<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, 1997

       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
                                 (313) 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 8, 1997, was 5,781,991.



<PAGE>   2



                           MECHANICAL DYNAMICS, INC.

                                   FORM 10-Q
                               TABLE OF CONTENTS



                                                                       PAGE
                                                                       ----

PART I - FINANCIAL INFORMATION

  Item 1. Financial Statements

          Condensed Consolidated Balance Sheets
          June 30, 1997 and December 31, 1996 ......................     3

          Condensed Consolidated Statements of Income
          Three and Six Months Ended June 30, 1997 and 1996 ........     4

          Condensed Consolidated Statements of Cash Flows
          Six Months Ended June 30, 1997 and 1996 ..................     5

          Notes to Condensed Consolidated Financial Statements .....     6

  Item 2. Management's Discussion and Analysis of
            Financial Condition and Results of Operations ..........     7

PART II - OTHER INFORMATION

  Item 4. Submission of Matters to a Vote of Security
            Holders ................................................    12

  Item 6. Exhibits and Reports on Form 8-K .........................    12

SIGNATURES .........................................................    13

INDEX TO EXHIBITS ..................................................    14


                                       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                                        1997              1996      
--------------------------------------------------------------------------------
                                                (Unaudited)                     
<S>                                             <C>                 <C>
ASSETS:                                         
Current assets:                                         
  Cash and cash equivalents                       $20,784             $20,570   
  Accounts receivable                               5,954               5,019   
  Prepaid and deferred expenses                     1,079               1,074   
--------------------------------------------------------------------------------
    Total current assets                           27,817              26,663   
--------------------------------------------------------------------------------
Net property and equipment                          1,913               1,643   
Other assets                                        1,485               1,506   
--------------------------------------------------------------------------------
Total assets                                      $31,215             $29,812   
================================================================================
                                                        

LIABILITIES AND SHAREHOLDERS' EQUITY:                                           
Current liabilities:                                            
  Borrowings under lines of credit                $    38             $    45   
  Accounts payable                                    508                 762   
  Accrued expenses                                  2,755               2,982   
  Deferred revenue                                  3,928               3,671   
--------------------------------------------------------------------------------
    Total current liabilities                       7,229               7,460   
--------------------------------------------------------------------------------
Minority interest                                     448                   0   
Redeemable common stock                               167                 167   
Shareholders' equity:                                           
  Common stock                                     19,713              19,583   
  Preferred Stock                                       0                   0   
  Retained earnings                                 3,612               2,546   
  Cumulative translation adjustment                    46                  56   
--------------------------------------------------------------------------------
    Total shareholders' equity                     23,371              22,185   
--------------------------------------------------------------------------------
Total liabilities and shareholders' equity        $31,215             $29,812   
================================================================================
</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                1997                1996               1997                 1996
===================================================================================================================================
<S>                                                     <C>                  <C>               <C>                   <C>
Revenue:                                                                        
  Software licenses                                        $3,996               $3,678            $7,916                $7,519   
  Services                                                  3,209                2,563             5,990                 4,770   
-----------------------------------------------------------------------------------------------------------------------------------
    Total revenue                                           7,205                6,241            13,906                12,289   
-----------------------------------------------------------------------------------------------------------------------------------
Cost of revenue:                                                                                                    
  Software licenses                                           189                  158               292                   358   
  Services                                                  1,658                1,332             3,262                 2,693   
-----------------------------------------------------------------------------------------------------------------------------------
    Total cost of revenue                                   1,847                1,490             3,554                 3,051   
-----------------------------------------------------------------------------------------------------------------------------------
Gross profit                                                5,358                4,751            10,352                 9,238   
-----------------------------------------------------------------------------------------------------------------------------------
Operating expenses:                                                                                                 
  Sales and marketing                                       2,897                2,453             5,491                 4,797   
  Research and development                                  1,061                  869             2,135                 1,755   
  General and administrative                                  772                  685             1,584                 1,369   
-----------------------------------------------------------------------------------------------------------------------------------
    Total operating expenses                                4,730                4,007             9,210                 7,921   
-----------------------------------------------------------------------------------------------------------------------------------
Operating income                                              628                  744             1,142                 1,317   
Other income, net                                             189                   75               356                    76   
-----------------------------------------------------------------------------------------------------------------------------------
Income before income taxes and minority interest              817                  819             1,498                 1,393   
Provision for income taxes                                    247                  258               451                   461   
-----------------------------------------------------------------------------------------------------------------------------------
Net income before minority interest                           570                  561             1,047                   932   
Minority interest in net income (loss) of subsidiary          (19)                   0               (19)                    0   
-----------------------------------------------------------------------------------------------------------------------------------
Net income                                                   $589                 $561            $1,066                  $932   
===================================================================================================================================
Net income per common share                                 $0.10                $0.12             $0.18                 $0.22   
===================================================================================================================================
Common and common equivalent shares                     5,828,778            4,729,217         5,877,117             4,294,985   
===================================================================================================================================

</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>
                                                                JUNE 30,              JUNE 30,  
IN THOUSANDS                                                      1997                  1996    
===============================================================================================
<S>                                                             <C>                  <C>
Cash flows from operating activities:                                                           
  Net income                                                    $ 1,066              $   932    
  Adjustments to reconcile net income to net cash                                                       
    provided by operating activities:                                                   
      Depreciation and amortization                                 450                  262    
      Provision (credit) for deferred income taxes                    0                  (35)   
      (Gain) loss on disposal of assets, net                         13                    4    
      Minority interest in net income (loss) of subsidiary          (19)                   0    
      Changes in assets and liabilities:                                                
        Accounts receivable                                        (721)                 (91)   
        Prepaid and deferred expenses                                67                  (20)   
        Other assets                                                (14)                  34    
        Accounts payable                                           (407)                 (51)   
        Accrued expenses                                           (275)                 489    
        Deferred revenue                                            160                  530    
-----------------------------------------------------------------------------------------------
          Net cash provided by operating activities                 320                2,054    
-----------------------------------------------------------------------------------------------
Cash flows from investing activities:                                                           
  Proceeds from the sale of property and equipment                   22                    0    
  Purchases of property and equipment                              (751)                (230)   
-----------------------------------------------------------------------------------------------
          Net cash used in investing activities                    (729)                (230)   
-----------------------------------------------------------------------------------------------
Cash flows from financing activities:                                                           
  Net borrowings (payments) under line of credit agreements          (7)                 (49)   
  Proceeds from the issuance of common stock                        130               17,850    
  Proceeds from collections on subscriptions receivable               0                   10    
  Minority investment in consolidated subsidiary                    467                    0    
-----------------------------------------------------------------------------------------------
          Net cash provided by financing activities                 590               17,811    
-----------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash                              33                    9    
-----------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents                           214               19,644    
Cash and cash equivalents at beginning of period                 20,570                1,141    
-----------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period                      $20,784              $20,785    
===============================================================================================
Supplemental disclosures of cash flow information:                                                              
  Cash paid during the year for:                                                         
    Interest                                                         $7                  $17    
    Income taxes                                                   $403                 $234    
===============================================================================================

</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, 1996.

     Operating results for the three and six month periods ended June 30, 1997
and 1996 are not necessarily indicative of the results that may be expected for
the full year.


(2)  - EARNINGS PER SHARE

     In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings per Share." The
Company will be required to adopt this new standard for the year and the
quarter ended December 31, 1997. Early adoption is not permitted. The primary
requirements of this standard include: (1) the replacement of primary earnings
per share with basic earnings per share, which eliminates the dilutive effect
of stock options and warrants; (2) the use of average share price in applying
the treasury method to compute dilution for stock options and warrants for
diluted earnings per share; and (3) a disclosure reconciling the numerator and
denominator of earnings per share calculations. The Company believes that the
implementation of this standard will not have a material effect on it's
consolidated financial statements for the periods presented.


(3)  - FINANCING ARRANGEMENTS

     In June 1997, the Company entered into an agreement with its principal
bank for a $4.0 million line of credit facility.  The agreement expires on June
30, 1999.  No borrowings were outstanding under this agreement as of June 30,
1997.


(4)  - MINORITY INTEREST

     In April 1997, the Company established a Japanese subsidiary, Mechanical
Dynamics Japan K.K., through a joint venture agreement with Information
Services International-Dentsu Ltd. ("ISI-Dentsu") of Tokyo, Japan, the
distributor of the Company's software in Japan.  The Company owns 66% of
Mechanical Dynamics Japan K.K., while ISI-Dentsu owns a 34% minority interest.
Pursuant to the agreement, the Company and ISI-Dentsu made combined capital
contributions of approximately $1,372,000 to Mechanical Dynamics Japan K.K.
through the second quarter of 1997.  Mechanical Dynamics Japan K.K. will
provide consulting and other professional services directly to customers in
Japan, and will support ISI-Dentsu in marketing the Company's software in
Japan.


(5)  - REDEEMABLE COMMON STOCK AND SHAREHOLDERS' EQUITY

     In July 1997, the redemption privileges associated with the remaining
20,843 shares of redeemable common stock expired. The redemption privileges on
these shares of redeemable common stock outstanding were exercisable at $8.00 
per share between June 15, 1997 and July 14, 1997.

                                       6

<PAGE>   7


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 condensed consolidated financial statements and the notes thereto
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 the 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 in the future to be,
derived almost exclusively 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 of 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 or acquisitions, including related
charges, 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.


                                       7

<PAGE>   8

RESULTS OF OPERATIONS

     REVENUE

<TABLE>
<CAPTION>
                             THREE MONTHS ENDED JUNE 30,           SIX MONTHS ENDED JUNE 30,                                    
                          --------------------------------     --------------------------------
dollars in thousands       1997          1996     % CHANGE       1997       1996    % CHANGE    
===============================================================================================
<S>                       <C>           <C>       <C>          <C>        <C>        <C>
Software licenses         $3,996        $3,678     8.6%        $ 7,916    $ 7,519     5.3%      
  % of total revenue       55.5%         58.9%                   56.9%      61.2%                       

Services                  $3,209        $2,563    25.2%        $ 5,990    $ 4,770    25.6%      
  % of total revenue       44.5%         41.1%                   43.1%      38.8%                       
                                                                                                                        
-----------------------------------------------------------------------------------------------
Total revenue             $7,205        $6,241    15.4%        $13,906    $12,289    13.2%      
===============================================================================================

</TABLE>


     The Company's total revenue increased 15.4% and 13.2% during the three and
six month periods ended June 30, 1997, respectively, as compared to similar
periods in 1996.  The growth in revenue primarily resulted from an increase in
the services provided to the Company's customers, as well as from increased
sales of the Company's software products.

     Revenue from international customers accounted for approximately 62.7% and
59.2% of the Company's total revenue during the three months ended June 30,
1997 and 1996, respectively.  International revenue accounted for approximately
58.4% and 62.2% of total revenue during the six months ended June 30, 1997 and
1996, respectively.  The decrease in international revenue as a percent of
total revenue during the six month period ended June 30, 1997, as compared to
the similar period in 1996, was due, in part, to the strengthening of the
dollar in 1997 relative to the European and Japanese currencies.  The
strengthening of the dollar negatively affected the Company's international
revenue during the first six months of 1997 by approximately $600,000.  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 dollar
continues to strengthen in 1997 relative to the European 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.  The decrease in international revenue as a percent of
total revenue during the six month period ended June 30, 1997, as compared to
the similar period in 1996, was also due, in part, to a $280,000 decline in
revenue from the licensing of a third party's software products through the
Company's European subsidiaries.  This resulted from the planned termination of
the Company's licensing agreement with the third party software company in
March 1996.  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 subsidiaries.
Software licenses revenue increased 8.6% and 5.3% during the three and six
month periods ended June 30, 1997, respectively, as compared to similar periods
in 1996.  Excluding the $280,000 decline in license revenue from a third
party's software products mentioned above, software licenses revenue grew 8.6%
and 9.4% during the three and six month periods ended June 30, 1997,
respectively, as compared to similar periods in 1996.  These increases resulted
from a higher volume of sales of the Company's software products.

     Services revenue consists of revenue from software maintenance agreements
and professional services, including consulting, training and funded research
and development. Services revenue increased 25.2% and 25.6% during the three
and six month periods ended June 30, 1997, respectively, as compared to similar
periods in 1996.  Both the software maintenance and the professional service
components of services revenue have experienced solid growth during the first
six months of 1997. The overall increase in services revenue reflects the
Company's continued emphasis on providing total solutions to its customers.


                                       8

<PAGE>   9
COST OF REVENUE

<TABLE>
<CAPTION>
                                              THREE MONTHS ENDED JUNE 30,                     SIX MONTHS ENDED JUNE 30,   
                                      --------------------------------------          -----------------------------------------
dollars in thousands                    1997            1996        % CHANGE            1997            1996           % CHANGE 
===============================================================================================================================
<S>                                   <C>             <C>             <C>             <C>             <C>               <C>
Cost of software licenses             $  189          $  158          19.6%           $  292          $  358            -18.4%  
  % of software licenses revenue        4.7%            4.3%                            3.7%            4.8%                    

Cost of services                      $1,658          $1,332          24.5%           $3,262          $2,693             21.1%  
  % of services revenue                51.7%           52.0%                           54.5%           56.5%                    
===============================================================================================================================

</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
19.6% from the second quarter of 1996 to approximately $189,000 in the second
quarter of 1997.  The $31,000 absolute dollar increase was due to additional
royalties paid to third parties whose products are embedded in the Company's
ADAMS software.  The 18.4% decrease in cost of software licenses during the six
month period ended June 30, 1997, as compared to a similar period in 1996, was
primarily due to lower royalties paid to a third party whose products were
licensed through the Company's European subsidiaries through the first quarter
of 1996.  This resulted from the planned termination of the Company's licensing
agreement with the third party software company in March 1996.

     Cost of services includes payroll and overhead expenses attributable to
hotline support, consulting, training and funded research and development.
Cost of services revenue grew 24.5% and 21.1% during the three and six month
periods ended June 30, 1997, respectively, as compared to similar periods in
1996.  These increases resulted from the hiring of additional employees to
support the growth in services provided to the Company's customers during 1997.


  OPERATING EXPENSES

<TABLE>
<CAPTION>
                                              THREE MONTHS ENDED JUNE 30,                     SIX MONTHS ENDED JUNE 30,   
                                      --------------------------------------          -----------------------------------------
dollars in thousands                    1997            1996        % CHANGE            1997            1996           % CHANGE 
===============================================================================================================================
<S>                                   <C>             <C>             <C>             <C>             <C>               <C>
Sales and marketing                   $2,897          $2,453          18.1%           $5,491          $4,797            14.5%   
  % of total revenue                   40.2%           39.3%                           39.5%           39.0%                    

Research and development              $1,061          $  869          22.1%           $2,135          $1,755            21.7%   
  % of total revenue                   14.7%           13.9%                           15.4%           14.3%                    

General and administrative            $  772          $  685          12.7%           $1,584          $1,369            15.7%   
  % of total revenue                   10.7%           11.0%                           11.4%           11.1%                    
===============================================================================================================================

</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 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, 1997, as compared to
similar periods in 1996, resulted from the Company's continued expansion of its
worldwide sales and marketing organization.  Total sales and marketing
employees increased to 61 at June 30, 1997, an increase of 35.6% from 45 at
June 30, 1996.  The Company expects to continue to expand its sales and
marketing organization in the future to meet the growing demand for its
products and services.


                                      9

<PAGE>   10




     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.  The
absolute dollar increase in research and development expenses during the three
and six month periods ended June 30, 1997, as compared to similar periods in
1996, primarily resulted from an increase in personnel and related costs in
support of expanded development efforts in general, including efforts
associated with the July 1997 release of Version 9.0 of the company's ADAMS
software.  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 12.7% and 15.7% during the three and six month periods ended June 30,
1997, respectively, as compared to similar periods in 1996.  The absolute
dollar increases in these expenses were primarily due to additional expenses
incurred to support the Company's worldwide growth, as well as to support the
operations of a publicly-traded company.  The Company expects general and
administrative expenses to increase in absolute dollars in the future.
However, these expenses may vary as a percentage of total revenue from period
to period.


   OTHER INCOME, NET

<TABLE>
<CAPTION>
                                      THREE MONTHS ENDED JUNE 30,                       SIX MONTHS ENDED JUNE 30,  
                                ----------------------------------------         ---------------------------------------
dollars in thousands            1997           1996             % CHANGE         1997          1996             % CHANGE        
========================================================================================================================
<S>                             <C>            <C>              <C>              <C>           <C>              <C>
Other income, net               $189            $75             152.0%           $356           $76             368.4%  
  % of total revenue            2.6%           1.2%                              2.6%          0.6%                     

</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 in the three and six month
periods ended June 30, 1997, as compared to similar periods in 1996, primarily
resulted from interest earned on the $17.8 million in net proceeds raised
from the Company's initial public offering in May 1996, as well as interest
earned on cash generated from operations over the past year.  These increases
were partially offset by increased foreign currency transaction losses incurred
during 1997.


   PROVISION FOR INCOME TAXES

     The Company's effective income tax rate was 30.1% and 33.1% for the first
six months of 1997 and 1996, respectively.  The difference between the
Company's effective rate and the 34.0% statutory federal rate during the first
six months of 1997 was primarily due to the benefits of tax-exempt interest
income and the Company's foreign sales corporation.


   MINORITY INTEREST IN NET INCOME (LOSS) OF SUBSIDIARY

     In April 1997, the Company established a Japanese subsidiary, Mechanical
Dynamics Japan K.K., through a joint venture agreement with ISI-Dentsu of
Tokyo, Japan, the distributor of the Company's software in Japan.  The
($19,000) in minority interest in net income (loss) of subsidiary represents
ISI Dentsu's 34% interest in the net loss of Mechanical Dynamics Japan K.K.
during the second quarter of 1997.




                                       10

<PAGE>   11


  EMPLOYEES

     The number of the Company's worldwide employees increased 32.6% to 187 at
June 30, 1997, compared with 141 at June 30, 1996.  Employment increased
significantly to support the Company's growing operations worldwide.


LIQUIDITY AND CAPITAL RESOURCES

     Cash and cash equivalents increased $214,000 during the first six months
of 1997 to $20.8 million at June 30, 1997, compared with $20.6 million at
December 31, 1996.  Through June 30, 1997, cash and cash equivalents increased
primarily as a result of the $467,000 minority investment made into Mechanical
Dynamics Japan K.K., $320,000 in cash generated from operations, and $130,000
in proceeds from stock issued under the Company's employee stock purchase plan.
These increases were partially offset by the $751,000 in cash used to purchase
property and equipment during 1997.

     At June 30, 1997, 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, 1997.

     In June 1997, the Company entered into 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, 1997.   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
$660,000.  Approximately $38,000 in borrowings were outstanding under these
facilities as of June 30, 1997.

     In January 1997, the Company announced that the Board of Directors had
authorized the Company to repurchase up to 500,000 shares of its common stock.
As of June 30, 1997, no shares of common stock had been repurchased.

     In April 1997, the Company established a Japanese subsidiary, Mechanical
Dynamics Japan K.K., through a joint venture agreement with ISI-Dentsu of
Tokyo, Japan, the distributor of the Company's software in Japan.  The Company
owns 66% of Mechanical Dynamics Japan K.K., while ISI-Dentsu owns a 34%
minority interest.  Pursuant to the agreement, the Company and ISI-Dentsu made
combined capital contributions of approximately $1,372,000 to Mechanical
Dynamics Japan K.K. through the second quarter of 1997.  Mechanical Dynamics
Japan K.K. will provide consulting and other professional services directly to
customers in Japan, and will support ISI-Dentsu in marketing the Company's
software in Japan.

     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
1994 through the second of quarter of 1997 and intends to continue its policy
of retaining earnings to finance future growth.



                                       11

<PAGE>   12


                          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 14,
1997.  At the Annual Meeting, the shareholders of the Company (1) elected
Michael E. Korybalski, Mitchell I. Quain and Robert R. Ryan as Directors of the
Company to hold office until the Annual Meeting of Shareholders to be held in
2000; (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, 1997; and (3) approved an increase in the number of
shares available under the Company's 1996 Stock Incentive Plan for Key
Employees from 450,000 shares to 650,000 shares.  The votes were as follows:


<TABLE>
<CAPTION>
                                                                     WITHHELD                             BROKER
                                                       FOR          OR AGAINST       ABSTAINED          NON-VOTES      
------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>               <C>              <C>               <C>

(1)   Election of Directors:                                                                    
        Michael E. Korybalski                       4,527,663           4,764                                   
        Mitchell I. Quain                           4,527,663           4,764                                   
        Robert R. Ryan                              4,527,663           4,764                                   
                                                                                        
(2)   Approval of Arthur Andersen:                  4,529,770             400           2,257                   
                                                                                        
(3)   Approval to Increase the Shares in the 
      Company's 1996 Stock Incentive
      Plan for Key Employees:                       3,845,716         683,561           3,150                   
------------------------------------------------------------------------------------------------------------------

</TABLE>


ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(A)  EXHIBITS


NUMBER                     EXHIBIT
--------------------------------------------------------------------------------
(4.2)   Line of Credit Demand Note between KeyBank National Association and 
        the Company dated June 30, 1997

 (11)   Statement Re Computation of Per Share Earnings

 (27)   Financial Data Schedule

(B) REPORTS ON FORM 8-K

     No reports on Form 8-K were filed by the Company during the three months
     ended June 30, 1997.



                                       12

<PAGE>   13


                                   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 13, 1997        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)


                                       13