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


                                   FORM 10-Q



(Mark One)
[X]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934
       For the  fiscal period ended:  MARCH 31, 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 April
30, 1997, was 5,770,681.





<PAGE>   2

                           MECHANICAL DYNAMICS, INC.

                                   FORM 10-Q
                               TABLE OF CONTENTS



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

 Item 1. Financial Statements

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

        Condensed Consolidated Statements of Income
        Three Months Ended March 31, 1997 and 1996..........................  4

        Condensed Consolidated Statements of Cash Flows
        Three Months Ended March 31, 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 6. Exhibits and Reports on Form 8-K................................... 12

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

INDEX TO EXHIBITS........................................................... 14
</TABLE>




                                      2

<PAGE>   3

                         PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS



                   MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES

                     CONDENSED CONSOLIDATED BALANCE SHEETS



<TABLE>
<CAPTION>
                                           MARCH 31,   DECEMBER 31,
in thousands                                 1997          1996
------------------------------------------------------------------
                                           (Unaudited)
<S>                                        <C>           <C>
                                   ASSETS
                                   -------
Current assets:
 Cash and cash equivalents............     $ 21,172      $ 20,570
 Accounts receivable..................        5,131         5,019
 Prepaid and deferred expenses........          922         1,074
                                           --------      --------
     Total current assets.............       27,225        26,663
                                           --------      --------
Net property and equipment............        1,759         1,643
                                           --------      --------
Total other assets....................        1,479         1,506
                                           --------      --------
                                           $ 30,463      $ 29,812
                                           ========      ========

                    LIABILITIES AND SHAREHOLDERS' EQUITY
                    -------------------------------------

Current liabilities:
 Borrowings under line of credit......           42            45
 Accounts payable.....................          648           762
 Accrued expenses.....................        2,902         2,982
 Deferred revenue.....................        4,029         3,671
                                           --------      --------
     Total current liabilities........        7,621         7,460
                                           --------      --------
Redeemable common stock                         167           167
                                           --------      --------
Shareholders' equity:
 Common stock.........................       19,646        19,583
 Preferred stock......................           --            --
 Retained earnings....................        3,023         2,546
 Cumulative translation adjustment....            6            56
                                           --------      --------
     Total shareholders' equity.......       22,675        22,185
                                           --------      --------
                                           $ 30,463      $ 29,812
                                           ========      ========
</TABLE>

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





                                      3

<PAGE>   4

                   MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES

                  CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                                  (Unaudited)



<TABLE>
<CAPTION>
                                                             THREE MONTHS ENDED
                                                                  MARCH 31,
                                                           ---------------------
in thousands, except per share data                            1997       1996
--------------------------------------------------------------------------------
<S>                                                        <C>        <C>
Revenue:
 Software licenses.....................................    $    3,920 $    3,841
 Services..............................................         2,781      2,207
                                                           ---------- ----------
     Total revenue.....................................         6,701      6,048
                                                           ---------- ----------
Cost of revenue:
 Software licenses.....................................           103        200
 Services..............................................         1,604      1,361
                                                           ---------- ----------
     Total cost of revenue.............................         1,707      1,561
                                                           ---------- ----------
Gross profit...........................................         4,994      4,487
                                                           ---------- ----------
Operating expenses:
 Sales and marketing...................................         2,594      2,344
 Research and development..............................         1,074        886
 General and administrative............................           812        684
                                                           ---------- ----------
     Total operating expenses..........................         4,480      3,914
                                                           ---------- ----------
Operating income.......................................           514        573
Other income (expense), net............................           167          1
                                                           ---------- ----------
Income before income taxes.............................           681        574
Provision for income taxes.............................           204        203
                                                           ---------- ----------
Net income.............................................    $      477 $      371
                                                           ========== ==========
Pro Forma net income per common share..................    $     0.08 $     0.10
                                                           ========== ==========
Weighted average common and common equivalent shares...     5,865,979  3,878,987
                                                           ========== ==========
</TABLE>

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






                                      4

<PAGE>   5

                   MECHANICAL DYNAMICS, INC. AND SUBSIDIARIES

                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (Unaudited)



<TABLE>
<CAPTION>
                                                                      THREE MONTHS ENDED
                                                                           MARCH 31,
                                                                     --------------------
in thousands                                                             1997       1996
----------------------------------------------------------------------------------------
<S>                                                                   <C>         <C>
Cash flows from operating activities:
 Net income.........................................................  $    477    $   371
 Adjustments to reconcile net income to net cash provided by
 operating activities --
  Depreciation and amortization.....................................       207        141
  (Gain) loss on disposal of assets.................................        (8)        --
  Changes in assets and liabilities --
   Accounts receivable..............................................        37        249
   Prepaid and deferred expenses....................................       205        (38)
   Other assets.....................................................        14       (129)
   Accounts payable.................................................      (222)       (79)
   Accrued expenses.................................................      (120)      (267)
   Deferred revenue.................................................       288        128
                                                                      --------    -------
     Net cash provided by operating activities......................       878        376
                                                                      --------    -------
Cash flows from investing activities:
 Proceeds from sale of property and equipment.......................        21         --
 Purchases of property and equipment................................      (348)       (84)
                                                                      --------    -------
     Net cash used in investing activities..........................      (327)       (84)
                                                                      --------    -------
Cash flows from financing activities:
 Net borrowings (payments) under line of credit agreements..........        (3)        12
 Proceeds from issuance of common stock.............................        63         63
 Proceeds from collections on subscriptions receivable..............        --         10
                                                                      --------    -------
     Net cash provided by financing activities......................        60         85
                                                                      --------    -------
Effect of exchange rate changes on cash.............................        (9)        --
                                                                      --------    -------
Net increase in cash................................................       602        377
Cash at beginning of period.........................................    20,570      1,141
                                                                      --------    -------
Cash at end of period...............................................  $ 21,172    $ 1,518
                                                                      ========    =======
Supplemental disclosures of cash flow information --
 Interest paid......................................................  $      1    $     6
                                                                      ========    =======
 Income taxes paid..................................................  $     95    $   116
                                                                      ========    =======
</TABLE>

 The accompanying notes are an integral part of these consolidated 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-month periods ended March 31, 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 its
consolidated financial statements for the periods presented.


                                      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 MARCH 31,
                                               ------------------------------
dollars in thousands                             1997    % CHANGE     1996
-----------------------------------------------------------------------------
<S>                                            <C>        <C>        <C>
Software licenses..........................    $ 3,920      2.1%     $ 3,841
 % of total revenue........................       58.5%                 63.5%

Services...................................    $ 2,781     26.0%     $ 2,207
 % of total revenue........................       41.5%                 36.5%

Total revenue..............................    $ 6,701     10.8%     $ 6,048
</TABLE>

     The Company's total revenue increased 10.8% to $6.7 million in the first
quarter of 1997 from $6.0 million in the first quarter of 1996. The growth in
revenue resulted primarily 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 53.8% and
65.4% of the Company's total revenue in the first quarter of 1997 and 1996,
respectively. The decrease in international revenue as a percent of total
revenue was due, in part, to a $280,000 decline in revenue from the licensing
of third party software products through the Company's European subsidiaries.
This decline resulted primarily from the planned termination of a licensing
agreement with a third party software company in March 1996.  In addition, the
strengthening of the dollar in 1997, relative to the European and Japanese
currencies, negatively affected international revenue in the first quarter of
1997 by approximately $275,000. 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 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 grew 2.1% over the first quarter of 1996 to
approximately $3.9 million in the first quarter of 1997. Excluding the $280,000
decline in license revenue from third party software products mentioned above,
software licenses revenue grew 10.1% in the first quarter of 1997 as compared
to the first quarter of 1996.  This increase 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 grew 26.0% over the first quarter of 1996 to
approximately $2.8 million in the first quarter of 1997.  Both the software
maintenance and the professional service components of services revenue
continued to experience solid growth during the first quarter 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 MARCH 31,
                                               -----------------------------
dollars in thousands                              1997   % CHANGE    1996
----------------------------------------------------------------------------
<S>                                            <C>       <C>        <C>
Cost of software licenses..................     $  103   (48.5%)    $  200
 % of software licenses revenue............        2.6%                5.2%

Cost of services...........................     $1,604    17.9%     $1,361
 % of services revenue.....................       57.7%               61.7%
</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 decreased
48.5% from the first quarter of 1996 to approximately $103,000 in the first
quarter of 1997. The decrease was primarily due to lower royalties paid to
third parties whose products are licensed through the Company's European
subsidiaries.

     Cost of services includes payroll and overhead expenses attributable to
hotline support, consulting, training and funded research and development. Cost
of services revenue grew 17.9% from the first quarter of 1996 to approximately
$1.6 million in the first quarter of 1997. The increase resulted from the
hiring of additional employees to support the growth in services provided to
the Company's customers during 1997. Cost of services as a percent of service
revenue decreased from 61.7% in the first quarter of 1996 to 57.7 % in the
first quarter of 1997, primarily as a result of the strong growth experienced
in the higher-margin software maintenance component of services revenue.


     OPERATING EXPENSES


<TABLE>
<CAPTION>
                                                 THREE MONTHS ENDED MARCH 31,
                                               -------------------------------
dollars in thousands                              1997   % CHANGE    1996
------------------------------------------------------------------------------
<S>                                            <C>       <C>        <C>
Sales and marketing........................    $ 2,594    10.7%     $ 2,344
 % of total revenue........................       38.7%                38.8%

Research and development...................    $ 1,074    21.2%     $   886
 % of total revenue........................       16.0%                14.6%

General and administrative.................    $   812    18.7%     $   684
 % of total revenue........................       12.1%                11.3%
</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 first quarter of 1997 as compared to the first quarter of 1996
resulted from the Company's continued expansion of its worldwide sales and
marketing organization. Total sales and marketing headcount increased to 55 at
March 31, 1997, an increase of 22.2% from 45 at March 31, 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.

     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 first
quarter of 1997 as compared to the first quarter of 1996 primarily resulted
from an increase in personnel and related costs in support of expanded
product development efforts. The Company intends to continue to invest
significant resources in research and development in the future.




                                      9

<PAGE>   10

     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 18.7% during the first quarter of 1997 as compared to the first
quarter of 1996. The absolute dollar increase in these expenses was 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 (EXPENSE), NET


<TABLE>
<CAPTION>
                                                    THREE MONTHS ENDED MARCH 31,
                                                    ---------------------------
dollars in thousands                                  1997    % CHANGE   1996
-------------------------------------------------------------------------------
<S>                                                  <C>       <C>      <C>
Other income (expense), net....................      $ 167     >100.0%  $   1
 % of total revenue............................        2.5%                 --
</TABLE>

     Other income (expense), 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 (expense), net in the
first quarter of 1997 as compared to the first quarter of 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. The increase was
partially offset by increased foreign currency transaction losses incurred
during 1997.


     PROVISION FOR INCOME TAXES

     The Company's effective income tax rate was 30.0% and 35.4% for the first
quarter of 1997 and 1996, respectively. The difference between the effective
rate and the statutory federal rate during the first quarter of 1997 was
primarily due to the benefits of tax-exempt interest income and the Company's
foreign sales corporation.


     EMPLOYEES

     The number of the Company's worldwide employees increased 20.1% to 173 at
March 31, 1997, compared with 144 at March 31, 1996.  Employment increased
significantly to support the Company's growing operations worldwide.


LIQUIDITY AND CAPITAL RESOURCES

     Cash and cash equivalents were $21.2 million at March 31, 1997, compared
to $20.6 million at December 31, 1996. The increase in cash and cash
equivalents of $602,000 during the first quarter of 1997 primarily resulted
from the $878,000 in cash flow generated from operations, which was offset by
the $348,000 in cash used to purchase property and equipment.

     At March 31, 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 March 31, 1997.

     The Company has an agreement with its principal bank for an unsecured $3.0
million line of credit. No borrowings were outstanding under this agreement as
of March 31, 1997. The Company's subsidiaries in Germany, Italy, Sweden, and
France also have line of credit and overdraft facilities that provide for
aggregate borrowing 




                                     10

<PAGE>   11

availability of approximately $660,000. Approximately $42,000 in borrowings 
were outstanding under these facilities as of March 31, 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 March 31, 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 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., with ISI-Dentsu holding the remaining minority
portion. Pursuant to the agreement, the Company and ISI-Dentsu will make
combined capital contributions of approximately $1.3 million 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 first 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 6.  EXHIBITS AND REPORTS ON FORM 8-K


(A)  EXHIBITS


<TABLE>
<CAPTION>
 NUMBER                                  EXHIBIT
-------------------------------------------------------------------------------
<S>     <C>
 (2)    Joint Venture Agreement between Mechanical Dynamics, Inc. and
        Information Services International - Dentsu, Ltd.

 (11)   Statement Re Computation of Per Share Earnings

 (27)   Financial Data Schedule
</TABLE>

(B) REPORTS ON FORM 8-K

     No reports on Form 8-K were filed by the Company during the three months
ended March 31, 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: May 12, 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

<PAGE>   14

                               INDEX TO EXHIBITS



<TABLE>
<CAPTION>
NUMBER                               EXHIBIT TITLE
------  ------------------------------------------------------------------------
<S>     <C>
 (2)    Joint Venture Agreement between Mechanical Dynamics, Inc. and
         Information Services International - Dentsu, Ltd.

 (11)   Statement Re Computation of Per Share Earnings

 (27)   Financial Data Schedule
</TABLE>











                                     14