<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:  JUNE 30, 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
August 9, 2000, was 6,211,725.




<PAGE>   2

                            MECHANICAL DYNAMICS, INC.

                                    FORM 10-Q
                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                                             PAGE
                                                                                                             ----
<S>        <C>                                                                                               <C>
PART I - FINANCIAL INFORMATION

  Item 1.  Financial Statements

           Condensed Consolidated Balance Sheets
           June 30, 2000 and December 31, 1999......................................................            3

           Condensed Consolidated Statements of Income
           Three and Six Months Ended June 30, 2000 and 1999........................................            4

           Condensed Consolidated Statements of Cash Flows
           Six Months Ended June 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 4.  Submission of Matters to a Vote of Security Holders......................................           15

  Item 6.  Exhibits and Reports on Form 8-K.........................................................           15

SIGNATURES..........................................................................................           16

INDEX TO EXHIBITS...................................................................................           17
</TABLE>


                                       2


<PAGE>   3
                         PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS


                   MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES
                      CONDENSED CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                                 JUNE 30,               DECEMBER 31,
   in thousands                                                                                    2000                     1999
------------------------------------------------------------------------------------------------------------------------------------
   ASSETS:                                                                                      (UNAUDITED)
<S>                                                                                              <C>                    <C>
   Current assets:
     Cash and cash equivalents                                                                    $19,538                  $17,741
     Accounts receivable, net                                                                      10,608                   10,454
     Prepaid and deferred expenses                                                                  2,768                    2,755
------------------------------------------------------------------------------------------------------------------------------------
       Total current assets                                                                        32,914                   30,950
------------------------------------------------------------------------------------------------------------------------------------
   Property and equipment, net                                                                      2,737                    3,118
   Goodwill, net                                                                                    3,175                    3,436
   Other assets                                                                                       921                      685
------------------------------------------------------------------------------------------------------------------------------------
   Total assets                                                                                   $39,747                  $38,189
====================================================================================================================================

   LIABILITIES AND SHAREHOLDERS' EQUITY:
   Current liabilities:
     Borrowings under lines of credit                                                                  $7                      $14
     Accounts payable                                                                               1,777                    1,447
     Accrued expenses                                                                               2,587                    3,246
     Deferred revenue                                                                               7,619                    5,832
------------------------------------------------------------------------------------------------------------------------------------
       Total current liabilities                                                                   11,990                   10,539
------------------------------------------------------------------------------------------------------------------------------------
   Minority interest                                                                                  507                      479
   Shareholders' equity:
     Common stock                                                                                  22,376                   22,586
     Preferred stock                                                                                    0                        0
     Retained earnings                                                                              4,675                    4,168
     Accumulated other comprehensive income                                                           199                      417
------------------------------------------------------------------------------------------------------------------------------------
       Total shareholders' equity                                                                  27,250                   27,171
------------------------------------------------------------------------------------------------------------------------------------
   Total liabilities and shareholders' equity                                                     $39,747                  $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
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                        THREE MONTHS ENDED                    SIX MONTHS ENDED
                                                                             JUNE 30,                             JUNE 30,
                                                                  ------------------------------------------------------------------
   in thousands except share and per share data                     2000               1999                2000             1999
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                            <C>                 <C>                <C>               <C>
   Revenue:
     Software licenses                                            $5,742              $4,020             $11,778           $9,296
     Software maintenance services                                 2,468               1,767               4,721            3,599
     Professional services and other                               2,871               3,371               5,321            6,629
------------------------------------------------------------------------------------------------------------------------------------
       Total revenue                                              11,081               9,158              21,820           19,524
------------------------------------------------------------------------------------------------------------------------------------
   Cost of revenue:
     Software licenses                                             1,003                 781               2,102            1,649
     Services                                                      2,768               2,868               5,322            5,557
------------------------------------------------------------------------------------------------------------------------------------
       Total cost of revenue                                       3,771               3,649               7,424            7,206
------------------------------------------------------------------------------------------------------------------------------------
   Gross profit                                                    7,310               5,509              14,396           12,318
------------------------------------------------------------------------------------------------------------------------------------
   Operating expenses:
     Sales and marketing                                           4,151               3,865               8,354            7,785
     Research and development                                      1,474               1,434               2,920            2,756
     General and administrative                                    1,018                 931               2,044            1,884
     Goodwill amortization                                           113                 114                 227              227
------------------------------------------------------------------------------------------------------------------------------------
       Total operating expenses                                    6,756               6,344              13,545           12,652
------------------------------------------------------------------------------------------------------------------------------------
   Operating income (loss)                                           554                (835)                851             (334)
   Other income, net                                                 130                 103                 215              299
------------------------------------------------------------------------------------------------------------------------------------
   Income (loss) before income taxes and minority interest           684                (732)              1,066              (35)
   Provision (credit) for income taxes                               204                (219)                318              (10)
------------------------------------------------------------------------------------------------------------------------------------
   Net income (loss) before minority interest                        480                (513)                748              (25)
   Minority interest in net income (loss) of subsidiary                1                 (10)                 28                4
------------------------------------------------------------------------------------------------------------------------------------
   Net income (loss)                                                $479               ($503)               $720             ($29)
------------------------------------------------------------------------------------------------------------------------------------

   Basic net income (loss) per common share                        $0.08              ($0.08)              $0.11            $0.00
------------------------------------------------------------------------------------------------------------------------------------
   Weighted average common shares                              6,260,951           6,247,776           6,273,763        6,241,446
------------------------------------------------------------------------------------------------------------------------------------

   Diluted net income (loss) per common share                      $0.08              ($0.08)              $0.11            $0.00
------------------------------------------------------------------------------------------------------------------------------------
   Weighted average common and common equivalent shares        6,266,564           6,247,776           6,275,689        6,241,446
------------------------------------------------------------------------------------------------------------------------------------
</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
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                            SIX MONTHS ENDED
                                                                                                JUNE 30,
                                                                                -----------------------------------
   in thousands                                                                          2000              1999
-------------------------------------------------------------------------------------------------------------------
<S>                                                                                   <C>               <C>
   Cash flows from operating activities:
     Net income (loss)                                                                   $720              ($29)
     Adjustments to reconcile net income to net cash
      provided by (used in) operating activities:
       Depreciation and amortization                                                      840               871
       (Gain) loss on disposal of assets, net                                             (24)               26
       Minority interest in net income of subsidiary                                       28                 4
       Changes in assets and liabilities:
         Accounts receivable                                                             (475)             (900)
         Prepaid and deferred expenses                                                    (72)             (381)
         Other assets                                                                     (71)             (115)
         Accounts payable                                                                 523              (283)
         Accrued expenses                                                                (563)             (370)
         Deferred revenue                                                               1,881               706
-------------------------------------------------------------------------------------------------------------------
            Net cash provided by (used in) operating activities                         2,787              (471)
-------------------------------------------------------------------------------------------------------------------
   Cash flows from investing activities:
     Proceeds from the sale of property and equipment                                     118                 0
     Purchases of property and equipment                                                 (531)             (744)
-------------------------------------------------------------------------------------------------------------------
            Net cash used in investing activities                                        (413)             (744)
-------------------------------------------------------------------------------------------------------------------
   Cash flows from financing activities:
     Purchases of Company common stock                                                   (529)                0
     Net borrowings (payments) under line of credit agreements                             (7)               94
     Proceeds from the issuance of common stock                                           106               141
-------------------------------------------------------------------------------------------------------------------
            Net cash provided by (used in) financing activities                          (430)              235
-------------------------------------------------------------------------------------------------------------------
   Effect of exchange rate changes on cash                                               (147)               11
-------------------------------------------------------------------------------------------------------------------
   Net increase (decrease) in cash and cash equivalents                                 1,797              (969)
   Cash and cash equivalents at beginning of period                                    17,741            16,843
-------------------------------------------------------------------------------------------------------------------
   Cash and cash equivalents at end of period                                         $19,538           $15,874
-------------------------------------------------------------------------------------------------------------------
   Supplemental disclosures of cash flow information:
     Cash paid during the period for:
       Interest                                                                            $3                $5
       Income taxes                                                                      $440              $370
-------------------------------------------------------------------------------------------------------------------
</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 and six month periods ended June 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 (loss) was $333,000 and ($526,000)
for the three month periods ended June 30, 2000 and 1999, respectively, and
$502,000 and ($141,000) for the six month periods ended June 30, 2000 and 1999,
respectively. The difference between net income (loss), as reported in the
accompanying condensed consolidated statements of income, and comprehensive
income (loss) is the foreign currency translation adjustment for the respective
periods.


(3) - EARNINGS PER SHARE

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

<TABLE>
<CAPTION>
                                                             THREE MONTHS ENDED             SIX MONTHS ENDED
                                                                  JUNE 30,                      JUNE 30,
                                                          ---------------------------- ------------------------
                                                               2000         1999             2000      1999
---------------------------------------------------------------------------------------------------------------
<S>                                                       <C>           <C>            <C>          <C>
 Weighted average common shares used in basic net
    income (loss) per common share.......................  6,260,951      6,247,776      6,273,763    6,241,446
    Effect of stock options..............................      5,613             --          1,926           --
                                                           ---------    -----------    -----------  -----------
 Weighted average common and common equivalent
    shares used in diluted net income (loss) per
    common share.........................................  6,266,564      6,247,776      6,275,689    6,241,446
                                                           =========    ===========    ===========  ===========

</TABLE>

For the three and six month periods ended June 30, 1999, the effect of stock
options outstanding for the purchase of 0 and 9 shares, respectively, were not
included in the net loss per common share calculation because doing so would
have been anti-dilutive.


(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" ("SFAS 133, SFAS 137, and SFAS 138"). These
statements establish accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and hedging activities. The statements require that an entity record
all




                                       6

<PAGE>   7

derivatives as either assets or liabilities at fair value. Under certain
conditions, a derivative may be designated as a hedge of (1) potential changes
in the fair value of an asset or liability or firm commitment, (2) the foreign
currency exposure of a forecasted transaction, or (3) the foreign currency
exposure of the net investment in a foreign operation. The accounting for
changes in the fair value of a derivative instrument depends on the intended use
of the derivative and the resulting designation. These statements are effective
for fiscal years beginning after June 15, 2000. The Company's derivative
activities are currently limited to entering into forward contracts to hedge
potential changes in the fair value of its receivables denominated in certain
foreign currencies.

    Additional accounting pronouncements which have been issued but are not yet
effective include, but are not limited to, Securities and Exchange Commission
Staff Accounting Bulletin No. 101, "Revenue Recognition," which the Company must
adopt no later than the fourth quarter of 2000, and Financial Accounting
Standards Board Interpretation No. 44, "Accounting for Certain Transactions
involving Stock Compensation, an interpretation of APB Opinion No. 25," which
generally is effective for all periods after July 1, 2000. Certain conclusions
in this Interpretation cover specific events that occur after either December
15, 1998, or January 12, 2000. Management expects that adoption of these
pronouncements will have little, if any, impact on the Company's consolidated
financial position or results of operations.


(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 JUNE 30,          SIX MONTHS ENDED JUNE 30,
                                                ------------------------------- -------------------------------
In thousands                                       2000             1999              2000              1999
---------------------------------------------------------------------------------------------------------------
<S>                                            <C>             <C>              <C>               <C>
Revenue:
  North America
     United States..........................   $   2,855         $   2,711        $   5,636         $   5,708
     Canada and Mexico......................       1,203               897            2,539             1,700
  Europe
     Germany................................       1,498             1,314            2,531             2,593
     Other European countries...............       2,558             2,448            5,087             5,001
  Asia/Pacific
     Japan..................................       2,302             1,359            4,963             3,488
     Other Asian countries..................         665               429            1,064             1,034
                                               ---------         ---------        ---------         ---------
          Total revenue.....................   $  11,081         $   9,158        $  21,820         $  19,524
                                               =========         =========        =========         =========

</TABLE>


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


                                       7

<PAGE>   8

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

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

OVERVIEW

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

FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY

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

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

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

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




                                       8

<PAGE>   9

RESULTS OF OPERATIONS

   REVENUE

<TABLE>
<CAPTION>
                                          THREE MONTHS ENDED JUNE 30,             SIX MONTHS ENDED JUNE 30,
                                     -----------------------------------     ----------------------------------
   dollars in thousands               2000          1999        % CHANGE       2000         1999       % CHANGE
---------------------------------------------------------------------------------------------------------------
<S>                                  <C>           <C>         <C>          <C>           <C>         <C>
   Software licenses                 $ 5,742       $ 4,020         42.8%     $11,778       $ 9,296        26.7%
    % of total revenue                  51.8%         43.9%                     54.0%         47.6%

   Software maintenance services     $ 2,468       $ 1,767         39.7%     $ 4,721       $ 3,599        31.2%
    % of total revenue                  22.3%         19.3%                     21.6%         18.4%

   Professional services and other   $ 2,871       $ 3,371        (14.8%)    $ 5,321       $ 6,629       (19.7%)
    % of total revenue                  25.9%         36.8%                     24.4%         34.0%
---------------------------------------------------------------------------------------------------------------
   Total revenue                     $11,081       $ 9,158         21.0%     $21,820       $19,524        11.8%
===============================================================================================================
</TABLE>

    The Company's total revenue increased 21.0% and 11.8% during the three and
six month periods ended June 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, 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 63.4% and
60.6% of the Company's total revenue during the three months ended June 30, 2000
and 1999, respectively. International revenue accounted for approximately 62.5%
and 62.1% of total revenue during the six months ended June 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, offset partially by a decline in
the percent of total revenue derived from European customers during the quarter.
The strengthening of the dollar relative to the European currencies negatively
impacted the Company's revenue by approximately $440,000 during the three months
ended June 30, 2000. Since most of the Company's international operating
expenses were incurred in foreign currencies, the net impact of exchange rate
fluctuations on income from operations 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 six
month period ended June 30, 2000, the Company achieved 33.3% 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 in the second half of 2000. 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. 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 42.8% and 26.7% during the
three and six month periods ended June 30, 2000, respectively, as compared to
the corresponding periods 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 $1.1 million, or 10.0% of
total revenue during the three month period ended June 30, 2000, as compared to
$930,000, or



                                       9

<PAGE>   10


10.2% of total revenue during the corresponding period in 1999. Revenue from
third party products totaled approximately $2.4 million, or 10.9% of total
revenue during the six month period ended June 30, 2000, as compared to $2.0
million, or 10.2% 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 39.7% and 31.2% during the three and six
month periods ended June 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 six 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 14.8% and 19.7% during the three and six month
periods ended June 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 six 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 21.0% decline
in the number of employees deployed by the Company towards consulting services
in the United States as of June 30, 2000, compared to June 30, 1999, and (iii) a
decrease in funded development activities during the first six months of 2000,
as compared to the same period in 1999.


   COST OF REVENUE


<TABLE>
<CAPTION>
                                                        THREE MONTHS ENDED JUNE 30,               SIX MONTHS ENDED JUNE 30,
                                                    -----------------------------------      -----------------------------------
           dollars in thousands                      2000            1999      % CHANGE       2000           1999       % CHANGE
--------------------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>             <C>       <C>           <C>           <C>           <C>
           Cost of software licenses                $1,003          $  781        28.4%      $2,102        $1,649          27.5%
             Gross profit margin on software          82.5%           80.6%                    82.2%         82.3%
               licenses revenue

           Cost of services                         $2,768          $2,868        (3.5%)     $5,322        $5,557          (4.2%)
             Gross profit margin on services          48.2%           44.2%                    47.0%         45.7%
               revenue
---------------------------------------------------------------------------------------------------------------------------------
</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 revenue increased 28.4% and
27.5% during the three and six month periods ended June 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 ADAMS software.

    Gross profit margin on software licenses revenue was 82.5% and 80.6% during
the three month periods ended June 30, 2000 and 1999, respectively. Gross profit
margin on software licenses revenue was 82.2% and 82.3% during the six month
periods ended June 30, 2000 and 1999, respectively. The increase in gross profit
margin during the three month period ending June 30, 2000 was due to the
decreased sales of third party software products as a percent of total software
licenses revenue, compared to the corresponding period in 1999. The gross profit
margin derived from sales of third party software products has historically been
lower than the gross profit margin derived from sales of the Company's software
products..

    Cost of services includes payroll and overhead expenses attributable to
hotline support, consulting, training and funded research and development. Cost
of services revenue declined 3.5% and 4.2% during the three and six month
periods ended June 30, 2000, respectively, as compared to the corresponding
periods in 1999. The decrease in the




                                       10

<PAGE>   11

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 half of 2000, compared to the corresponding period in 1999.

    Gross profit margin on services revenue was 48.2% and 44.2% during the three
month periods ended June 30, 2000 and 1999, respectively. Gross profit margin on
services revenue was 47.0% and 45.7% during the six month periods ended June 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, 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

<TABLE>
<CAPTION>
                                                 THREE MONTHS ENDED JUNE 30,             SIX MONTHS ENDED JUNE 30,
                                              -------------------------------------  -------------------------------------
   dollars in thousands                          2000        1999       % CHANGE        2000        1999       % CHANGE
--------------------------------------------------------------------------------------------------------------------------
<S>                                             <C>         <C>         <C>            <C>         <C>         <C>
   Sales and marketing                            $4,151      $3,865        7.4%         $8,354      $7,785        7.3%
    % of total revenue                              37.5%       42.2%                      38.3%       39.9%

   Research and development                       $1,474      $1,434        2.8%         $2,920      $2,756        6.0%
    % of total revenue                              13.3%       15.7%                      13.4%       14.1%

   General and administrative                     $1,018      $  931        9.3%         $2,044      $1,884        8.5%
    % of total revenue                               9.2%       10.2%                       9.4%        9.6%

   Goodwill amortization                          $  113      $  114       (0.9%)        $  227      $  227        0.0%
    % of total revenue                               1.0%        1.2%                       1.0%        1.2%
--------------------------------------------------------------------------------------------------------------------------
</TABLE>

    Sales and marketing expenses include costs associated with the Company's
sales channels, such as personnel, commissions, sales office costs, travel,
promotional events, sales order processing, including license administration and
order fulfillment, and advertising and public relations programs. Sales and
marketing expenses also include an allocation of overhead expenses incurred by
the Company. The absolute dollar increase in sales and marketing expenses during
the three and six month periods ended June 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
six month periods ended June 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 9.3% and 8.5% during the three and six month periods ended June 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

<PAGE>   12

    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 six month periods ended June 30, 2000, respectively, as
compared to the corresponding periods in 1999. No acquisitions were made by the
Company during 1999 or during the first half 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 JUNE 30,             SIX MONTHS ENDED JUNE 30,
                                     -------------------------------------  -------------------------------------
                                        2000       1999        % CHANGE        2000       1999        % CHANGE
-----------------------------------------------------------------------------------------------------------------
<S>                                  <C>          <C>          <C>          <C>          <C>         <C>
Other income, net                          $130       $103       26.2%            $215       $299      (28.1%)
 % of total revenue                         1.2%       1.1%                        1.0%       1.5%
-----------------------------------------------------------------------------------------------------------------
</TABLE>

    Other income, net consists of net interest income (expense), foreign
currency transaction gain (loss) and gain (loss) on the disposal of property and
equipment. The increase in other income, net during the three month period ended
June 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 six month
period ended June 30, 2000, as compared to the corresponding period in 1999,
primarily resulted from foreign currency transaction losses incurred by the
Company during the first half 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 28.6% for the first
six months of 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 Japan.
Minority interest in net income of subsidiary of $28,000 and $4,000 for the six
month periods ended June 30, 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 3.0% to 287 at
June 30, 2000, compared with 296 at June 30, 1999. On a sequential basis, the
Company's workforce grew by two employees during the quarter, from 285 employees
at March 31, 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
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.



                                       12


<PAGE>   13

    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 $1.8 million during the first six months
of 2000 to $19.5 million at June 30, 2000, compared with $17.7 million at
December 31, 1999. Through June 30, 2000, cash and cash equivalents increased
primarily as a result of the $2.8 million in cash provided by operations. This
increase was partially offset by $531,000 used to purchase property and
equipment and $529,000 used to repurchase 87,800 shares of the Company's common
stock.

    At June 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 June 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
June 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 $7,000 in borrowings was
outstanding under these facilities as of June 30, 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




                                       13

<PAGE>   14

dividends during the period from 1996 through the second 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.









                                       14

<PAGE>   15


                           PART II - OTHER INFORMATION

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     The Annual Meeting of Shareholders of the Company was held on May 11, 2000.
At the Annual Meeting, the shareholders of the Company (1) elected Mitchell I.
Quain, Robert R. Ryan and Michael E. Korybalski as Directors of the Company to
hold office until the Annual Meeting of Shareholders to be held in 2003; and (2)
ratified and approved the Board of Directors' selection of Arthur Andersen LLP
as the independent auditors of the Company for the current fiscal year ending
December 31, 2000. The votes were as follows:

<TABLE>
<CAPTION>
                                                              FOR           WITHHELD     ABSTAINED
                                                                           OR AGAINST
------------------------------------------------------------------------------------------------------
<S>                                                         <C>            <C>           <C>
   (1) Election of Directors:
         Mitchell I. Quain                                   4,420,535         6,096         15,077
         Robert R. Ryan                                      4,420,535         6,096         15,077
         Michael E. Korybalski                               4,420,535         6,096         15,077

   (2) Approval of Arthur Andersen LLP:                      4,436,903         2,293          2,512

------------------------------------------------------------------------------------------------------
</TABLE>


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 June 30, 2000.








                                       15

<PAGE>   16

                                   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: August 11, 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)














                                       16
<PAGE>   17


                               INDEX TO EXHIBITS



    NUMBER                       EXHIBIT TITLE
--------------- ----------------------------------------------------------------
     (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.
















                                       17