------- | ------ | ------------- | ------ | ------------ | ------ | ------ | ------ | 
|                                           |                               |                                        |                            |        | September 30, |        | December 31,
|in thousands                               |                               | 2000                                   |                            | 1999  
|                                           |                               |                                        |                            |       
|Assets:                                    |                               |                                        | (Unaudited                 | )     
|                                          
|                                          
|                                          
|                                          
|Current assets:                           
|                                          
|                                          
|                                          
|                                          
|                                           | Cash and cash equivalents     |                                        | $                          | 20,620 |               |        | $            | 17,741 |       
|                                          
|                                          
|                                          
|                                          
|                                           | Accounts receivable, net      |                                        |                            | 9,865  |               |        |              | 10,454 |       
|                                          
|                                          
|                                          
|                                          
|                                           | Prepaid and deferred expenses |                                        |                            | 2,564  |               |        |              | 2,755  |       
|                                           |                               |                                        |                            |        |               |        |              |        |       
|                                           |                               |                                        | Total current assets       |        |               | 33,049 |              |        |        | 30,950 | 
|                                           |                               |                                        |                            |        |               |        |              |        |       
|Property and equipment, net                |                               |                                        | 2,576                      |        |               |        | 3,118        |       
|                                          
|                                          
|                                          
|                                          
|Goodwill, net                              |                               |                                        | 3,062                      |        |               |        | 3,436        |       
|                                          
|                                          
|                                          
|                                          
|Other assets                               |                               |                                        | 942                        |        |               |        | 685          |       
|                                           |                               |                                        |                            |        |               |        |              |        |       
|Total assets                               |                               | $                                      | 39,629                     |        |               | $      | 38,189       |       
|                                           |                               |                                        |                            |        |               |        |              |        |       
|Liabilities and
Shareholders Equity:     
|                                          
|                                          
|                                          
|                                          
|Current liabilities:                      
|                                          
|                                          
|                                          
|                                          
|                                           |                               | Borrowings under lines of credit       |                            | $      | 50            |        |              | $      | 14     |       
|                                          
|                                          
|                                          
|                                          
|                                           |                               | Accounts payable                       |                            |        | 1,576         |        |              |        | 1,447  |       
|                                          
|                                          
|                                          
|                                          
|                                           |                               | Accrued expenses                       |                            |        | 3,024         |        |              |        | 3,246  |       
|                                          
|                                          
|                                          
|                                          
|                                           |                               | Deferred revenue                       |                            |        | 6,895         |        |              |        | 5,832  |       
|                                           |                               |                                        |                            |        |               |        |              |        |       
|                                           |                               |                                        | Total current liabilities  |        |               | 11,545 |              |        |        | 10,539 | 
|                                           |                               |                                        |                            |        |               |        |              |        |       
|Minority interest                          |                               |                                        | 533                        |        |               |        | 479          |       
|                                          
|                                          
|                                          
|                                          
|Shareholders equity:                     
|                                          
|                                          
|                                          
|                                          
|                                           |                               | Common stock                           |                            |        | 22,275        |        |              |        | 22,586 |       
|                                          
|                                          
|                                          
|                                          
|                                           |                               | Preferred stock                        |                            |        | 0             |        |              |        | 0      |       
|                                          
|                                          
|                                          
|                                          
|                                           |                               | Retained earnings                      |                            |        | 5,252         |        |              |        | 4,168  |       
|                                          
|                                          
|                                          
|                                          
|                                           |                               | Accumulated other comprehensive income |                            |        | 24            |        |              |        | 417    |       
|                                           |                               |                                        |                            |        |               |        |              |        |       
|                                           |                               |                                        | Total shareholders equity |        |               | 27,551 |              |        |        | 27,171 | 
|                                           |                               |                                        |                            |        |               |        |              |        |       
|Total liabilities and shareholders equity |                               | $                                      | 39,629                     |        |               | $      | 38,189       |       
|                                           |                               |                                        |                            |        |               |        |              |        |       

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

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##### Table of Contents






MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |        | 
|---------------------------------------------------- | ------------------------------- | ------------------------ | --------- | ------------------ | ------ | ----------------- | --------- | ----- | ----- | - | --------- | ------ | ------ | - | --------- | ------ | ------ | 
|                                                     |                                 |                          |           | Three Months Ended |        | Nine Months Ended
|                                                     |                                 |                          |           | September 30,      |        | September 30,    
|                                                     |                                 |                          |           |                    |        |                  
|in thousands except share and per share data         |                                 | 2000                     |           | 1999               |        | 2000              |           | 1999 
|                                                     |                                 |                          |           |                    |        |                   |           |      
|Revenue:                                            
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Software licenses               |                          | $         | 5,463              |        |                   | $         | 4,572 |       |   | $         | 17,241 |        |   | $         | 13,868 |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Software maintenance services   |                          |           | 3,147              |        |                   |           | 2,097 |       |   |           | 7,868  |        |   |           | 5,696  |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Professional services and other |                          |           | 2,971              |        |                   |           | 3,060 |       |   |           | 8,292  |        |   |           | 9,689  |       
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|                                                     |                                 | Total revenue            |           |                    | 11,581 |                   |           |       | 9,729 |   |           |        | 33,401 |   |           |        | 29,253 | 
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|Cost of revenue:                                    
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Software licenses               |                          |           | 940                |        |                   |           | 871   |       |   |           | 3,042  |        |   |           | 2,520  |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Services                        |                          |           | 2,808              |        |                   |           | 2,797 |       |   |           | 8,130  |        |   |           | 8,354  |       
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|                                                     |                                 | Total cost of revenue    |           |                    | 3,748  |                   |           |       | 3,668 |   |           |        | 11,172 |   |           |        | 10,874 | 
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|Gross profit                                         |                                 |                          | 7,833     |                    |        |                   | 6,061     |       |       |   | 22,229    |        |        |   | 18,379    |       
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|Operating expenses:                                 
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Sales and marketing             |                          |           | 4,344              |        |                   |           | 3,631 |       |   |           | 12,698 |        |   |           | 11,416 |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Research and development        |                          |           | 1,528              |        |                   |           | 1,362 |       |   |           | 4,448  |        |   |           | 4,118  |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | General and administrative      |                          |           | 1,038              |        |                   |           | 886   |       |   |           | 3,082  |        |   |           | 2,770  |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Goodwill amortization           |                          |           | 113                |        |                   |           | 113   |       |   |           | 340    |        |   |           | 340    |       
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|                                                     |                                 | Total operating expenses |           |                    | 7,023  |                   |           |       | 5,992 |   |           |        | 20,568 |   |           |        | 18,644 | 
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|Operating income (loss)                              |                                 |                          | 810       |                    |        |                   | 69        |       |       |   | 1,661     |        |        |   | (265      | )     
|                                                    
|                                                    
|                                                    
|                                                    
|Other income, net                                    |                                 |                          | 181       |                    |        |                   | 116       |       |       |   | 396       |        |        |   | 415       |       
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|Income before income taxes and minority interest     |                                 |                          | 991       |                    |        |                   | 185       |       |       |   | 2,057     |        |        |   | 150       |       
|                                                    
|                                                    
|                                                    
|                                                    
|Provision (credit) for income taxes                  |                                 |                          | 297       |                    |        |                   | (449      | )     |       |   | 615       |        |        |   | (459      | )     
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|Net income before minority interest                  |                                 |                          | 694       |                    |        |                   | 634       |       |       |   | 1,442     |        |        |   | 609       |       
|                                                    
|                                                    
|                                                    
|                                                    
|Minority interest in net income (loss) of subsidiary |                                 |                          | 26        |                    |        |                   | (6        | )     |       |   | 54        |        |        |   | (2        | )     
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|Net income                                           |                                 | $                        | 668       |                    |        | $                 | 640       |       |       | $ | 1,388     |        |        | $ | 611       |       
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|Basic net income per common share                    |                                 | $                        | 0.11      |                    |        | $                 | 0.10      |       |       | $ | 0.22      |        |        | $ | 0.10      |       
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|Weighted average common shares                       |                                 |                          | 6,208,463 |                    |        |                   | 6,260,443 |       |       |   | 6,251,996 |        |        |   | 6,247,778 |       
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|Diluted net income per common share                  |                                 | $                        | 0.11      |                    |        | $                 | 0.10      |       |       | $ | 0.22      |        |        | $ | 0.10      |       
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       
|Weighted average common and common equivalent shares |                                 |                          | 6,210,668 |                    |        |                   | 6,260,443 |       |       |   | 6,254,046 |        |        |   | 6,247,778 |       
|                                                     |                                 |                          |           |                    |        |                   |           |       |       |   |           |        |        |   |           |        |       

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

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##### Table of Contents






MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

|                                                   |                                  |                                                                                   |                                                           |      |                   |       |        |   |     |        |  
|-------------------------------------------------- | -------------------------------- | --------------------------------------------------------------------------------- | --------------------------------------------------------- | ---- | ----------------- | ----- | ------ | - | --- | ------ | -
|                                                   |                                  |                                                                                   |                                                           |      | Nine Months Ended
|                                                   |                                  |                                                                                   |                                                           |      | September 30,    
|                                                   |                                  |                                                                                   |                                                           |      |                  
|in thousands                                       |                                  | 2000                                                                              |                                                           | 1999
|                                                   |                                  |                                                                                   |                                                           |     
|Cash flows from operating activities:             
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  | Net income                                                                        |                                                           | $    | 1,388             |       |        | $ | 611 |       
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  | Adjustments to reconcile net income to net cash
provided by operating activities:
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Depreciation and amortization                             |      |                   | 1,264 |        |   |     | 1,502  |  
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | (Gain) loss on disposal of assets, net                    |      |                   | (22   | )      |   |     | 63     |  
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Minority interest in net income of subsidiary             |      |                   | 54    |        |   |     | (2     | )
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Changes in assets and liabilities:                       
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Accounts receivable                                       |      |                   | (93   | )      |   |     | 552    |  
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Prepaid and deferred expenses                             |      |                   | 51    |        |   |     | (603   | )
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Other assets                                              |      |                   | (97   | )      |   |     | (359   | )
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Accounts payable                                          |      |                   | 551   |        |   |     | (581   | )
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Accrued expenses                                          |      |                   | 3     |        |   |     | (542   | )
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Deferred revenue                                          |      |                   | 1,287 |        |   |     | 466    |  
|                                                   |                                  |                                                                                   |                                                           |      |                   |       |        |   |     |       
|                                                   |                                  |                                                                                   | Net cash provided by operating activities                 |      |                   | 4,386 |        |   |     | 1,107  |  
|                                                   |                                  |                                                                                   |                                                           |      |                   |       |        |   |     |       
|Cash flows from investing activities:             
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Proceeds from the sale of property and equipment          |      |                   | 124   |        |   |     | 0      |  
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Purchases of property and equipment                       |      |                   | (729  | )      |   |     | (1,046 | )
|                                                   |                                  |                                                                                   |                                                           |      |                   |       |        |   |     |       
|                                                   |                                  |                                                                                   | Net cash used in investing activities                     |      |                   | (605  | )      |   |     | (1,046 | )
|                                                   |                                  |                                                                                   |                                                           |      |                   |       |        |   |     |       
|Cash flows from financing activities:             
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Repurchases of Company common stock                       |      |                   | (770  | )      |   |     | 0      |  
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Net borrowings (payments) under line of credit agreements |      |                   | 36    |        |   |     | (31    | )
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Proceeds from the issuance of common stock                |      |                   | 155   |        |   |     | 203    |  
|                                                   |                                  |                                                                                   |                                                           |      |                   |       |        |   |     |       
|                                                   |                                  |                                                                                   | Net cash provided by (used in) financing activities       |      |                   | (579  | )      |   |     | 172    |  
|                                                   |                                  |                                                                                   |                                                           |      |                   |       |        |   |     |       
|Effect of exchange rate changes on cash            |                                  |                                                                                   | (323                                                      | )    |                   |       | 46     |  
|                                                   |                                  |                                                                                   |                                                           |      |                   |       |        |   |     |       
|Net increase in cash and cash equivalents          |                                  |                                                                                   | 2,879                                                     |      |                   |       | 279    |  
|                                                  
|                                                  
|                                                  
|                                                  
|Cash and cash equivalents at beginning of period   |                                  |                                                                                   | 17,741                                                    |      |                   |       | 16,843 |  
|                                                   |                                  |                                                                                   |                                                           |      |                   |       |        |   |     |       
|Cash and cash equivalents at end of period         |                                  | $                                                                                 | 20,620                                                    |      |                   | $     | 17,122 |  
|                                                   |                                  |                                                                                   |                                                           |      |                   |       |        |   |     |       
|Supplemental disclosures of cash flow information:
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   | Cash paid during the period for:
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Interest                                                  |      | $                 | 5     |        |   | $   | 13     |  
|                                                  
|                                                  
|                                                  
|                                                  
|                                                   |                                  |                                                                                   | Income taxes                                              |      | $                 | 913   |        |   | $   | 172    |  
|                                                   |                                  |                                                                                   |                                                           |      |                   |       |        |   |     |       

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

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MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1)   Basis of Presentation

The accompanying unaudited condensed consolidated financial statements
include the accounts of Mechanical Dynamics, Inc. (MDI or the Company) and
its subsidiaries, and have been prepared in accordance with generally accepted
accounting principles for interim financial information and with Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. The Company believes all adjustments, consisting of
normal recurring adjustments considered necessary for a fair presentation, have
been included. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Companys Form 10-K for the
year ended December 31, 1999.

Operating results for the three and nine month periods ended September 30,
2000 and 1999 are not necessarily indicative of the results that may be
expected for the full year.

(2)  Comprehensive Income

Comprehensive income is the total of net income and all other non-owner
changes in equity. Total comprehensive income was $493,000 and $912,000 for
the three month periods ended September 30, 2000 and 1999, respectively, and
$995,000 and $771,000 for the nine month periods ended September 30, 2000 and
1999, respectively. The difference between net income, as reported in the
accompanying condensed consolidated statements of income, and comprehensive
income is the foreign currency translation adjustment for the respective
periods.

(3)  Earnings per Share

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

|                                                                                                 |  |                    |           |                   |  |      |           |      |  |  |           |  |  |  |           | 
|------------------------------------------------------------------------------------------------ |  | ------------------ | --------- | ----------------- |  | ---- | --------- | ---- |  |  | --------- |  |  |  | --------- | 
|                                                                                                 |  | Three Months Ended |           | Nine Months Ended
|                                                                                                 |  | September 30,      |           | September 30,    
|                                                                                                 |  |                    |           |                  
|                                                                                                 |  | 2000               |           | 1999              |  | 2000 |           | 1999
|                                                                                                 |  |                    |           |                   |  |      |           |     
|Weighted average common
shares used in basic net
income per common share                         |  |                    | 6,208,463 |                   |  |      | 6,260,443 |      |  |  | 6,251,996 |  |  |  | 6,247,778 | 
|                                                                                                
|                                                                                                
|                                                                                                
|                                                                                                
|Effect of stock options                                                                          |  |                    | 2,205     |                   |  |      |          |      |  |  | 2,050     |  |  |  |          | 
|                                                                                                 |  |                    |           |                   |  |      |           |      |  |  |           |  |  |  |           | 
|Weighted average common
and common equivalent
shares used in diluted
net income per common
share |  |                    | 6,210,668 |                   |  |      | 6,260,443 |      |  |  | 6,254,046 |  |  |  | 6,247,778 | 
|                                                                                                 |  |                    |           |                   |  |      |           |      |  |  |           |  |  |  |           | 

For the three and nine month periods ended September 30, 1999, there were no
dilutive options outstanding.

(4)  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 (collectively SFAS 133). 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

6



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##### Table of Contents



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.

Additionally, the Securities and Exchange Commission has issued Staff
Accounting Bulletin No. 101, Revenue Recognition, (SAB 101) which the
Company must adopt no later than the fourth quarter of 2000, 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 had no impact on the Companys financial statements
and management expects that adoption of SFAS 133 and SAB 101 will have little,
if any, impact on the Companys consolidated financial position or results of
operations.

(5) Geographic Operations and Segment Information

The Company operates in one segment  the development, marketing and
support of software products and services for the mechanical segment of the
computer-aided engineering industry. The Company licenses products to
customers on a worldwide basis. 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.

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

|             |               |                          |               |      |                                  |        |                                 |      |       |       |  |   |       |        |  |   |       |        | 
|------------ | ------------- | ------------------------ | ------------- | ---- | -------------------------------- | ------ | ------------------------------- | ---- | ----- | ----- |  | - | ----- | ------ |  | - | ----- | ------ | 
|             |               |                          |               |      | Three Months Ended September 30, |        | Nine Months Ended September 30,
|             |               |                          |               |      |                                  |        |                                
|In thousands |               | 2000                     |               | 1999 |                                  | 2000   |                                 | 1999
|             |               |                          |               |      |                                  |        |                                 |     
|Revenue:    
|            
|            
|            
|            
|             | North America
|            
|            
|            
|            
|             |               | United States            |               | $    | 3,150                            |        |                                 | $    | 3,057 |       |  | $ | 8,786 |        |  | $ | 8,765 |       
|            
|            
|            
|            
|             |               | Canada and Mexico        |               |      | 926                              |        |                                 |      | 856   |       |  |   | 3,465 |        |  |   | 2,556 |       
|            
|            
|            
|            
|             | Europe       
|            
|            
|            
|            
|             |               | Germany                  |               |      | 1,106                            |        |                                 |      | 1,181 |       |  |   | 3,637 |        |  |   | 3,774 |       
|            
|            
|            
|            
|             |               | Other European countries |               |      | 2,555                            |        |                                 |      | 2,084 |       |  |   | 7,642 |        |  |   | 7,085 |       
|            
|            
|            
|            
|             | Asia/Pacific 
|            
|            
|            
|            
|             |               | Japan                    |               |      | 3,028                            |        |                                 |      | 2,057 |       |  |   | 7,991 |        |  |   | 5,545 |       
|            
|            
|            
|            
|             |               | Other Asian countries    |               |      | 816                              |        |                                 |      | 494   |       |  |   | 1,880 |        |  |   | 1,528 |       
|             |               |                          |               |      |                                  |        |                                 |      |       |       |  |   |       |        |  |   |       |       
|             |               |                          | Total revenue |      | $                                | 11,581 |                                 |      | $     | 9,729 |  |   | $     | 33,401 |  |   | $     | 29,253 | 
|             |               |                          |               |      |                                  |        |                                 |      |       |       |  |   |       |        |  |   |       |       

Total assets by geographic location have not changed significantly from
December 31, 1999.

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##### Table of Contents






Item 2. Managements Discussion and
Analysis of Financial Condition and Results of Operations

The following discussion provides an analysis of the Companys financial
condition and results of operations, and should be read in conjunction with the
Companys consolidated financial statements and the notes included in Item 1 of
this Form 10-Q.

Overview

The Company develops, markets and supports virtual prototyping solutions.
The Companys virtual prototyping software allows an engineer or designer to
design a complete product by simulating, both visually and mathematically, a
product in motion. The Companys principal software product, ADAMS Full
Simulation Package, is used by customers to simulate mechanical systems. The
Companys revenue has in the past been, and is expected to be in the future,
derived primarily from its ADAMS Full Simulation Packageand related software
products and services.

Forward-Looking Information is Subject to Risk and Uncertainty

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



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

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

Due to all of the foregoing factors, the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as an indication of future
performance. It is likely that, in some future quarters, the Companys
operating results will be below the expectations of stock market analysts and
investors. In such an event, the price of the Companys common stock would
likely be materially adversely affected.

8



---



##### Table of Contents



Results of Operations

Revenue

|                                |                    |      |                                  |      |                                 |          |       |      |   |      |      |          |  |   |        |      |   |   |        |      |   |  |       |    | 
|------------------------------- | ------------------ | ---- | -------------------------------- | ---- | ------------------------------- | -------- | ----- | ---- | - | ---- | ---- | -------- |  | - | ------ | ---- | - | - | ------ | ---- | - |  | ----- | -- | 
|                                |                    |      | Three Months Ended September 30, |      | Nine Months Ended September 30,
|                                |                    |      |                                  |      |                                
|dollars in thousands            |                    | 2000 |                                  | 1999 |                                 | % Change |       | 2000 |   | 1999 |      | % Change
|                                |                    |      |                                  |      |                                 |          |       |      |   |      |      |         
|Software licenses               |                    | $    | 5,463                            |      |                                 | $        | 4,572 |      |   |      | 19.5 | %        |  | $ | 17,241 |      |   | $ | 13,868 |      |   |  | 24.3  | % 
|                               
|                               
|                               
|                               
|                                | % of total revenue |      |                                  | 47.2 | %                               |          |       | 47.0 | % |      |      |          |  |   |        | 51.6 | % |   |        | 47.4 | %
|                               
|                               
|                               
|                               
|Software maintenance services   |                    | $    | 3,147                            |      |                                 | $        | 2,097 |      |   |      | 50.1 | %        |  | $ | 7,868  |      |   | $ | 5,696  |      |   |  | 38.1  | % 
|                               
|                               
|                               
|                               
|                                | % of total revenue |      |                                  | 27.2 | %                               |          |       | 21.5 | % |      |      |          |  |   |        | 23.6 | % |   |        | 19.5 | %
|                               
|                               
|                               
|                               
|Professional services and other |                    | $    | 2,971                            |      |                                 | $        | 3,060 |      |   |      | (2.9 | %)       |  | $ | 8,292  |      |   | $ | 9,689  |      |   |  | (14.4 | %)
|                               
|                               
|                               
|                               
|                                | % of total revenue |      |                                  | 25.7 | %                               |          |       | 31.5 | % |      |      |          |  |   |        | 24.8 | % |   |        | 33.1 | %
|                                |                    |      |                                  |      |                                 |          |       |      |   |      |      |          |  |   |        |      |   |   |        |      |   |  |       |   
|Total revenue                   |                    | $    | 11,581                           |      |                                 | $        | 9,729 |      |   |      | 19.0 | %        |  | $ | 33,401 |      |   | $ | 29,253 |      |   |  | 14.2  | % 
|                                |                    |      |                                  |      |                                 |          |       |      |   |      |      |          |  |   |        |      |   |   |        |      |   |  |       |   

The Companys total revenue increased 19.0% and 14.2% during the three and
nine month periods ended September 30, 2000, respectively, as compared to the
corresponding periods in 1999. The growth in revenue 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. The
increase in software sales was partially offset by a decrease in professional
services provided to the Companys customers.

Revenue from international customers accounted for approximately 64.8% and
59.8% of the Companys total revenue during the three months ended September
30, 2000 and 1999, respectively. International revenue accounted for
approximately 63.3% and 61.3% of total revenue during the nine months ended
September 30, 2000 and 1999, respectively. The increase in international
revenue as a percent of total revenue was due primarily to increased sales 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 $570,000 during the three months ended September 30, 2000. Since
most of the Companys European 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 continues to strengthen in 2000 relative to the European currencies, the
Companys international revenue will be negatively impacted, which could have a
material adverse effect on the Companys consolidated results of operations.

In 1999, the Companys international revenue was negatively impacted by
economic weakness in certain countries in Asia, including Japan. During the
nine month period ended September 30, 2000, the Company achieved 39.6% revenue
growth in Asia, as compared to the corresponding period in 1999. This
improvement in revenue was driven principally by increased sales of ADAMS
software licenses in Japan. Given the uncertainty experienced in the Asian
markets over the past several years, the Company continues to remain cautious
in its overall outlook for Asian revenue. If the economies in Asia deteriorate
in the remainder of 2000 or 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. The Company nonetheless expects
that international revenue will continue to account for a significant portion
of its total revenue in future periods.

Software licenses revenue consists primarily of license fees for the
Companys software products and, to a lesser extent, license fees for third
party software products licensed through the Companys European and Canadian
subsidiaries. Software licenses revenue increased 19.5% and 24.3% during the
three and nine month periods ended September 30, 2000, respectively, as
compared to the corresponding periods in 1999. This increase resulted
primarily from a higher volume of the Companys ADAMSand Dynamic Designer
products, as well as increased sales of third party software licenses sold
worldwide. Revenue from third party software products totaled

9



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##### Table of Contents



approximately
$1.1 million, or 9.2% of total revenue during the three month period ended
September 30, 2000, as compared to $864,000, or 8.9% of total revenue during
the corresponding period in 1999. Revenue from third party products totaled
approximately $3.5 million, or 10.3% of total revenue during the nine month
period ended September 30, 2000, as compared to $2.9 million, or 9.8% of total
revenue during the corresponding period in 1999.

Software maintenance services revenue consists of revenue generated from
maintenance and support agreements on the Companys software products.
Software maintenance services revenue increased 50.1% and 38.1% during the
three and nine month periods ended September 30, 2000, respectively, as
compared to the corresponding periods in 1999. The increase reflects 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 the first nine months
of 2000, the Companys maintenance services revenue benefited from a price
increase implemented in the second half of 1999, whereby fees for the Companys
maintenance services increased from 15% to 18% of paid-up license fees.

Professional services and other revenue consists primarily of revenue from
consulting, training and funded research and development projects.
Professional services revenue decreased 2.9% and 14.4% during the three and
nine month periods ended September 30, 2000, respectively, as compared to the
corresponding periods in 1999. The decrease in revenue was due to a
combination of several factors, including: (i) a shift in spending during the
first nine months of 2000 on the part of the Companys large Japanese
customers, whereby they invested less in consulting services and more in
software licenses, (ii) a 16% decline in the number of employees deployed by
the Company towards consulting services in the United States as of September
30, 2000, compared to September 30, 1999, and (iii) a decrease in funded
development activities during the first nine months of 2000, as compared to the
same period in 1999.

Cost of Revenue

|                          |                                 |                  |       |                                  |   |                                 |       |      |   |      |     |          |  |   |       |      |   |   |       |      |   |  |      |    |  | 
|------------------------- | ------------------------------- | ---------------- | ----- | -------------------------------- | - | ------------------------------- | ----- | ---- | - | ---- | --- | -------- |  | - | ----- | ---- | - | - | ----- | ---- | - |  | ---- | -- |  | 
|                          |                                 |                  |       | Three Months Ended September 30, |   | Nine Months Ended September 30,
|                          |                                 |                  |       |                                  |   |                                
|dollars in thousands      |                                 | 2000             |       | 1999                             |   | % Change                        |       | 2000 |   | 1999 |     | % Change
|                          |                                 |                  |       |                                  |   |                                 |       |      |   |      |     |         
|Cost of software licenses |                                 | $                | 940   |                                  |   | $                               | 871   |      |   |      | 7.9 | %        |  | $ | 3,042 |      |   | $ | 2,520 |      |   |  | 20.7 | % 
|                         
|                         
|                         
|                         
|                          | Gross profit margin on software |                  |       | 82.8                             | % |                                 |       | 80.9 | % |      |     |          |  |   |       | 82.4 | % |   |       | 81.8 | %
|                         
|                         
|                         
|                         
|                          |                                 | licenses revenue
|                         
|                         
|                         
|                         
|Cost of services          |                                 | $                | 2,808 |                                  |   | $                               | 2,797 |      |   |      | 0.4 | %        |  | $ | 8,130 |      |   | $ | 8,354 |      |   |  | (2.7 | %)
|                         
|                         
|                         
|                         
|                          | Gross profit margin on services |                  |       | 54.1                             | % |                                 |       | 45.8 | % |      |     |          |  |   |       | 49.7 | % |   |       | 45.7 | %
|                         
|                         
|                         
|                         
|                          |                                 | 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 software licenses revenue increased
7.9% and 20.7% during the three and nine month periods ended September 30,
2000, respectively, as compared to the corresponding periods in 1999. The
increase in cost of software licenses was 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 ADAMSsoftware.

Gross profit margin on software licenses revenue was 82.8% and 80.9%
during the three month periods ended September 30, 2000 and 1999, respectively.
Gross profit margin on software licenses revenue was 82.4% and 81.8% during
the nine month periods ended September 30, 2000 and 1999, respectively.

Cost of services includes payroll and overhead expenses attributable to
hotline support, consulting, training and funded research and development.
Cost of services revenue increased 0.4% during the three month period ended
September 30, 2000, as compared to the corresponding period in 1999. Cost of
services revenue decreased 2.7% during the nine month period ended September
30, 2000, as compared to the corresponding period in 1999. The decrease in the
absolute cost of services during the nine month periods ended September 30,
2000, as compared to

10



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##### Table of Contents



the corresponding period in 1999, was primarily due to a
decreased number of consultants employed by the Company in the United States in
2000.

Gross profit margin on services revenue was 54.1% and 45.8% during the
three month periods ended September 30, 2000 and 1999, respectively. Gross
profit margin on services revenue was 49.7% and 45.7% during the nine month
periods ended September 30, 2000 and 1999, respectively. Changes in the gross
profit margin on services revenue are principally due to fluctuations in the
mix of services revenue, the increase in the pricing of maintenance services
referred to above, and, to a lessor extent, to fluctuations in the profit
margins realized by the Company on consulting projects performed during the
respective periods. Historically, revenue from software maintenance agreements
has generated higher profit margins than revenue from professional services.

Operating Expenses

|                           |                    |      |                                  |      |                                 |          |       |      |   |      |      |          |  |   |        |      |   |   |        |      |   |  |      |   | 
|-------------------------- | ------------------ | ---- | -------------------------------- | ---- | ------------------------------- | -------- | ----- | ---- | - | ---- | ---- | -------- |  | - | ------ | ---- | - | - | ------ | ---- | - |  | ---- | - | 
|                           |                    |      | Three Months Ended September 30, |      | Nine Months Ended September 30,
|                           |                    |      |                                  |      |                                
|dollars in thousands       |                    | 2000 |                                  | 1999 |                                 | % Change |       | 2000 |   | 1999 |      | % Change
|                           |                    |      |                                  |      |                                 |          |       |      |   |      |      |         
|Sales and marketing        |                    | $    | 4,344                            |      |                                 | $        | 3,631 |      |   |      | 19.6 | %        |  | $ | 12,698 |      |   | $ | 11,416 |      |   |  | 11.2 | %
|                          
|                          
|                          
|                          
|                           | % of total revenue |      |                                  | 37.5 | %                               |          |       | 37.3 | % |      |      |          |  |   |        | 38.0 | % |   |        | 39.0 | %
|                          
|                          
|                          
|                          
|Research and development   |                    | $    | 1,528                            |      |                                 | $        | 1,362 |      |   |      | 12.2 | %        |  | $ | 4,448  |      |   | $ | 4,118  |      |   |  | 8.0  | %
|                          
|                          
|                          
|                          
|                           | % of total revenue |      |                                  | 13.2 | %                               |          |       | 14.0 | % |      |      |          |  |   |        | 13.3 | % |   |        | 14.1 | %
|                          
|                          
|                          
|                          
|General and administrative |                    | $    | 1,038                            |      |                                 | $        | 886   |      |   |      | 17.2 | %        |  | $ | 3,082  |      |   | $ | 2,770  |      |   |  | 11.3 | %
|                          
|                          
|                          
|                          
|                           | % of total revenue |      |                                  | 9.0  | %                               |          |       | 9.1  | % |      |      |          |  |   |        | 9.2  | % |   |        | 9.5  | %
|                          
|                          
|                          
|                          
|Goodwill amortization      |                    | $    | 113                              |      |                                 | $        | 113   |      |   |      | 0.0  | %        |  | $ | 340    |      |   | $ | 340    |      |   |  | 0.0  | %
|                          
|                          
|                          
|                          
|                           | % of total revenue |      |                                  | 1.0  | %                               |          |       | 1.2  | % |      |      |          |  |   |        | 1.0  | % |   |        | 1.2  | %
|                           |                    |      |                                  |      |                                 |          |       |      |   |      |      |          |  |   |        |      |   |   |        |      |   |  |      |  

Sales and marketing expenses include costs associated with the Companys
sales channels, such as personnel, commissions, sales office costs, travel,
promotional events, sales order processing, including license administration
and order fulfillment, and advertising and public relations programs. Sales
and marketing expenses also include an allocation of overhead expenses incurred
by the Company. The absolute dollar increase in sales and marketing expenses
during the three and nine month periods ended September 30, 2000, as compared
to the corresponding periods in 1999, 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.

Research and development expenses include all payroll costs attributable
to research and development activities. Research and development expenses also
include an allocation of overhead expenses incurred by the Company. Costs
associated with funded research and development projects are included in cost
of services. The increase in research and development expenses during the three
and nine month periods ended September 30, 2000, as compared to the
corresponding periods in 1999, primarily resulted from an increase in costs to
support the Companys expanded development efforts. The Company intends to
continue to invest significant resources in research and development in the
future.

General and administrative expenses include the cost of salaries, employee
benefits and other payroll costs associated with the Companys finance,
accounting, human resources, information systems and executive management
functions. General and administrative expenses also include an allocation of
overhead expenses incurred by the Company. General and administrative expenses
increased 17.2% and 11.3% during the three and nine month periods ended
September 30, 2000, respectively, as compared to the corresponding periods in
1999. The absolute dollar increase in these expenses was primarily due to
additional expenses incurred to support the Companys worldwide growth.

11



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##### Table of Contents



Goodwill amortization includes the amortization of purchase price in
excess of net assets on the Companys past acquisitions. Goodwill
amortization was flat during the three and nine month periods ended September
30, 2000, respectively, as compared to the corresponding periods in 1999. No
acquisitions were made by the Company during 1999 or during the first three
quarters of 2000. The Company amortizes goodwill over the periods estimated to
be benefited from the acquisitions, after considering such factors as demand,
competition and service lives of employees.

Other Income, Net

|                     |                    |      |                                  |      |                                 |          |     |      |   |      |      |          |  |   |     |     |   |   |     |     |   |  |      |    | 
|-------------------- | ------------------ | ---- | -------------------------------- | ---- | ------------------------------- | -------- | --- | ---- | - | ---- | ---- | -------- |  | - | --- | --- | - | - | --- | --- | - |  | ---- | -- | 
|                     |                    |      | Three Months Ended September 30, |      | Nine Months Ended September 30,
|                     |                    |      |                                  |      |                                
|dollars in thousands |                    | 2000 |                                  | 1999 |                                 | % Change |     | 2000 |   | 1999 |      | % Change
|                     |                    |      |                                  |      |                                 |          |     |      |   |      |      |         
|Other income, net    |                    | $    | 181                              |      |                                 | $        | 116 |      |   |      | 56.0 | %        |  | $ | 396 |     |   | $ | 415 |     |   |  | (4.6 | %)
|                    
|                    
|                    
|                    
|                     | % of total revenue |      |                                  | 1.6  | %                               |          |     | 1.2  | % |      |      |          |  |   |     | 1.2 | % |   |     | 1.4 | %
|                     |                    |      |                                  |      |                                 |          |     |      |   |      |      |          |  |   |     |     |   |   |     |     |   |  |      |   

Other income, net consists of net interest income (expense), foreign
currency transaction gain (loss) and gain (loss) on the disposal of property
and equipment. The increase in other income, net during the three month period
ended September 30, 2000, as compared to the corresponding period in 1999,
primarily resulted from an increase in interest earned given the Companys
higher cash and cash equivalents balance. The decrease in other income, net
during the nine month period ended September 30, 2000, as compared to the
corresponding period in 1999, primarily resulted from foreign currency
transaction losses incurred by the Company during the first three quarters of
2000. From time to time, the Company may enter into forward exchange contracts
to hedge exposures related to significant foreign currency transactions. The
Company does not use any other types of derivatives to hedge such exposures nor
does it speculate in foreign currency.

Provision for Income Taxes

The Companys effective income tax rate was 29.9% and (306.0%) for the
first nine months of 2000 and 1999, respectively. The difference between the
Companys effective rate and the 34.0% statutory federal rate during the nine
month period ended September 30, 2000 resulted primarily from tax-exempt
interest income earned by the Company as well as tax benefits gained from the
Companys foreign sales corporation. The difference between the Companys
effective rate and the 34.0% statutory federal rate during the nine month
period ended September 30, 1999 resulted primarily from the recognition of
research and development tax credits earned by the Company as a result of its
investment in new technologies during 1999 as well as certain prior years.
Excluding these credits, the Companys effective tax rate for the nine month
period was 30.0%.

Minority Interest in Net Income of Subsidiary

The Company owns a 66% interest in its Japanese subsidiary, Mechanical
Dynamics Japan K.K. (MDI-Japan), through a joint venture agreement with
ISI-Dentsu of Tokyo, Japan, the distributor of the Companys software in Japan.
Minority interest in net income (loss) of subsidiary of $54,000 and ($2,000)
for the nine month periods ended September 30, 2000 and 1999, respectively,
represents ISI-Dentsus 34% interest in the net income (loss) of MDI-Japan.

Employees

The number of the Companys worldwide employees decreased by one employee
to 282 at September 30, 2000, compared with 283 at September 30, 1999. On a
sequential basis, the Companys workforce decreased by 5 employees during the
quarter, from 287 employees at June 30, 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

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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. The primary external costs related to the Year 2000
issue included replacement of the Companys primary business management and
accounting systems in January 1999. The cost of the new systems, including
certain hardware upgrades, was approximately $150,000. These systems are based
on third-party products that were certified for Year 2000 compliance.

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. 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 increased $2.9 million during the first nine
months of 2000 to $20.6 million at September 30, 2000, compared with $17.7
million at December 31, 1999. Through September 30, 2000, cash and cash
equivalents increased primarily as a result of the $4.4 million in cash
provided by operations. This increase was partially offset by $729,000 used to
purchase property and equipment and $770,000 used to repurchase 129,300 shares
of the Companys common stock.

At September 30, 2000, the Companys principal commitments consisted of
obligations under operating leases for facilities and equipment. The Company
had no borrowings under long-term debt arrangements at September 30, 2000.

The Company has an agreement with its principal bank for a $4.0 million
line of credit facility. No borrowings were outstanding under this agreement
as of September 30, 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 up to $510,000. Approximately $50,000 in
borrowings was outstanding under these facilities as of September 30, 2000.

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Long-term cash requirements, other than for normal operating expenses, are
anticipated for the development of new software products and enhancements of
existing products, financing growth, repurchases of the Companys common stock
and the possible acquisition of software products, technologies and businesses
complementary to the Companys business. The Company believes that cash flows
from operations, together with existing cash balances, and available borrowings
will be adequate to meet the Companys cash requirements for working capital,
capital expenditures and stock repurchases for the next twelve months and the
foreseeable future. The Company has not paid dividends during the period from
1996 through the third quarter of 2000 and intends to continue its policy of
retaining earnings to finance future growth.




Item 3. Quantitative and Qualitative Disclosures about Market Risk

Other than as disclosed in this report on Form 10-Q, there have been no
significant changes in our market risk exposure as described in Managements
Discussion and Analysis of Financial Condition and Results of Operations
included as Item 7a. on Form 10-K for the year ended December 31, 1999 and
incorporated herein by reference.

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PART II  OTHER INFORMATION




Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

|          |  |                                                                       
|--------- |  | ----------------------------------------------------------------------
|Number    |  | Exhibit                                                               
|          |  |                                                                       
|(11)
(27) |  | Statement Re Computation of Per Share Earnings
Financial Data Schedule

For our documents incorporated by reference, references are to File No. 0-20679.

(b) Reports on Form 8-K

No reports on Form 8-K were filed by the Company during the three months
ended September 30, 2000.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

|                        |  |  |     |  |  |                                                                                                                                
|----------------------- |  |  | --- |  |  | -------------------------------------------------------------------------------------------------------------------------------
|Dated: November 9, 2000 |  |  |     |  |  | MECHANICAL DYNAMICS, INC.
(Registrant)                                                                                         
|                       
|                        |  |  | By: |  |  | /s/ Michael E. KorybalskiMichael E. Korybalski
Chairman of the Board and  Chief Executive Officer
(Principal Executive Officer)
|                       
|                        |  |  | By: |  |  | /s/ David PeraltaDavid Peralta
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)         

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INDEX TO EXHIBITS

|          |  |                                                                       
|--------- |  | ----------------------------------------------------------------------
|Number    |  | Exhibit Title                                                         
|          |  |                                                                       
|(11)
(27) |  | Statement Re Computation of Per Share Earnings
Financial Data Schedule

For our documents incorporated by reference, references are to File No. 0-20679.

17