<PAGE>   1
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                    FORM 10-Q


(Mark One)
[X]      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934
         For the fiscal period ended: MARCH 31, 2000

         OR

[ ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934
         For the transition period from              to


                         Commission file number: 0-20679



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



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


                             2301 COMMONWEALTH BLVD.
                            ANN ARBOR, MICHIGAN 48105
                                 (734) 994-3800
             (Address of principal executive offices, including zip
                code, and telephone number, including area code)


    Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
                                 [X] Yes [ ] No



       The number of outstanding shares of the Registrant's common stock, as of
May 5, 2000, was 6,273,325.




<PAGE>   2



                            MECHANICAL DYNAMICS, INC.

                                    FORM 10-Q
                                TABLE OF CONTENTS

<TABLE>
<CAPTION>

                                                                                                             PAGE

                                                                                                             ----
<S>                                                                                                           <C>
PART I - FINANCIAL INFORMATION

  Item 1.  Financial Statements

           Condensed Consolidated Balance Sheets
           March 31, 2000 and December 31, 1999.....................................................            3

           Condensed Consolidated Statements of Income
           Three Months Ended March 31, 2000 and 1999...............................................            4

           Condensed Consolidated Statements of Cash Flows
           Three Months Ended March 31, 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....            7

  Item 3.  Quantitative and Qualitative Disclosures about Market Risk...............................           13

PART II -  OTHER INFORMATION

  Item 6.  Exhibits and Reports on Form 8-K.........................................................           14

SIGNATURES..........................................................................................           15

INDEX TO EXHIBITS...................................................................................           16

</TABLE>




<PAGE>   3


                         PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

                   MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>


                                                                                  MARCH 31,         DECEMBER 31,
   in thousands                                                                     2000               1999
----------------------------------------------------------------------------------------------------------------
<S>                                                                               <C>               <C>
   ASSETS:                                                                     (Unaudited)
   Current assets:
     Cash and cash equivalents                                                     $17,813           $17,741
     Accounts receivable, net                                                       11,069            10,454
     Prepaid and deferred expenses                                                   2,203             2,755
----------------------------------------------------------------------------------------------------------------
       Total current assets                                                         31,085            30,950
----------------------------------------------------------------------------------------------------------------
   Property and equipment, net                                                       2,877             3,118
   Goodwill, net                                                                     3,317             3,436
   Other assets                                                                        935               685
----------------------------------------------------------------------------------------------------------------
   Total assets                                                                    $38,214           $38,189
================================================================================================================

   LIABILITIES AND SHAREHOLDERS' EQUITY:
   Current liabilities:
     Borrowings under lines of credit                                                  $60               $14
     Accounts payable                                                                1,458             1,447
     Accrued expenses                                                                2,718             3,246
     Deferred revenue                                                                6,081             5,832
----------------------------------------------------------------------------------------------------------------
       Total current liabilities                                                    10,317            10,539
----------------------------------------------------------------------------------------------------------------
   Minority interest                                                                   506               479
   Shareholders' equity:
     Common stock                                                                   22,637            22,586
     Preferred stock                                                                     0                 0
     Retained earnings                                                               4,409             4,168
     Accumulated other comprehensive income                                            345               417
----------------------------------------------------------------------------------------------------------------
       Total shareholders' equity                                                   27,391            27,171
----------------------------------------------------------------------------------------------------------------
   Total liabilities and shareholders' equity                                      $38,214           $38,189
================================================================================================================
</TABLE>

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


                                       3

<PAGE>   4
                   MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
                   CONDENSED CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
                                                                                       THREE MONTHS ENDED
                                                                                             MARCH 31,
                                                                                  -------------------------------
   in thousands except share and per share data                                         2000            1999
=================================================================================================================
                                                                                             (UNAUDITED)
<S>                                                                                     <C>             <C>
   Revenue:
     Software licenses                                                                  $6,036          $5,276
     Software maintenance services                                                       2,253           1,832
     Professional services and other                                                     2,450           3,258
-----------------------------------------------------------------------------------------------------------------
       Total revenue                                                                    10,739          10,366
-----------------------------------------------------------------------------------------------------------------
   Cost of revenue:
     Software licenses                                                                   1,099             868
     Services                                                                            2,554           2,689
-----------------------------------------------------------------------------------------------------------------
       Total cost of revenue                                                             3,653           3,557
-----------------------------------------------------------------------------------------------------------------
   Gross profit                                                                          7,086           6,809
-----------------------------------------------------------------------------------------------------------------
   Operating expenses:
     Sales and marketing                                                                 4,203           3,920
     Research and development                                                            1,446           1,322
     General and administrative                                                          1,026             953
     Goodwill amortization                                                                 114             113
-----------------------------------------------------------------------------------------------------------------
       Total operating expenses                                                          6,789           6,308
-----------------------------------------------------------------------------------------------------------------
   Operating income                                                                        297             501
   Other income, net                                                                        85             196
-----------------------------------------------------------------------------------------------------------------
   Income before income taxes and minority interest                                        382             697
   Provision for income taxes                                                              114             209
-----------------------------------------------------------------------------------------------------------------
   Net income before minority interest                                                     268             488
   Minority interest in net income of subsidiary                                            27              14
-----------------------------------------------------------------------------------------------------------------
   Net income                                                                             $241            $474
=================================================================================================================
   Basic net income per common share                                                     $0.04           $0.08
=================================================================================================================
   Weighted average common shares                                                    6,286,725       6,235,247
=================================================================================================================
   Diluted net income per common share                                                   $0.04           $0.08
=================================================================================================================
   Weighted average common and common equivalent shares                              6,287,077       6,247,630
=================================================================================================================
</TABLE>

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

                                       4
<PAGE>   5
                  MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
                       CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>



                                                                                      THREE MONTHS ENDED
                                                                                            MARCH 31,
                                                                                -----------------------------------
   in thousands                                                                          2000              1999
===================================================================================================================
                                                                                          (UNAUDITED)
<S>                                                                                      <C>               <C>
   Cash flows from operating activities:
     Net income                                                                          $241              $474
     Adjustments to reconcile net income to net cash
      provided by (used in) operating activities:
       Depreciation and amortization                                                      413               480
       (Gain) loss on disposal of assets, net                                             (14)                4
       Minority interest in net income of subsidiary                                       27                14
       Changes in assets and liabilities:
         Accounts receivable                                                             (815)             (691)
         Prepaid and deferred expenses                                                    516              (245)
         Other assets                                                                     (83)             (135)
         Accounts payable                                                                 156              (245)
         Accrued expenses                                                                (476)             (487)
         Deferred revenue                                                                 312               351
-------------------------------------------------------------------------------------------------------------------
            Net cash provided by (used in) operating activities                           277              (480)
-------------------------------------------------------------------------------------------------------------------
   Cash flows from investing activities:
     Proceeds from the sale of property and equipment                                      84                 0
     Purchases of property and equipment                                                 (315)             (368)
-------------------------------------------------------------------------------------------------------------------
            Net cash used in investing activities                                        (231)             (368)
-------------------------------------------------------------------------------------------------------------------
   Cash flows from financing activities:
     Net borrowings (payments) under line of credit agreements                             46                (8)
     Proceeds from the issuance of common stock                                            51                72
-------------------------------------------------------------------------------------------------------------------
            Net cash provided by financing activities                                      97                64
-------------------------------------------------------------------------------------------------------------------
   Effect of exchange rate changes on cash                                                (71)              (37)
-------------------------------------------------------------------------------------------------------------------
   Net increase (decrease) in cash and cash equivalents                                    72              (821)
   Cash and cash equivalents at beginning of period                                    17,741            16,843
-------------------------------------------------------------------------------------------------------------------
   Cash and cash equivalents at end of period                                         $17,813           $16,022
===================================================================================================================
   Supplemental disclosures of cash flow information:
     Cash paid during the period for:
       Interest                                                                            $1                $1
       Income taxes                                                                      $240              $202
===================================================================================================================
</TABLE>

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



                                       5


<PAGE>   6



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


(1) - BASIS OF PRESENTATION

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

    Operating results for the three month periods ended March 31, 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. Comprehensive income was $169,000 and $385,000 for the three
month periods ended March 31, 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:

<TABLE>
<CAPTION>
                                                                                              THREE MONTHS ENDED MARCH 31,
                                                                                          -------------------------------------
                                                                                                  2000               1999
-------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                         <C>                <C>
 Weighted average common shares used in basic net income per common share.............          6,286,725          6,235,247
    Effect of stock options...........................................................                352             12,383
                                                                                            -------------        -----------
 Weighted average common and common equivalent shares used in diluted net
    income per common share...........................................................          6,287,077          6,247,630
                                                                                            =============        ===========
</TABLE>

(4) - DERIVATIVES

    In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts and hedging activities. It
requires that an entity record all derivatives as either assets or liabilities
at fair value. Under certain conditions, a derivative may be designated as a
hedge of (1) potential changes in the fair value of an asset or liability or
firm commitment, (2) the foreign currency exposure of a forecasted transaction,
or (3) the foreign currency exposure of the net investment in a foreign
operation. The accounting for changes in the fair value of a derivative
instrument depends on the intended use of the derivative and the resulting
designation. Originally, the statement had been effective for all quarters of
fiscal years beginning after June 15, 1999. In June 1999, the FASB issued
Statement of Financial Accounting Standards No. 137, "Accounting for Derivative
Instruments and Hedging Activities", which postponed the adoption of SFAS 133
until fiscal years

                                       6
<PAGE>   7

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.

(5) GEOGRAPHIC OPERATIONS AND SEGMENT INFORMATION

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

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

<TABLE>
<CAPTION>
                                                                             THREE MONTHS ENDED MARCH 31,
                                                                        ----------------------------------------
In thousands                                                                  2000                  1999
----------------------------------------------------------------------------------------------------------------
<S>                                                                       <C>                   <C>
Revenue:
  North America
     United States..............................................          $   2,781             $   2,997
     Canada and Mexico..........................................              1,336                   803
  Europe
     Germany....................................................              1,033                 1,279
     Other European countries...................................              2,529                 2,553
  Asia/Pacific
     Japan......................................................              2,661                 2,129
     Other Asian countries......................................                399                   605
                                                                          ---------             ---------
          Total revenue.........................................          $  10,739             $  10,366
                                                                          =========             =========
</TABLE>



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



ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

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

OVERVIEW

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

                                       7

<PAGE>   8


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.


RESULTS OF OPERATIONS

   REVENUE

<TABLE>
<CAPTION>

                                                                           THREE MONTHS ENDED MARCH 31,
                                                                      ----------------------------------------
 dollars in thousands                                                    2000         1999        % CHANGE
--------------------------------------------------------------------------------------------------------------
<S>                                                                      <C>          <C>          <C>
Software licenses                                                         $6,036       $5,276        14.4%
  % of total revenue                                                       56.2%        50.9%

Software maintenance services                                             $2,253       $1,832        23.0%
  % of total revenue                                                       21.0%        17.7%

Professional services and other                                           $2,450       $3,258      (24.8%)
  % of total revenue                                                       22.8%        31.4%
--------------------------------------------------------------------------------------------------------------
                                                                         $10,739      $10,366        3.6%
==============================================================================================================
</TABLE>

                                       8
<PAGE>   9


    The Company's total revenue increased 3.6% during the three month period
ended March 31, 2000, as compared to the corresponding period in 1999. The
growth in revenue resulted from an increase in sales of the Company's software
products, 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 offset by a decrease in the professional services provided
to the Company's customers.

    Revenue from international customers accounted for approximately 61.7% and
63.3% of the Company's total revenue during the three months ended March 31,
2000 and 1999, respectively. The decrease in international revenue as a percent
of total revenue was due primarily to the strengthening of the U.S. dollar in
2000 relative to certain European currencies which negatively impacted the
Company's revenue by approximately $497,000. Since most of the Company's
international operating expenses were incurred in foreign currencies, the net
impact of exchange rate fluctuations on income from operations was considerably
less than the impact on revenue. If the U.S. dollar strengthens in 2000 relative
to the European, Canadian and Japanese currencies, the Company's international
revenue will be negatively impacted, which could have a material adverse effect
on the Company's consolidated results of operations.

    In 1999 and 1998, the Company's international revenue was negatively
impacted by economic weakness in certain countries in Asia, including Japan.
During the first quarter of 2000, the Company achieved 11.9% revenue growth in
Asia as compared to the first quarter of 1999, driven principally by 123.1%
growth of ADAMS software licenses revenue in Japan. If the economies in Asia
deteriorate in the remainder of 2000, the Company's overall Asian revenue could
be adversely impacted, which could have a material adverse effect on the
Company's consolidated results of operations. Consequently, the Company remains
cautious in its overall outlook for Asian revenue in 2000. The Company expects
that international revenue will continue to account for a significant portion of
its total revenue in future periods.

    Software licenses revenue consists primarily of license fees for the
Company's software products and, to a lesser extent, license fees for third
party software products licensed through the Company's European and Canadian
subsidiaries. Software licenses revenue increased 14.4% during the three month
period ended March 31, 2000, as compared to the corresponding period in 1999.
This increase resulted primarily from a higher volume of the Company's ADAMS and
Dynamic Designer products, as well as increased sales of third party software
licenses sold worldwide. Revenue from third party software products totaled
approximately $1.3, or 11.9% of total revenue during the three months ended
March 31, 2000, as compared to $1.1 million, or 10.3% 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 23.0% during the three month period ended
March 31, 2000, as compared to the corresponding period 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.

    Professional services and other revenue consists primarily of revenue from
consulting, training and funded research and development projects. Professional
services revenue decreased 24.8% during the three month period ended March 31,
2000, as compared to the corresponding period in 1999. The decrease in revenue
was due to a combination of several factors, including: (i) a shift in spending
during the quarter on the part of the Company's large Japanese customers,
whereby they invested less in consulting services and more in software licenses,
(ii) a 14.5% decline in the number of employees deployed by the Company towards
consulting services in the United States, and (iii) a decrease in funded
development activities during the quarter, as compared to the first quarter of
1999.

                                       9
<PAGE>   10
   COST OF REVENUE
<TABLE>
<CAPTION>
                                                                            THREE MONTHS ENDED MARCH 31,
                                                                       ---------------------------------------
dollars in thousands                                                        2000        1999      % CHANGE
--------------------------------------------------------------------------------------------------------------
<S>                                                                        <C>           <C>        <C>
Cost of software licenses                                                  $1,099        $868       26.6%
 Gross profit margin on software licenses revenue                           81.8%       83.5%

Cost of services                                                           $2,554      $2,689       (5.0%)
 Gross profit margin on services revenue                                    45.7%       47.2%
--------------------------------------------------------------------------------------------------------------
</TABLE>

    Cost of software licenses includes software royalty fees, media costs,
payroll and other costs attributable to software documentation and distribution,
and an allocation of depreciation, utilities and other overhead expenses
incurred by the Company. Cost of software licenses increased 26.6% from the
first quarter of 1999 to approximately $1.1 million in the first quarter of
2000. 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, and additional royalties paid to third parties whose
products are embedded in the Company's ADAMS software.

    Gross profit margin on software licenses revenue was 81.8% and 83.5% during
the three month periods ended March 31, 2000 and 1999, respectively. The decline
in gross profit margin was due to the increased sales of third party software
products as a percent of total software licenses revenue. The gross profit
margin realized from sales of third party software products has historically
been lower than the gross profit margin realized from sales of the Company's
software products.

    Cost of services includes payroll and overhead expenses attributable to
hotline support, consulting, training and funded research and development. Cost
of services decreased 5.0% during the three month period ended March 31, 2000,
as compared to the corresponding period in 1999. The decrease in the absolute
cost of services was primarily due to the decline in the number of employees
deployed by the Company towards consulting services in the United States in the
first quarter of 2000, compared to the first quarter of 1999.

    Gross profit margin on services revenue was 45.7% and 47.2% during the three
month periods ended March 31, 2000 and 1999, respectively. The decrease in gross
profit margin on services revenue was due primarily to a decline in services
revenue realized per consultant in Japan during the quarter, due to the shift
noted in spending in the region, whereby customers invested less in services and
more in software licenses.

   OPERATING EXPENSES

<TABLE>
<CAPTION>

                                                                            THREE MONTHS ENDED MARCH 31,
                                                                       ---------------------------------------
   dollars in thousands                                                    2000        1999        % CHANGE
--------------------------------------------------------------------------------------------------------------
<S>                                                                        <C>         <C>         <C>
Sales and marketing                                                        $4,203      $3,920        7.2%
 % of total revenue                                                         39.1%       37.8%

Research and development                                                   $1,446      $1,322        9.4%
 % of total revenue                                                         13.5%       12.8%

General and administrative                                                 $1,026        $953        7.7%
 % of total revenue                                                          9.6%        9.2%

Goodwill amortization                                                        $114        $113        0.9%
% of total revenue                                                           1.1%        1.1%
--------------------------------------------------------------------------------------------------------------
</TABLE>


   Sales and marketing expenses include costs associated with the Company's
sales channels, such as personnel, commissions, sales office costs, travel,
promotional events, sales order processing, including license administration and
order fulfillment, and advertising and public relations programs. Sales and
marketing expenses also include an

                                       10
<PAGE>   11

allocation of overhead expenses incurred by the Company. The absolute dollar
increase in sales and marketing expenses during the three month period ended
March 31, 2000, as compared to the corresponding period 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
month period ended March 31, 2000, as compared to corresponding period 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 7.7% during the three month period ended March 31, 2000, as compared
to the corresponding period in 1999. The absolute dollar increase in these
expenses was primarily due to additional expenses incurred to support the
Company's worldwide growth.

    Goodwill amortization includes the amortization of purchase price in excess
of net assets on the Company's past acquisitions. Goodwill amortization
increased 0.9% during the three month period ended March 31, 2000, as compared
to the corresponding period in 1999. No acquisitions were made by the Company
during 1999, or during the first quarter of 2000. The Company amortizes goodwill
over the periods estimated to be benefited from the acquisitions, after
considering such factors as demand, competition, service lives of employees, and
expected actions of competitors.


   OTHER INCOME, NET
<TABLE>
<CAPTION>
                                                                             THREE MONTHS ENDED MARCH 31,
                                                                         ----------------------------------
dollars in thousands                                                       2000        1999     % CHANGE
-----------------------------------------------------------------------------------------------------------
<S>                                                                        <C>        <C>       <C>
Other income, net                                                           $85       $196      (56.6%)
   % of total revenue                                                      0.8%       1.9%
-----------------------------------------------------------------------------------------------------------
</TABLE>



    Other income, net consists of net interest income (expense), foreign
currency transaction gain (loss) and gain (loss) on the disposal of property and
equipment. The decrease in other income, net during the three month period ended
March 31, 2000, as compared to the corresponding period in 1999, primarily
resulted from foreign currency transaction losses incurred by the Company during
the first quarter 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 29.8% and 30.0% for the three
months ended March 31, 2000 and 1999, respectively. The difference between the
Company's effective rate and the 34.0% statutory federal rate during each period
resulted primarily from tax-exempt interest income earned by the Company as well
as tax benefits gained from the Company's foreign sales corporation.

   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

                                       11

<PAGE>   12

Japan. Minority interest in net income of subsidiary of $27,000 and $14,000 for
the three month periods ended March 31, 2000 and 1999, respectively, represents
ISI-Dentsu's 34% interest in the net income of MDI-Japan.

   EMPLOYEES

    The number of the Company's worldwide employees decreased 4% to 285 at March
31, 2000, compared with 297 at March 31, 1999. On a sequential basis, the
Company's workforce grew by one employee during the quarter, from 284 employees
at the end of 1999.

   YEAR 2000 COMPLIANCE

    The Year 2000 issue is the result of computer programs using a two-digit
format, as opposed to four digits, to indicate the year. Such computer systems
will be unable to interpret dates beyond the year 1999, which could cause a
system failure or other computer errors. The Company 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.


                                       12
<PAGE>   13
LIQUIDITY AND CAPITAL RESOURCES

    Cash and cash equivalents increased $72,000 during the first three months of
2000 to $17.8 million at March 31, 2000, compared with $17.7 million at December
31, 1999. Through March 31, 2000, cash and cash equivalents increased primarily
as a result of the $277,000 in cash generated by operations, offset by $231,000
in cash used for purchases of equipment (net of proceeds from disposals).

    At March 31, 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 March 31, 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
March 31, 2000. The Company's subsidiaries in Germany, Italy, Sweden, and France
also have line of credit and overdraft facilities that provide for aggregate
borrowing availability of up to $510,000. Approximately $60,000 in borrowings
was outstanding under these facilities as of March 31, 2000.

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

                                       13


<PAGE>   14




PART II - OTHER INFORMATION

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(A)      EXHIBITS



    NUMBER                                                    EXHIBIT
--------------------------------------------------------------------------------
     (11)       Statement Re Computation of Per Share Earnings

     (27)       Financial Data Schedule

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 March 31, 2000.



                                       14
<PAGE>   15


                                   SIGNATURES

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

Dated: May 12, 2000          MECHANICAL DYNAMICS, INC.
                             (Registrant)


                         By: /s/ Michael E. Korybalski
                            ---------------------------------------------------
                             Michael E. Korybalski
                             Chairman of the Board and Chief Executive Officer
                             (Principal Executive Officer)


                          By: /s/ David Peralta
                             --------------------------------------------------
                              David Peralta
                              Vice President and Chief Financial Officer
                              (Principal Financial and Accounting Officer)



                                       15
<PAGE>   16


                                INDEX TO EXHIBITS


    NUMBER                         EXHIBIT TITLE
--------------------------------------------------------------------------------
    (11)       Statement Re Computation of Per Share Earnings

    (27)       Financial Data Schedule



                                       16