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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

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FORM 10-K/A(Amendment No. 1)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2002

Commission File Number 1-8722

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MSC.SOFTWARE CORPORATION(Exact Name of Registrant as Specified in its Charter)

Delaware(State or Other Jurisdiction of
Incorporation or Organization)

95-2239450(I.R.S. Employer
Identification No.)2 MacArthur Place
Santa Ana, California(Address of Principal Executive Offices)

92707(Zip Code)


(714) 540-8900(Registrant's Telephone Number, Including Area Code)

Securities Registered Pursuant to Section 12(b) of the Act:

|Title of Each Class                     |  | Name of Each Exchange On Which Registered
|--------------------------------------- |  | -----------------------------------------
|Common Stock, Par Value $0.01 Per Share |  | New York Stock Exchange                  

Securities Registered Pursuant to Section 12(g) of the Act:Warrants

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

Indicate
by check mark whether the Registrant is an accelerated filer (as defined by Rule 12b-2 of the
Act). Yes ý    No o

Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of
Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o

As
of March 21, 2003 and June 28, 2002, the approximate aggregate market value of MSC.Software Corporation's voting stock held by non-affiliates was
$222,632,000 and $240,538,000, respectively.

As
of March 21, 2003, there were outstanding 29,931,280 shares of Common Stock of MSC.Software Corporation.

Documents
Incorporate By Reference: Part III: Proxy Statement for Registrant's Annual Stockholders Meeting to be filed within 120 days of fiscal year end.

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MSC.SOFTWARE CORPORATION  INDEX TO FORM 10-K  DECEMBER 31, 2002

EXPLANATORY NOTE

This Form 10-K/A amends and restates certain portions of the Annual Report on Form 10-K for the year ended December 31, 2002 of MSC.Software
Corporation and is being filed for the purpose of reflecting changes and to provide information in response to comments that MSC.Software Corporation received from the United States Securities and
Exchange Commission and to provide additional information. In accordance with Rule 12b-15 promulgated under the Securities Exchange Act of 1934, as amended, MSC.Software Corporation has amended
in its entirety each item of its Annual Report on Form 10-K for the year ended December 31, 2002 that has been changed. This Form 10-K/A does not reflect events occurring after
the filing of the original Form 10-K.

|         |  |                                                                                       |  | Page
|-------- |  | ------------------------------------------------------------------------------------- |  | ----
|PART I  
|Item 1.  |  | Business                                                                              |  | 1   
|Item 3.  |  | Legal Proceedings                                                                     |  | 18  
|PART II 
|Item 5.  |  | Market for Registrant's Common Equity and Related Stockholder Matters                 |  | 20  
|Item 6.  |  | Selected Financial Data                                                               |  | 21  
|Item 7.  |  | Management's Discussion and Analysis of Financial Condition and Results of Operations |  | 22  
|Item 8.  |  | Financial Statements and Supplementary Data                                           |  | 41  
|PART IV 
|Item 15. |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                       |  | 89  

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PART I

ITEM 1. BUSINESS

GENERAL

We are a leader in the development, marketing and support of virtual product development tools including simulation software, professional services and
information technology systems. Our products and services help customers optimize product designs, increase quality and reliability, reduce product development costs and speed time to market. We also
provide a broad range of strategic consulting services to help our customers improve the integration and performance of their product development process and lower the total cost of ownership of their
technology investments. We serve customers in multiple industries, including aerospace, automotive, machinery, electronics, consumer products, biomedical, shipbuilding and rail. In 2002, we sold our
products and services to approximately 8,000 customers worldwide through our dedicated sales force and network of value added resellers. We maintain 71 offices in 23 countries. Representative
customers in various markets that are within the top 10% of our customers in terms of revenue for the current fiscal year include Airbus, Amgen, BMW, Boeing, Cooper Tire, DaimlerChrysler, Denso,
General Motors, Hyundai, Lloyd's Register, Lockheed Martin, Matsushita, NASA, Sony and Toyota.

2003
marks the 40th year that we have been providing simulation software to manufacturers, universities, research institutions and technology companies around the world.
The current product development process for manufacturing companies relies upon designs being tested in a virtual computer environment before time and money is spent building prototypes and performing
physical tests. Simulation tools allow engineers to construct computer models of products, components, systems and assemblies to simulate performance conditions and predict physical responses to
certain variables, such as stress, motion and temperature. This allows our customers to reduce costly and time-consuming physical testing of prototypes, and to design more reliable
products that incur lower costs to support once in service. Advances in computer technology have made virtual
product development tools available for any and all companies and engineers who manufacture products, from the largest aerospace company to the individual inventor.

We
have engaged in a number of key strategic initiatives to expand into market opportunities that are natural extensions of our expertise in simulation software. These initiatives
include:



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INDUSTRY



The product lifecycle includes four significant segments; conception of the product, design of the product, manufacture of the product and maintenance of the
product. These key product lifecycle segments utilize various digital technologies and software tools including mechanical computer-aided design, or CAD, computer-aided engineering, or CAE,
computer-aided manufacturing, or CAM, and product data management, or PDM, and related services and systems. Our software and services are used throughout the entire lifecycle of a product and, with
the acquisition of AES and MDI, we added CAD, CAM, CAE and PDM tools to our product offering. Our information systems and integration activities provide the infrastructure necessary for efficient and
effective implementation of a virtual product development environment.

Prior
to the development of computer-driven design tools, the product development cycle demanded a long lead-time since modifications to a product's design required time and
cost-intensive manual redesign at each step. Today, virtual product development tools such as CAD, CAM and CAE allow engineers the flexibility to create and test designs much more quickly
and accurately by using a computer environment. These cost effective tools not only reduce the need to build and test physical prototypes, but also allow our customers the ability to explore more
product design alternatives that result in improved reliability.

Once
focused on the individual engineer's demand for functionality, the market is now driven by the needs of the original equipment manufacturers, suppliers, partners and customers to
collaborate, share data and integrate the multiple sub-assemblies in the creation of a complex master digital model. These needs have raised decision making to executive management levels.
However, the
requirement for an enterprise level solution has not lessened the need to provide superior functionality and engineering capabilities to the individual user.

CAE
provides design engineers at all levels of the organization with the ability to develop simulations and test designs through physics-based rules to determine whether a mechanical
part or assembly performs in the desired manner. CAE simulates stresses that the part or assembly may encounter, such as an automobile being crash tested into a cement wall. These simulations enable
design engineers to gain important information on the likely performance of their products and allow them to make alterations. By making these changes earlier in the process, companies save time and
money by eliminating later redesigns. Our simulation software portfolio is designed to operate seamlessly with other leading mechanical computer-aided design and engineering software products in the
market, giving customers a complete set of interoperable tools for every engineering discipline.



The systems integrator industry is the extended arm of technology manufacturers. In essence, a CAD/CAM/CAE systems integrator delivers and integrates a mix of new
and legacy products from a variety of sources into a complete toolset that is tailored to a customer's particular needs. Systems integrators add value to both product manufacturers and customers
because they can better evaluate a customer's individual needs and tailor a customized, turnkey solution consisting of hardware, software, and a variety of product and integration services,
application support and training. A systems integrator's goal is to be the expert source where customers can acquire products, knowledge, support, training and integration resources.

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There
are many factors that determine the overall success of a CAD/CAM/CAE systems integrator organization relative to competitors. These include technical expertise (technical skill
sets, industry experience, etc.), pre- and post-sales support capabilities, customer relationship management (sales and service staff), security (financial soundness, years in
business, etc.), geographic coverage and price. Competition in these industries includes the direct sales forces of other technology companies and legacy capabilities built by manufacturers
themselves.

OUR STRATEGY

Our goal is to expand our leading position as a provider of virtual product development software, services and systems. Our strategy has the following key
elements:



SOFTWARE

Our simulation software products consist primarily of physics-based solvers, which are computerized procedures for solving mathematical problems coded with the
standard equations of physics, integrated with graphical user interfaces, sometimes referred to as pre- and post-processors. These solvers are capable of simulating virtually
any mechanical or structural phenomena.

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The
governing principle for our core software is to provide:



We
market our software products under the name MSC.visualNastran and we group our products into four families:



MSC.visualNastran Enterprise Family

MSC.Nastran.MSC.Nastran is a descendant of NASTRAN, an open-source computer program
owned by the United States Government. We have improved upon NASTRAN since it was first released in 1970, resulting in substantially greater capabilities and scope of our product, MSC.Nastran. We have
been selling MSC.Nastran since 1971. Pursuant to a 1982 agreement with the
National Aeronautics and Space Administration, we acquired the non-exclusive perpetual rights to commercially use those elements of NASTRAN which are embodied in MSC.Nastran.

We
believe that MSC.Nastran is the leading program for engineering analysis worldwide, based upon capability, functionality, international acceptance and sales volume. MSC.Nastran, based
on finite element technology, is used to analyze structures in order to determine, among other things, their strength, safety and performance characteristics. For example, in the aerospace industry,
MSC.Nastran is employed to determine the stress distribution in the major parts of an aircraft, such as engines, wings, fuselage and tail.

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MSC.Nastran
results can be applied to improve the design of aircraft by suggesting the removal of material where stresses are low and the addition of material where stresses are high, while reducing
the need for physical prototypes and other testing. With this knowledge, an aircraft can be made both stronger and lighter. The same principles are applied to improve the design of jets, rockets,
engines, automobiles, trucks, tires, ships, farm equipment, heavy industrial equipment, nuclear containment vessels, helicopters, spacecraft and other products and structures.

Because
MSC.Nastran has been designed in a modular way, new features can be added and obsolete features replaced without disrupting the other modules of the system. As a result, major
changes in computer technology have been systematically accommodated. For example, the program has been adapted to be used on a variety of computer types, from supercomputers to Linux Clusters to
personal computers. We believe that the continued development and maintenance of MSC.Nastran, together with the modular design features of that program, have prevented, and will continue to prevent,
its obsolescence, although no assurance can be given that future changes in hardware or breakthroughs in software design will not result in the obsolescence of the program.

MSC.Patran.MSC.Patran is a graphical user interface and provides finite element modeling, analysis
data integration, analysis simulation, and results evaluation capabilities to simulate product performance early in the design-for-manufacture process. All of the functions of
MSC.Patran may be integrated, automated and tailored to the user's specific requirements using a powerful programming command language. We believe MSC.Patran is the standard simulation environment for
manufacturers worldwide, based upon its enhanced usability, direct CAD access, automated finite element modeling and completeness of analysis integration.

MSC.ADAMS.MSC.ADAMS is a kinematics tool that simulates motion and kinematic stresses and loads.
This product came to MSC.Software as part of the acquisition of Mechanical Dynamics in April of 2002. MSC.ADAMS is used heavily in the automotive and ground transportation industries to perform
kinematic simulation of systems and subsystems such as suspensions and engines.

MSC.Marc.MSC.Marc simulates nonlinear physical behavior due to material contact conditions such as
impact, crash and crush, resulting in material failure under extreme stress. MSC.Marc is increasingly being used in areas where materials undergo large deformations, such as rubber, plastics or metal
forming and many other applications. MSC.Marc also has extensive distributed parallel processing capabilities. Distributed parallel processing is a programming technique to divide the solution of
computer equations into many parts that can be solved by separate computer processors. MSC.Marc is also known for its computer algorithms that simulate how two bodies come in contact with one another,
or contact algorithms, and its extensive materials library.

MSC.Dytran.MSC.Dytran is complementary to MSC.Marc and uniquely combines fluid-structure interaction
to facilitate the simulation of, for example, tire hydroplaning and occupant safety (airbag-occupant interaction). It is used specifically by manufacturers for high-speed interactions such
as crashes and projectiles.

MSC.Enterprise Mvision.MSC.Enterprise Mvision delivers quality materials information for use and
reuse during the product development, testing and manufacturing cycles. This valuable resource and data is available to engineers worldwide via integrated Intranet and Extranet web access.
MSC.Enterprise Mvision provides electronic data exporting directly into popular CAD/CAE programs, and can be supplied complete with authoritative, ready-to-go materials
databanks from the extensive MSC.Mvision library.

MSC.visualNastran Professional/Desktop Family

MSC.Nastran for Windows.MSC.Nastran for Windows is a Windows NT-based simulation
product, incorporating finite element modeling, simulation and post-processing. It uses MSC.Nastran as a solver engine and Windows NT as it's interface. MSC.Nastran for Windows was
launched in early 1995.

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MSC.Working Model.The December 1998 acquisition of Knowledge Revolution ("KR") led to the
MSC.visualNastran Desktop suite of products for motion and visualization/animation. These products can be linked to solid modelers such as Solid Works, Mechanical Desktop and Solid Edge. We plan to
extend their visualization capabilities to work with our core solvers.

MSC.visualNastran 4D.MSC.visual Nastran 4D is a stand-alone kinematics tool for simulating motion
and the resulting stresses. It is used primarily by small and medium sized manufacturers and utilizes the MSC.Nastran solver.

MSC.Dynamic Designer.MSC.Dynamic Designer, which was also a part of the acquisition of Mechanical
Dynamics, is a CAD-embedded simulation tool that provides design engineers the ability to perform simulations within their preferred CAD interface. The MSC.Dynamic Designer product can be
embedded into most CAD systems on the market, including Autodesk Inventor, Ideas, Solid Works and Solid Edge among others.

Other Software Products

We also offer other software products, including:



Software Royalties

Some of our products include technology owned by third parties and we have entered into royalty agreements for use of all such technology. Should these agreements
be terminated, we would need to find an alternative source to replace the functionality of such technology. However, these agreements allow for significant lead time prior to termination by the third
party, which should allow us to develop or find an alternative source of such technology. See "We have entered into royalty agreements with
third parties for the inclusion of their technology as a component of some of our products. The termination of these agreements could adversely affect our business" under "Risk Factors."

PROFESSIONAL SERVICES

We offer services in the areas of PLM and product development, engineering and manufacturing solutions, including consulting, deployment, development and
engineering.



We provide engineering analysis and design services to our existing software customers and to companies who do not use our software. These services are delivered
to our current customers to provide analysis or design expertise that they may not have and to augment their capabilities if they have a manpower shortage. These services are provided to other
companies who do not have any analysis or design professionals on staff, but who need these capabilities provided via outsourcing. We deliver the expertise of over 200 highly trained engineers who
write, support and use our software, as well as third part products, on a daily basis. We have provided services to automotive, aerospace, biomedical, electronic packaging, petrochemical, nuclear and
consumer product manufacturers and suppliers. In addition to

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analysis
and design services before a product's manufacture, we have also investigated the cause of in-service failures for a wide range of products. Typical examples of our engineering
services include:



Engineering
consulting arrangements are separate and distinct from our software arrangements. Terms of the consulting arrangements are set forth in the individual arrangements with each
customer, including services to be provided, amounts to be charged, and other terms of the engagement.



We work closely with our key customers to advise them on product development processes, enabling them to make better products in less time and for less cost. We
assist our customers to automate the process by providing software systems that integrate our software with CAD, product data management, test and in-house software. Automation moves
simulation up front in the conceptual and detailed design phases to enable simulation to be performed by design engineers and to be an integral part of the product development process. In many of our
service engagements, we use the MSC.Acumen toolkit to create design engineering workflow templates that capture and automate the engineering process.



We provide services that allow our customers to efficiently and effectively deploy IT solutions. These services include:



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HIGH PERFORMANCE COMPUTING SERVICES



An expanding services area for us is porting to the Linux operating system. For Linux, we help our customers move from Unix, configure systems, port proprietary
software, customize middleware for special needs, and provide training.

TRAINING AND ONSITE SERVICES



SYSTEMS

Our systems business uses information technology solutions, systems integration and support services to address the high performance, workgroup, and enterprise
computing needs for organizations around
the world. We market our solutions to engineering, manufacturing, academic, scientific and commercial organizations. Our focus is on providing integrated hardware, software and services to help
companies deploy high performance/availability servers and clusters, databases and tools, workgroup systems, storage solutions including storage area networks ("SAN") or network attached storage,
backup and archive solutions, security and network infrastructure. Some of our key vendor partners for these solutions are industry-leaders like International Business Machines, Dell Computer, Hewlett
Packard, SGI International, Sun MicroSystems, eMachines, Hitachi, Veritas, Cisco Systems and Oracle.

Our
systems deployment and integration services include architecture design, performance tuning and customization, cluster configuration, storage assessment and implementation,
system/network operation and administration services, as well as complete systems integration. Networking services generally consist of networking mixed systems environments as well as supply chain
integration services.

By
offering a comprehensive software, hardware and systems-integration solution, we give customers all the tools to create and manage their product data and transfer knowledge throughout
their organizations efficiently and effectively.

RESEARCH AND DEVELOPMENT

We continually expend significant amounts on the development and maintenance of our suite of software products, as well as on new product research and
development. During the years ended December 31, 2002, 2001 and 2000, gross research and development expenditures were approximately

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$41,347,000,
$35,820,000 and $30,311,000, respectively. Of the amounts expended, $13,979,000, $13,752,000 and $13,655,000, respectively, were included in capitalized software costs.

Our
development activities have historically involved adding new capabilities to our family of simulation programs or converting those programs for use on new computer platforms. These
activities are intended to prevent technological obsolescence and assure our clients the maximum flexibility in selecting computer hardware.

Maintenance
of our software products includes system integration, quality assurance testing, error correction, and modifications to accommodate changes to computer system software. Given
the maturity of our software, most maintenance efforts stem from continuing new developments. Maintenance costs are expensed as incurred.

We
have increased our expenditures for software development. This increase resulted primarily from changes within our product management function in staffing and staff mix related to a
strategic revision in product development activity. This shift in strategy de-emphasizes features upgrades for specific products and promotes the development of technologies and integrated
software solutions for targeted customers. Our total development cost before software capitalization was 17% of software and services revenue for 2002, which was consistent with our target.

SALES AND MARKETING

We sell our products worldwide through a dedicated sales force as well as value added resellers. We also use the Internet for global marketing. At
December 31, 2002, our sales and marketing force consisted of 383 employees, including 176 in the Americas, 113 in Europe and 94 in Asia-Pacific. We market our products by
advertising in trade publications, participating in industry trade shows and exhibits, conducting training seminars and working with our strategic partners as described above.

Historically,
our software products were used primarily in the design phase of product development. Accordingly, we targeted our marketing efforts on the product design engineers of our
customers. With the addition of MSC.Marc, we have expanded our marketing efforts to also cover the manufacturing engineers of our customers. With the addition of AES, we have expanded our marketing
efforts to include designers and IT professionals, focusing on middle market companies with annual revenues between $25 million and $500 million. We now have offerings that cover the
entire lifecycle of a product, from design through manufacture, as well as covering the manufacturing company's IT infrastructure.

Pricing
of products sold in Europe through our European subsidiaries are generally denominated in Euros or local currency and products sold through our Japanese subsidiary are generally
denominated in Japanese Yen. Most other products are sold through contracts that are generally denominated in United States Dollars.

POST SALES SUPPORT

Client service is an integral aspect of our marketing program. We maintain toll-free numbers and a hot line service for our clients. We have invested
in advanced call center technology to improve our capabilities.

User
manuals, training and quality assurance are also essential to our marketing program. Our user manuals are comprehensive and updated on a regular basis. A staff of writers and
editors manage the design, writing, editing and preparation of user manuals as well as of training materials and promotional literature.

We
conduct formal training for clients, ranging from three-day introductory courses to intensive courses on specialized subjects for experienced users. Onsite courses for
clients are provided for larger user organizations. We also host technology conferences in the United States, Europe, Asia Pacific,

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Australia
and Latin America to gather data on client needs, new engineering applications, and new trends in computing technology.

PRICING

We provide a variety of licensing alternatives for the use of our software products. Our software products are offered on an annual non-cancelable,
pre-paid license basis and on a paid-up basis. An annual non-cancelable, pre-paid license is set at a fixed rate for the period and provides for payment
in advance of use. A paid-up license provides significant payment at the original time of sale of the product, with smaller payments for maintenance following the time of sale. Maintenance
revenue is deferred and recognized as revenue over the term of the maintenance agreement. Revenue from the sale of systems is recognized at the time of shipment.

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SALES AND SUPPORT OFFICES

We maintain North American sales and client support offices in:

  Alpharetta, Georgia

  Ann Arbor, Michigan

  Austin, Texas  Bellevue, Washington

  Cleveland, Ohio

  Dayton, Ohio  Denver, Colorado

  Fortworth, Texas

  Grapevine, Texas  Indianapolis, Indiana

  Littleton, Colorado

  Los Angeles, California  Lowell, Massachusetts

  Middleton, Connecticut

  Mount Laurel, New Jersey  Ontario, Canada

  Pleasanton, California

  Redwood City, California  San Diego, California

  Santa Ana, California

  Scottsdale, Arizona  Southfield, Michigan

  Sunnyvale, California

  Valencia, California


Sales
and technical support representatives who have engineering backgrounds and experience using our products are staffed in these offices. These representatives market our products,
provide training in
their use, respond to user support calls and provide solutions for simulation analysis throughout North America. In addition, sales and support personnel work out of numerous home offices throughout
the United States.

Our
products are marketed, distributed and supported outside of North America through a network of foreign subsidiary offices. Our wholly owned European subsidiary, headquartered in
Munich, Germany, manages our network of wholly owned subsidiaries in Europe. In the Asia Pacific region, sales and service are handled through our wholly owned subsidiary in Tokyo, Japan. We also have
subsidiary offices in Australia, Brazil and Korea. In addition, we maintain offices in the following countries:

Europe



Asia PacificAustria

Poland

JapanCzech Republic

Russia

People's Republic of ChinaFrance

Spain

TaiwanGermany

Sweden

MalaysiaItaly

Switzerland

SingaporeThe Netherlands

United KingdomNorway


Representative
arrangements are also utilized in several other European and Asia Pacific countries as well as in India and parts of Latin America.

All
of our offices are leased under agreements expiring at various times over the next one to 11 years. In 2001, we relocated our Corporate Headquarters and Costa Mesa office to
new office space in Santa Ana, California. The office in Santa Ana, California includes 203,000 square feet under a lease expiring in 2013.

CUSTOMERS

In 2002, we sold our products to approximately 8,000 customers. Customers in the aerospace, automotive and other manufacturing industries accounted for 22%, 20%
and 15%, respectively, of our revenues for 2002. Our top ten customers accounted for approximately 18% of our total revenues in 2002 and no single customer accounted for more than 5%. Our major
end-user customers, based upon 2002 revenues, include:



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For
2002, foreign sales accounted for approximately 48% of gross revenues, most of which was attributable to Europe (23%) and Asia-Pacific (25%). Less than 1% was
attributable to Canada and South America.

BACKLOG

We do not maintain backlog statistics for our software or systems products because they are generally available for delivery upon execution of a licensing
agreement or contract. Backlog for consulting services is currently not material.

INTELLECTUAL PROPERTY RIGHTS

We regard our software as proprietary and rely on a combination of trade secret, copyright and trademark laws, license agreements, nondisclosure and other
contractual provisions, and technical measures to protect our proprietary rights in our products. We distribute our software products under software license agreements that grant customers
nonexclusive licenses for the use of our products, which are nontransferable. Use of the licensed software is restricted to designated computers at specified sites, unless the customer obtains a
license offering other access to the software. Software and hardware security measures are also employed to prevent unauthorized use of our software, and the licensed software is subject to terms and
conditions prohibiting unauthorized reproduction and export of the software. As discussed in Item 3, the Company has entered into a settlement with the Federal Trade Commission. In accordance with
this settlement, the Company is required to license its current version of MSC.Nastran to up to two acquirers (the "Acquirers"). The Acquirers will have an unrestricted, perpetual right to license
this technology to others.

MSC,
MSC/, MSC/ARIES, MSC/PATRAN, MSC/MVISION, MSC/DYTRAN, MSCINCHECK (Design), MSC.ULTIMA, MSC.SUPERMODEL, MARC and EASY5 are some of our registered
trademarks. NASTRAN is a registered trademark of NASA. MSC.Nastran is an enhanced proprietary version of NASTRAN.

Many
of our trademarks have also been registered in foreign countries.

In
addition, we maintain federal statutory copyright protection with respect to our software programs and products and have copyrights on all documentation and manuals related to these
programs.

COMPETITION

With respect to our software business, the following list sets forth our primary competitors.



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In
our professional services business, we compete with in-house information technology personnel and consulting groups.

In
our systems business, our primary competitors include the direct sales forces of technology manufacturers as well as local systems resellers.

We
believe that the principal competitive factors affecting the software business include quality, functionality, ease of use and, to a lesser extent, price. In our professional services
business, we believe that the principal competitive factor is expertise. The principal competitive factors in our systems business include technical expertise, support capabilities, relationship
management, geographic coverage and price. Although we believe we currently compete effectively with respect to the factors in all of our businesses, we cannot assure you that we will be able to
maintain our competitive position against current and potential competitors.

EMPLOYEES

At December 31, 2002, we employed 1,514 persons, of whom 907 were involved in technical activities, 383 in sales and marketing, and 224 in administration.
We have no contracts with labor organizations and believe our relations with our employees are good.

COMPANY WEBSITE

MSC.Software Corporation maintains a website at www.mscsoftware.com where copies of our annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, and any amendments may be obtained free of charge. These reports are posted on our website the same day they are filed
with the SEC. The contents of our websites is not part of this Form 10-K.

EXECUTIVE OFFICERS OF THE REGISTRANT

The table below sets forth certain information about our executive officers. We are not aware of any arrangement or understanding between these persons and any
other persons pursuant to which the executive officers were selected as such. We are not aware of any family relationships between these executive officers and any other executive officers.

|Name              |  | Age |  | Current Position                                                         
|----------------- |  | --- |  | -------------------------------------------------------------------------
|Frank Perna, Jr.  |  | 65  |  | Chairman and Chief Executive Officer                                     
|Louis Greco       |  | 55  |  | Executive Vice President, Chief Financial Officer and Corporate Secretary
|Nader Khoshniyati |  | 49  |  | Executive Vice PresidentField Operations                                
|Robert R. Ryan    |  | 45  |  | Executive Vice PresidentProduct Division                                
|Kenneth Blakely   |  | 48  |  | Executive Vice PresidentSoftware                                        

Frank Perna, Jr.has served as Chairman and Chief Executive Officer since December 1998. Prior to that, Mr. Perna was
Chairman and Chief Executive Officer of EOS, a privately held provider of power supplies for electrical equipment and notebook computers, from 1994 to 1998. Mr. Perna also serves as a director
of California Amplifier, Inc., a public company that designs and manufacturers a broad line of microwave amplifier equipment used with satellite video and terrestrial broadband applications,
and as a director of Geometric Software Solutions Co. Ltd., a public company headquartered in India providing CAD/CAM/CAE/PDM software applications, component technology and development
services. Mr. Perna previously served as director of PDA Engineering from 1990 to 1994 and was a member of the Board of Directors of PDA Engineering when it was acquired by us.

Louis Grecohas served as Chief Financial Officer since March 1983. He has served as Corporate Secretary since
December 1985. Mr. Greco has a Bachelor of Science Degree in Business with an

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Accounting
Emphasis from California State University at Los Angeles and a Masters Degree in Business Administration from the University of Southern California.

Nader Khoshniyatihas served as Executive Vice President of Field Operations since July 2002. Mr. Khoshniyati joined us upon
our acquisition of Advanced Enterprise Solutions. From July 2001 to June 2002, he served as Executive Vice President of Systems. From 1989 to 2001, Mr. Khoshniyati was President
and CEO of Advanced Enterprise Solutions (acquired by MSC.Software in July 2001). Mr. Khoshniyati holds a Bachelors Degree in Industrial Accounting and Management, a Masters Degree in
Business Administration from Northeastern State University in Oklahoma, and has completed PhD postgraduate study pending dissertation in computer education and management at United States
International University in San Diego, California.

Robert R. Ryanhas served as the Executive Vice PresidentProducts since our acquisition of Mechanical Dynamics, Inc.
in April 2002. Dr. Ryan was the President of MDI from February 1997 and was MDI's Chief Operating Officer and Executive Vice President since 1991. He served as MDI's Vice
President of Product Development from 1988 through 1991. Before joining MDI, Dr. Ryan held various positions in sales and engineering services at Structural Dynamics Research Corporation, and
served on the engineering faculty at The University of Michigan. He holds a B.S. from the University of Cincinnati and an M.S. and Ph.D. in applied mechanics from Stanford University.

Kenneth Blakelyhas served as Executive Vice President of Software since July 2002. Prior positions at MSC.Software include
Executive Vice President of Software and Services; Senior Vice President and General Manager of our Mechanical Solutions Division; Vice President and General Manager of the Aerospace Business Unit;
Vice President of Marketing; Director of Product Management; and Manager of Technical Planning and Product Services. He also headed the MSC.Nastran for Windows team, responsible for conceiving,
developing and launching the product. Mr. Blakely has written more than 40 technical papers, primarily on test-analysis correlation, structural dynamics, PC applications, and
CAD-FEA interoperability. Mr. Blakely has a Bachelor of Science Degree in Engineering and a Masters Degree in Structural Dynamics from the University of California at Los Angeles.

RISK FACTORS

Some of the statements in this report are forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995 (the "Act"). You can
identify these statements by the use of words like "may", "will", "could", "continue", "expect" and variations of these words or comparable words. Actual results could differ substantially from the
results that the forward-looking statements suggest for various reasons, including those set forth below. The statements in this section are being made pursuant to the Act and with the intention of
obtaining the benefits of the "safe harbor" provisions of the Act. The forward-looking statements made in this report are made only as of the date of this report and we do not undertake to update or
revise the forward-looking statements.

Downturns in the aerospace and automotive industries we serve would adversely affect our sales and operating results.

In 2002, sales to customers in the aerospace and automotive industries accounted for approximately 22% and 20%, respectively, of our revenues. Changes in capital
spending by, and cyclical trends affecting, customers in these industries may adversely affect our sales to these customers and our operating results. In addition, these types of customers tend to
adhere to a technology choice for long periods, possibly an entire development cycle. As a result, a lost opportunity with a given customer may not again become a new opportunity for several years.

13

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We have significant international sales and thus are exposed to a number of additional material risks that could adversely affect our business.

Revenues from foreign sales represented approximately 48% of our revenue in 2002. We expect revenues from foreign export sales to continue to represent a
significant portion of total revenue. There are risks inherent in doing business internationally, including:



We have acquired and may continue to acquire other companies and may be unable to integrate successfully such companies with our operations, and we have recorded, and may
continue to record, a significant amount of goodwill in connection with our acquisitions.

We acquired Mechanical Dynamics, Inc., or MDI, in 2002, Advanced Enterprise Solutions, Inc., or AES, in 2001 and five other businesses in 1998 and
1999. In 2002 we also acquired certain assets and technology, collectively known as EASY5. We may continue to expand and diversify our operations with additional acquisitions. If we are unsuccessful
in integrating these companies or product lines with our operations, or if integration is more difficult than anticipated, we may experience disruptions that could have a material adverse effect on
our business, financial condition and results of operations. Some of the risks that may affect our ability to integrate or realize any anticipated benefits from companies we acquire include those
associated with:



As
a result of our acquisitions, goodwill accounted for approximately $189.0 million, or 37.3%, of our total assets as of December 31, 2002. We may record additional
goodwill related to future acquisitions. Under newly adopted generally accepted accounting principles, we will no longer amortize any goodwill. We will, however, perform an annual impairment analysis
on the carrying value of our goodwill. If the

14

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financial
benefits of our acquisitions do not ultimately exceed the associated costs, we could be required to write down some or all of the unamortized goodwill. As a result, our results of operations
would be adversely affected.

We have had losses and, should they continue, it could have a material adverse effect on our business, results of operations and financial condition.

We reported a net loss of $51.3 million for the year ended December 31, 2002 and an accumulated deficit of $36.2 million at
December 31, 2002. We cannot assure you that we will operate profitably, and if we cannot operate profitably, we may not be able to meet our debt service requirements or our working capital or
other needs. Our inability to meet these needs could have a material adverse effect on our business, results of operations and financial condition.

Our operating results are dependent on our ability to develop and introduce new and enhanced products and we may not be able to develop new and enhanced products to satisfy
changes in demand.

Our operating results will depend in part on our ability to develop and introduce new and enhanced products on a timely basis. Successful product development and
introduction depends on numerous factors, including our ability to anticipate customer requirements, changes in technology, our ability to differentiate our products from those of our competitors, and
market acceptance. We may not be able to develop and introduce new or enhanced products in a timely or cost-effective manner or to develop and introduce products that satisfy customer
requirements. Our products also may not achieve market acceptance or correctly anticipate technological changes.

The settlement with the Federal Trade Commission, or the FTC, relating to our acquisitions of Universal Analytics, Inc., or UAI, and Computerized Structural
Analysis & Research Corp., or CSAR, could harm our business.

In October 2001, the FTC issued an administrative complaint alleging that we had substantially lessened competition in the advanced Nastran market as a
result of the acquisitions of UAI and CSAR. In July 2002, a proposed settlement was reached with FTC staff, which was accepted by the Commissioners for public comment in August 2002. On
November 1, 2002, the Commissioners approved the settlement. The settlement requires us to license, on a non-exclusive basis to up to two acquirers, all intellectual property
(including computer code) related to the August 2002 version of MSC.Nastran, all intellectual property acquired in the acquisitions of UAI and CSAR, and certain information related to customers
using MSC.Nastran in the United States. In addition, for all customers that converted or convert to a paid-up license after June 24, 1999 through the first anniversary of the
divestiture license, we are required to allow the customer to terminate the paid-up agreement and to obtain a refund of a pro-rata portion of the consideration for the
MSC.Nastran portion of the paid-up license if the customer decides to switch from MSC.Nastran to the acquirer's version of Nastran. We estimate that the aggregate pro-rata
portion of the consideration for the MSC.Nastran portion of such paid-up licenses at December 31, 2002 was approximately $26.6 million. For arrangements with customers that
convert to a paid-up license after November 1, 2002, we defer revenue for the fair value of the Nastran paid-up license because of this provision in the FTC settlement
which, for accounting purposes, makes the fee not fixed or determinable. As of December 31, 2002, we have deferred approximately $6.4 million of such revenue (which is included in the
$26.6 million above) , which will be recognized ratably over a 48 month term until the customer requests a refund or the twelve month period to request such a refund lapses, at which
time the remaining deferred revenue will be recognized. The twelve month period to request a refund begins on the date we complete the divestiture of assets to one or more acquirers approved by the
FTC. We are currently in negotiations with an acquirer. Until a final agreement has been reached with one or more acquirers, and the customers who are entitled to a refund have requested a refund or
the refund period has expired, the

15

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effect
of the settlement on us cannot be determined and the ultimate outcome of this challenge could harm our business.

The timing of orders and shipments, which frequently occur at the end of a quarter, can cause fluctuations of our operating results that, in turn, may impact the price of our
common stock.

We derive most of our revenue from selling software products and services and information technology systems to high-end users of the product design
markets. Our revenue growth and our ability to match spending levels with revenue growth rates will directly affect our future operating results. Historically, a significant portion of our revenue has
been generated from shipments in the last month of a quarter, with this revenue frequently concentrated in the last weeks or days of a quarter. In addition, higher volumes of orders have been
experienced in the fourth quarter. The concentration of orders makes projections of quarterly financial results difficult. Accordingly, we may experience
fluctuations in our future operating results on a quarterly or annual basis which, in turn, could adversely affect the price of our common stock.

We have entered into royalty agreements with third parties for the inclusion of their technology as a component of some of our products. The termination of these agreements
could adversely affect our business.

Some of our products include technology owned by third parties and we have entered into royalty agreements for use of all such technology. Should these agreements
be terminated, we would need to find an alternative source to replace the functionality of such technology. We believe that we would be able to find an alternative source of the technology, or replace
the functionality through internal development. In addition, these agreements allow for significant lead time prior to termination by the third party, which should allow us sufficient time to replace
the functionality. However, in the unlikely event that all of these agreements were terminated within a very short time period, there is no guarantee that we could replace the technology and the
marketability of our products could be harmed if we were unable to do so.

The recent trend to paid-up licenses for our software products may cause our revenues and profits to fluctuate from period to period.

Recently, a greater percentage of our software revenues has come from perpetual paid-up licenses, under which we recognize a significant portion of
the license revenue at the time the license is entered into, as compared to annual licenses, under which we recognize the license revenue over the term of the license, which is generally
12 months. This trend, if it continues, may have the effect of increasing the volatility of our revenues and profits from period to period.

The impairment of capitalized software development costs could adversely affect our results of operations.

We capitalize software development costs related to product development in accordance with Statement of Financial Accounting Standards No. 86,
"Accounting for the Costs of Computer Software to Be Sold; Leased or Otherwise Marketed". These capitalized software development costs are subject to an
ongoing quarterly assessment of recoverability based on anticipated future revenue and changes in hardware and software technologies. Unamortized software development costs determined to be in excess
of net realizable value of the product are expensed immediately. Accordingly, our determination of the impairment of software development costs reduces our revenues and profits and could materially
and adversely affect our results of operations.

16

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Our operating expenses are fixed in advance. Therefore, we have limited ability to reduce expenses in response to any revenue shortfalls.

We plan our operating expense levels, in part, on expected revenue growth. Our expense levels, however, are generally committed in advance and, in the near term,
we are able to change only a relatively small portion of our expenses. As a result, our ability to convert operating outlays into expected revenue growth at profitable margins will affect our future
operating results. If our future revenues are less than expected, our net income may be disproportionately affected since expenses are relatively fixed.

Strong competition in the software and the reseller industries may affect prices, which could reduce margins and adversely affect our operating results and financial position,
and we may not be able to maintain our competitive position against current and potential competitors.

The simulation software and reseller industries are highly competitive. One or both of the industries may experience pricing and margin pressure which could
adversely affect our operating results and financial position. Some of our current and possible future competitors have greater financial, technical, marketing and other resources than we do, and some
have well-established relationships with our current and potential customers. It is also possible that alliances among competitors may emerge and rapidly acquire significant market share
or that competition will increase as a result of software industry consolidation. Increased competition may result in price reductions, reduced profitability and loss of market share, any of which
could have a material adverse effect on our business, financial condition and results of operations. We believe that the principal competitive factors affecting the software business include quality,
functionality, ease-of-use and, to a lesser extent, price. In our professional services business, we believe that the principal competitive factor is expertise. The principal
competitive factors in our systems business include technical expertise, support capabilities, relationship management, geographic coverage and price. Although we believe we currently compete
effectively with respect to the factors in all of our businesses, we cannot assure you that we will be able to maintain our competitive position against current and potential competitors.

Our future success depends in part on the continued service of our key technical and management personnel and our ability to identify, hire and retain additional personnel.

There is intense competition for qualified personnel in the software industry. We may not be able to continue to attract and retain qualified personnel necessary
for the development of our business or to replace qualified personnel who may leave our employ in the future. Any growth we experience is expected to place increased demands on our resources and will
likely require the addition of management and technical personnel, and the development of additional expertise by existing management personnel. Loss of the services of, or failure to recruit, key
technical and management personnel could harm our business.

We are located in an area subject to frequent earthquakes and a major earthquake could seriously disrupt our business.

Our corporate headquarters is located in Southern California, an area that experiences frequent earthquakes. The impact of a major earthquake on our facilities,
infrastructure and overall operations is not known. Although safety precautions have been implemented, there is no guarantee that an earthquake would not seriously disrupt our entire business process.
We are largely uninsured for losses and business disruptions caused by an earthquake.

If we cannot adequately protect our intellectual property rights, our financial results may suffer.

Our ability to compete is affected by our ability to protect our intellectual property rights. We rely on a combination of trademarks, copyrights, trade secrets,
confidentiality procedures and non-disclosure and licensing arrangements to protect our intellectual property rights. Despite these efforts, the steps we take

17

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to
protect our proprietary information may not be adequate to prevent misappropriation of our technology, and our competitors may independently develop technology that is substantially similar or
superior to our technology.

We could be harmed by litigation involving intellectual property rights.

We may be accused of infringing the intellectual property rights of third parties. Furthermore, we may have certain indemnification obligations to customers with
respect to the infringement of third-party intellectual property rights by our products. Infringement claims by third parties or claims for indemnification by customers or end users of our products
resulting from infringement claims may be asserted in the future and such assertions, if proven to be true, may harm our business. Any litigation relating to the intellectual property rights of third
parties, whether or not determined in our favor or settled by us, would at a minimum be costly and could divert the efforts and attention of our management and technical personnel. In the event of any
adverse ruling in any such litigation, we could be required to pay substantial damages, cease the manufacturing, use and sale of infringing products, discontinue the use of certain processes or obtain
a license under the intellectual property rights of the third party claiming infringement. A license might not be available on reasonable terms, or at all.

Certain provisions of our certificate of incorporation may delay, defer or prevent a change of control which could impact the price of our stock.

Certain provisions of our Certificate of Incorporation, as amended, and Restated Bylaws could make it more difficult for a third party to acquire control of us,
even if the change in control would be beneficial to stockholders. These provisions include the following:



In
addition to the above provisions, in 1998 we adopted a shareholder rights plan. This plan entitles each registered holder to purchase from us, under certain circumstances, one
one-hundredth of a share of Junior Participating Preferred Stock at a price of $35.00, subject to adjustments. The rights are generally exercisable only if a person or group acquires 20%
or more of our stock or announces a tender or exchange offer the completion of which would result in ownership by a person or group of 20% or more of our stock. In the event of a transaction commonly
known as a "squeeze-out merger," each holder of Junior Participating Preferred Stock may purchase either our common stock or the common stock of the merged entity at one-half
of such stock's market value. We may redeem the rights at a nominal value until ten days after the announcement of the acquisition of such a 20% interest and under certain other circumstances.

Changes in the accounting treatment of stock options could materially and adversely affect our results of operations.

The Financial Accounting Standards Board recently announced that it will require all companies to record the issuance of employee stock options as an expense,
although this requirement has yet to be promulgated. When the treatment of stock options as an expense for accounting purposes is incorporated into generally accepted accounting principles, we will be
obligated to change the manner in which we

18

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account
for the stock options that we have issued and will issue in the future, and such change could materially and adversely affect our results of operations.

ITEM 3. LEGAL PROCEEDINGS

We are involved in various pending or threatened litigation matters arising out of the normal conduct of our business. In our opinion, these matters will not have
a material adverse effect on our financial position or results of operations.

In
October 2001, the Federal Trade Commission ("FTC") issued an administrative challenge to our acquisition of two competitors in 1999, alleging that we had substantially lessened
competition in the Nastran market as a result of the acquisitions of UAI and CSAR. In July 2002, a settlement was proposed, which was accepted by the FTC and made available for public comment
in August 2002. On November 1, 2002, the FTC approved the settlement. The settlement requires us to license to up to two acquirers ("Acquirers") all intellectual property (including
computer code) related to the most current version of MSC.Nastran, as of the date of the settlement, all intellectual property acquired in the acquisitions of UAI and CSAR, and all information related
to customers using MSC.Nastran in the United States. In addition, for all customers that converted or convert to a paid-up license after June 24, 1999 through the first anniversary
after the divestiture, we are required to allow the customer to terminate the paid-up agreement and to obtain a refund of a pro-rata portion of the consideration for the
paid-up license if the customer decides to change from MSC.Nastran to the Acquirer's version of Nastran. We do not believe we will sustain a material loss as a result of the FTC
settlement. However, the value of the related contracts subject to potential refund was approximately $26,600,000 as of December 31, 2002. We are currently in negotiations with an Acquirer.
Until a final agreement has been reached with one or more Acquirers and the customers who are entitled to a refund have requested a refund or the refund period has expired, the effect of the
settlement on our financial statements cannot be determined. However, for our arrangements with customers that convert to a paid-up license after November 1, 2002, we defer revenue
for the fair value of the Nastran paid-up license because the arrangement is cancelable under certain circumstances pursuant to the FTC settlement and, as a result, the fee is not
considered to be fixed or determinable. As of December 31, 2002, we have deferred approximately $6,400,000 of such revenue (which is included in the $26,600,000 above), which will be
recognized ratably over a 48 month term until the customer requests a refund or the twelve month period to request such a refund lapses, at which time the remaining deferred revenue will be
recognized. The twelve month period to request a refund begins on the date we complete the divestiture of assets to one or more acquirers approved by the FTC.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock is listed for trading on the New York Stock Exchange ("NYSE") under the symbol "MNS". The following table sets forth the high, low, average and
closing prices, as reported on the NYSE composite trading system, for the periods shown:

Sales PricesHigh

Low

Average

CloseCalendar Year 2002:Fourth Quarter

$
8.90

$
2.74

$
6.32

$
7.72Third Quarter

$
11.72

$
7.45

$
9.84

$
8.52Second Quarter

$
22.75

$
7.42

$
12.75

$
8.95First Quarter

$
23.40

$
14.70

$
18.85

$
23.00Calendar Year 2001:Fourth Quarter

$
16.53

$
9.30

$
13.88

$
15.60Third Quarter

$
22.95

$
12.87

$
18.67

$
16.10Second Quarter

$
20.60

$
9.62

$
15.88

$
18.75First Quarter

$
10.57

$
7.74

$
9.58

$
10.25


As
of March 21, 2003, there were 286 record holders of our common stock. We eliminated our dividend in September 1996 and do not anticipate paying a dividend in the
foreseeable future. In addition, our loan agreement with our principal bank imposes restrictions on the payment of cash dividends or payments on account of or in redemption, retirement or purchase of
common stock or other distributions.

We
maintain the MSC.Software Profit Sharing Plan which includes a 401(k) feature that allows participants to make contributions to the plan from their compensation on a before-tax basis.
A participant's contributions to the plan are credited to an account maintained in his or her name under the plan. A participant is permitted to invest his or her Profit Sharing Plan account in the
MSC Stock Fund, an investment alternative under the plan that is invested principally in our common stock. Shares held in the MSC Stock Fund under the Profit Sharing Plan are purchased by the plan
trustee on the open market using contributions invested in that fund. During the period covered by this report, an aggregate of 165,000 shares of our common stock for an aggregate purchase price of
$1,646,000 were purchased on the market for the MSC Stock Fund and an aggregate of $1,122,000 of participant contributions were invested in the MSC Stock Fund. No exception to the registration
requirements of the Securities Act of 1933 existed for the sale of such shares to the participants. This practice has been suspended until the appropriate registration statement can be filed under the
Securities Act of 1933.

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ITEM 6. SELECTED FINANCIAL DATA

The selected financial data for the years ended December 31, 2002, 2001, 2000, 1999 and 1998 is derived from our audited consolidated financial statements.
The selected financial data should be read in conjunction with Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, the Consolidated Financial Statements and
the related Notes to Consolidated Financial Statements.

|                                                                                             |                                                  | As of and for the Years Ended December 31, |            
|-------------------------------------------------------------------------------------------- | ------------------------------------------------ | ------------------------------------------ | -----------
|
|
|CONSOLIDATED STATEMENT OF OPERATIONS DATA:                                                   |                                                  |                                            |            
|Revenue                                                                                      |                                                  | $                                          | 344,151,000
|Operating Income (Loss)                                                                      |                                                  | $                                          | (9,632,000 
|Income (Loss) Before Cumulative
Effect of Change In Accounting Principle                     |                                                  | $                                          | (12,029,000
|Net Income (Loss)                                                                            |                                                  | $                                          | (51,329,000
|Basic Earnings (Loss) Per Share Before Cumulative
Effect of Change In Accounting Principle   |                                                  | $                                          | (0.41      
|Diluted Earnings (Loss) Per Share Before Cumulative
Effect of Change In Accounting Principle |                                                  | $                                          | (0.41      
|Basic Earnings (Loss) Per Share                                                              |                                                  | $                                          | (1.75      
|Diluted Earnings (Loss) Per Share                                                            |                                                  | $                                          | (1.75      
|CONSOLIDATED BALANCE SHEET DATA:                                                             |                                                  |                                            |            
|Cash and Cash Equivalents                                                                    |                                                  | $                                          | 29,387,000 
|Working Capital                                                                              |                                                  | $                                          | 7,789,000  
|Total Assets                                                                                 |                                                  | $                                          | 507,274,000
|Long-Term Debt:                                                                              |                                                  |                                            |            
|                                                                                             | Notes Payable, Less Current Portion              |                                            | $          
|                                                                                             | Convertible Subordinated Debentures, Net         |                                            | $          
|                                                                                             | Subordinated Notes Payable, Less Current Portion |                                            | $          
|Total Shareholders' Equity                                                                   |                                                  | $                                          | 242,480,000

---

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion in this Report contains forward-looking statements that involve risks and uncertainties. Our actual results could differ
materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled
"Risk Factors" included elsewhere in this Report. You should also carefully review the risk factors set forth in other reports or documents that we file from time to time with the Securities and
Exchange Commission, particularly Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. You should also read the following discussion and analysis
in conjunction with our consolidated financial statements and related notes included in this Report.

OVERVIEW

We are a leader in the development, marketing and support of virtual product development tools including simulation software, professional services and
information technology systems. Our products and services help customers optimize product designs, increase quality and reliability, reduce product development costs and speed time to market. We also
provide a broad range of strategic consulting services to help our customers improve the integration and performance of their product development process and lower the total cost of ownership of their
technology investments. We serve customers in multiple industries, including aerospace, automotive, machinery, electronics, consumer products, biomedical, shipbuilding and rail.

During
the past three years, we have engaged in a number of key strategic activities to expand our market opportunities. These activities include the completion of two acquisitions to
broaden the technology scope of our core simulation software products, expand into information systems reselling and integration, and establish a focused professional services group. The professional
services group includes traditional engineering consulting activities as well as extreme performance computing services, with special technical expertise in the use of Linux and other related
operating systems.

RECENT ACQUISITIONS

We acquired Mechanical Dynamics, Inc. ("MDI") in 2002 and Advanced Enterprise Solutions, Inc. ("AES") in 2001.

Mechanical Dynamics, Inc.On April 19, 2002, we completed the acquisition of the outstanding common stock of MDI
through a tender offer. MDI developed, marketed and supported functional virtual prototyping solutions. This acquisition was completed because we believe the acquisition of MDI expands our core
software offerings, complements our existing product and service offerings and increases our presence in the product lifecycle management market to better serve customers.

To
accomplish the acquisition of MDI, we entered into the Agreement and Plan of Merger dated March 15, 2002 with MDI. Following the consummation of a tender offer at $18.85 per
share in cash and the satisfaction or waiver of certain conditions, all of the remaining outstanding shares of common stock of MDI were converted into the right to receive $18.85 per share in cash. As
a result of the tender offer and merger, we acquired approximately 6,200,000 shares of common stock of MDI, representing 100 percent of the outstanding shares of MDI at an aggregate price of
approximately $116,877,000. We also agreed to redeem all outstanding MDI stock options (922,340 options) for total consideration of $10,531,000 (the difference between $18.85 and the exercise price of
the options).

The
acquisition of MDI has been accounted for as a purchase, and accordingly, the results of operations of MDI since April 19, 2002 are included in our consolidated statement of
operations. A valuation of the intangible assets acquired was performed as of the date of the acquisition. The excess of the aggregate purchase price over the fair market value of the net tangible
assets acquired was

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$114,040,000.
Pursuant to SFAS 142, goodwill and indefinite lived intangibles will not be amortized, but will be evaluated for any indicators of impairment.

Advanced Enterprise Solutions, Inc.On July 20, 2001, we completed the acquisition of AES. AES is a systems and
software integrator and the largest IBM Product Lifecycle Management business partner in the Americas, selling Dassault Systemes' Product Lifecycle Management software portfolio comprised of CATIA,
ENOVIA, DELMIA and Smart Solutions.

To
accomplish the acquisition of AES, we entered into a Stock Purchase Agreement with Dassault Systemes of America Corp. ("DSA"), pursuant to which we purchased from DSA all of the
shares of AES held by DSA. We issued to DSA 1,763,400 shares of our common stock for DSA's minority interest in AES. We also entered into an Agreement and Plan of Merger with AES pursuant to which
AES was merged with our wholly owned subsidiary, which resulted in AES becoming our wholly owned subsidiary. In this transaction, the stockholders of AES, other than DSA, received:



We
also assumed outstanding options to acquire AES common stock, which were converted into fully vested options, with time based exercise restrictions, to acquire 718,898 shares of our
common stock.

The
5,281,100 shares of common stock issued as part of the transaction were valued at $80,695,000 based upon the fair value of our common stock immediately prior and subsequent to
May 2, 2001, the date of the signing and announcement of the definitive acquisition agreement. The options were valued at approximately $10,927,000 based on a calculation using the
Black-Scholes pricing model with the following assumptions: no dividend yield; expected volatility of 53%; a risk free rate of 5%; and an expected life of 5 years.

The
promissory notes were recorded at their estimated fair value at time of issuance, net of a discount of $411,000. The promissory notes bear interest at 7% with interest payments due
semi-annually in January and July. The entire principal amount of the notes of $20,000,000 is due in July 2004.

The
acquisition of AES has been accounted for as a purchase, and accordingly, the results of operations of AES since July 1, 2001 (the designated effective date when control of
AES was passed to us) are included in our consolidated statement of income. An independent valuation of the intangible assets acquired was performed in 2001. The excess of the aggregate purchase price
over the fair market value of the net assets acquired was $119,929,000. Pursuant to SFAS 142, goodwill and indefinite lived intangibles will not be amortized, but will be evaluated for any
indicators of impairment.

CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE

In June 2001, the FASB issued Statements of Financial Accounting Standards No. 141 ("SFAS No. 141"), "Business
Combinations", and No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets." Under these standards,
goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to impairment tests at least annually. Under SFAS No. 142, goodwill impairment is deemed
to exist if the net book value of a reporting unit exceeds its estimated fair value. Our reporting units are generally consistent with our operating segments. This methodology differs from our
previous policy, as permitted under accounting standards existing at that time, of using undiscounted cash flows on an enterprisewide basis to determine if goodwill is recoverable.

During
the second quarter of 2002, we completed the transitional impairment test required under the new rules and recorded a non-cash charge of $39,300,000 to reduce the
carrying value of goodwill effective in the first quarter of 2002. The impairment relates entirely to our Systems reporting unit, which was

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almost
entirely generated from the AES acquisition. Such charge is nonoperational in nature and is reflected as a cumulative effect of change in accounting principle in 2002. In calculating the
impairment charge, the fair value of the impaired reporting unit underlying the System segment was estimated using either a discounted cash flow methodology or recent comparable transactions. The
impairment primarily resulted from an increase in our stock price immediately prior to the date that the AES acquisition was announced and valued for accounting purposes, as well as a decline in
market multiples in the information systems reseller industry.

ASSET IMPAIRMENT AND RESTRUCTURING

We have consistently followed the policy of capitalizing software development costs related to product development in accordance with the guidelines established
under Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise
Marketed". Significant management judgment is required in determining whether technological feasibility has been achieved for a particular software project. These capitalized
software development costs are subject to an ongoing quarterly assessment of recoverability based on anticipated future revenue and changes in hardware and software technologies. Amortization of
software development costs begins when the product is available for general release. Amortization is provided on a product-by-product basis on the greater of the
straight-line method over periods not exceeding three years or the sales ratio method that is based on expected unit sales and the estimated life of the product. Unamortized software
development costs determined to be in excess of net realizable value of the product are expensed immediately.

Accordingly,
during 2002, we recognized non-cash pre-tax charges of $4,751,000 related to the write-down of the carrying value of capitalized software
development costs. The impairment was primarily due to the abandonment of certain products as a result of the acquisition of MDI as well as our restructuring during the second and third quarters.

Due
to the weakened economic conditions in all three world areas in which we operate, management determined in 2002 that our current and future revenue could not support our existing
cost structure. A review of our structure indicated several areas in which we could reduce costs. It was determined that workforce reductions and facility consolidations would be necessary to return
us to profitability. In addition, the acquisition of MDI created certain redundant expenses that needed to be eliminated. We accrued $5,794,000 of restructuring costs related to the integration of
MDI, including severance and related charges associated with a worldwide reduction in force of MDI employees, transaction costs, costs related to closing redundant facilities and terminating contracts
and other exit costs associated with the acquisition. In accordance with Emerging Issuance Task Force Issue No. 95-3, "Recognition of Liabilities in
Connection with a Purchase Business Combination" ("EITF 95-3"), the costs related to the integration of MDI were included as assumed liabilities in the net tangible
assets acquired. In addition, we recorded a restructuring charge of $9,064,000 in 2002 related to the Company's existing business operations. These additional restructuring charges related to
workforce reductions, impairment of assets caused by the terms of the MDI acquisition, to the consolidation of existing office facilities and other costs.

The
acquisition of AES in 2001 created certain redundant expenses that needed to be eliminated. In the third quarter of 2001, we recorded a restructuring charge of $1,894,000. In
addition, we recorded $563,000 of additional acquisition costs related to the integration of AES. In accordance with EITF 95-3, the costs relating to the consolidation of AES office
facilities were included in the purchase price allocation, resulting in additional goodwill. The restructuring charge that related to our business of $1,894,000 was recorded as a charge to income in
2001. These restructuring charges related to the impairment of an asset caused by the terms of the AES acquisition and the consolidation of existing office facilities.

24

---

The
following is the activity in the restructuring reserve:

Workforce
Reductions

Facilities

Asset
Impairments

TotalBalance at December 31, 2000

$


$
1,340,000

$


$
1,340,000Restructuring Charges





1,389,000


505,000


1,894,000Acquisition Related Additions





418,000


145,000


563,000Cash Payments





(1,743,000
)




(1,743,000
)Non-Cash Write-Offs








(650,000
)

(650,000
)Balance at December 31, 2001





1,404,000





1,404,000Restructuring Charges


7,516,000


554,000


994,000


9,064,000Acquisition Related Additions


4,093,000


752,000


949,000


5,794,000Cash Payments


(8,530,000
)

(1,582,000
)




(10,112,000
)Non-Cash Write-Offs








(1,943,000
)

(1,943,000
)Balance at December 31, 2002

$
3,079,000

$
1,128,000

$


$
4,207,000


We expect to pay all remaining amounts accrued as of December 31, 2002 during 2003.

RESULTS OF OPERATIONS

The following table sets forth items included in the consolidated statements of operations data as percentages of total revenue.

|                                                                                                                   |                                                      | 2002                     |      | 2001  |      | 2000  |     
|------------------------------------------------------------------------------------------------------------------ | ---------------------------------------------------- | ------------------------ | ---- | ----- | ---- | ----- | ----
|REVENUE:                                                                                                           |                                                      |                          |      |       |      |       |     
|                                                                                                                   | Software                                             |                          | 46.6 | %     | 63.7 | %     | 72.9
|                                                                                                                   | Services                                             |                          | 25.5 | %     | 25.1 | %     | 27.1
|                                                                                                                   | Systems                                              |                          | 27.9 | %     | 11.2 | %     | 0.0 
|                                                                                                                   |                                                      |                          |      |       |      |       |     
|                                                                                                                   |                                                      | Total Revenue            |      | 100.0 | %    | 100.0 | %   
|                                                                                                                   |                                                      |                          |      |       |      |       |     
|COST OF REVENUE:                                                                                                   |                                                      |                          |      |       |      |       |     
|                                                                                                                   | Software                                             |                          | 6.5  | %     | 11.1 | %     | 12.7
|                                                                                                                   | SoftwareImpairment of Capitalized Development Costs |                          | 1.4  | %     | 0.0  | %     | 0.0 
|                                                                                                                   | Services                                             |                          | 15.8 | %     | 14.1 | %     | 12.5
|                                                                                                                   | Systems                                              |                          | 23.6 | %     | 9.4  | %     | 0.0 
|                                                                                                                   |                                                      |                          |      |       |      |       |     
|                                                                                                                   |                                                      | Total Cost of Revenue    |      | 47.3  | %    | 34.6  | %   
|                                                                                                                   |                                                      |                          |      |       |      |       |     
|GROSS PROFIT                                                                                                       |                                                      | 52.7                     | %    | 65.4  | %    | 74.8  | %   
|                                                                                                                   |                                                      |                          |      |       |      |       |     
|OPERATING EXPENSE:                                                                                                 |                                                      |                          |      |       |      |       |     
|                                                                                                                   | Research and Development                             |                          | 8.0  | %     | 9.3  | %     | 9.4 
|                                                                                                                   | Selling, General and Administrative                  |                          | 42.3 | %     | 42.1 | %     | 46.2
|                                                                                                                   | Amortization of Goodwill and Other Intangibles       |                          | 1.9  | %     | 4.6  | %     | 6.2 
|                                                                                                                   | Restructuring Charges                                |                          | 2.6  | %     | 0.8  | %     | 0.0 
|                                                                                                                   | Write-Off of Acquired In-Process R&D                 |                          | 0.7  | %     | 0.0  | %     | 0.0 
|                                                                                                                   |                                                      |                          |      |       |      |       |     
|                                                                                                                   |                                                      | Total Operating Expense  |      | 55.5  | %    | 56.8  | %   
|                                                                                                                   |                                                      |                          |      |       |      |       |     
|OPERATING INCOME (LOSS)                                                                                            |                                                      | (2.8                     | %)   | 8.6   | %    | 13.0  | %   
|                                                                                                                   |                                                      |                          |      |       |      |       |     
|OTHER EXPENSE:                                                                                                     |                                                      |                          |      |       |      |       |     
|                                                                                                                   | Interest Expense                                     |                          | 2.4  | %     | 2.2  | %     | 3.8 
|                                                                                                                   | Other Expense (Income), Net                          |                          | 0.0  | %     | (0.7 | %)    | (0.1
|                                                                                                                   |                                                      |                          |      |       |      |       |     
|                                                                                                                   |                                                      | Total Other Expense, Net |      | 2.4   | %    | 1.5   | %   
|                                                                                                                   |                                                      |                          |      |       |      |       |     
|INCOME (LOSS) BEFORE PROVISION (BENEFIT) FOR INCOME TAXES AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLES |                                                      | (5.2                     | %)   | 7.1   | %    | 9.3   | %   
|Provision (Benefit) for Income Taxes                                                                               |                                                      | (1.7                     | %)   | 2.7   | %    | 3.0   | %   
|                                                                                                                   |                                                      |                          |      |       |      |       |     
|INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE                                           |                                                      | (3.5                     | %)   | 4.4   | %    | 6.3   | %   
|                                                                                                                   |                                                      |                          |      |       |      |       |     

25

---

2002 Compared to 2001

Net Income (Loss)Consolidated net loss was ($51,329,000), or ($1.75) per share, in 2002 compared to
net income of $10,271,000, or $0.47 per diluted share, in 2001.

RevenueWe reported revenue of $344,151,000 in 2002 compared to $236,097,000 in 2001, an increase of $108,054,000, or 46%.

Software RevenueSoftware revenue was $160,361,000 for 2002 compared to $150,342,000 for the prior year, an increase of
$10,019,000, or 7%. Software revenue consists of licensing fees, which are fees charged for the right to use our software or a third parties' software. Software is sold through monthly, annual or
longer lease arrangements and through paid-up license arrangements, whereby the customer purchases a long-term license for the use of the software. Software revenue generated
from the recently acquired MDI was $15,787,000 or 10% of total software revenue. Excluding software revenue generated from MDI, software revenue was $144,574,000, a decrease of $5,768,000, or 4%. The
decrease was primarily attributed to a decrease in recurring software revenue of $9,612,000 offset by an increase in paid-up licenses of $3,844,000.

Services RevenueServices revenue was $87,790,000 for 2002 compared to $59,224,000 for the prior year, an increase of
$28,566,000, or 48%. Services revenue includes maintenance, support, consulting and training services.    Consulting and training services range from installation and basic consulting to
training. Software support revenue was $48,052,000, or 55% of total services revenue, for 2002 compared to $34,497,000, or 58% of total services revenue, for 2001, an increase of $13,555,000, or 39%.
Revenue from consulting and training services was $39,738,000, or 45% of total services revenue, for 2002 compared to $24,727,000, or 42% of total services revenue, for 2001, an increase of
$15,011,000, or 61%. The increase was primarily due to the acquisition of MDI and an increase in maintenance revenue of $3,989,000. The recently acquired MDI generated software support revenue of
$9,566,000, or 20% of total software support revenue, and consulting and training services revenue of $10,618,000, or 27% of total consulting and training services revenue.

Systems RevenueSystems revenue includes the resale and integration of computer hardware and operating systems and was
$96,000,000 for 2002 compared to $26,531,000 for 2001. The increase in systems revenue in 2002 was primarily due to the acquisition of AES in July 2001, as well as weaker than normal sales in
2001 following the terrorist attacks on September 11, 2001.

The
following table shows revenue by geographic region and the related growth rates between 2001 and 2002:

|         |              | Years Ended December 31, |   | Revenue Growth |             | % of Total Revenue |            
|-------- | ------------ | ------------------------ | - | -------------- | ----------- | ------------------ | -----------
|
|Revenue: |              |                          |   |                |             |                    |            
|         | The Americas |                          | $ | 180,514,000    |             | $                  | 116,169,000
|         | Europe       |                          |   | 78,880,000     |             |                    | 63,380,000 
|         | Asia-Pacific |                          |   | 84,757,000     |             |                    | 56,548,000 
|         |              |                          |   |                |             |                    |            
|         |              | Total Revenue            |   | $              | 344,151,000 |                    | $          
|         |              |                          |   |                |             |                    |            

The
Americas reported a decrease of ($3,764,000) in software revenue and increases of $8,551,000 in services revenue and $59,558,000 in systems revenue. The decrease in software revenue
was primarily due to decreases in recurring software revenues of $11,665,000, offset by an increase in paid-up licenses of $4,301,000 and the acquisition of MDI, which generated $3,600,000
of software revenue in 2002. The increase in services revenue for the Americas was primarily due to the acquisition of MDI in April 2002, which generated $6,253,000 of services revenue in 2002.
The increase in systems revenue was due to our acquisition of AES in July 2001.

26

---

Europe
reported increases of $4,322,000 in software revenue, $8,912,000 in services revenue and $2,266,000 in systems revenue. The increase in revenue for Europe was primarily due to the
acquisitions of AES and MDI and an increase in software support revenue of $2,399,000, offset by a reduction in non-MDI paid-up licenses of $1,641,000. Revenue in Europe
generated from the recently acquired MDI was $5,788,000 of software revenue and $5,435,000 of services revenue. While AES was essentially a domestic operation prior to our acquisition, the increase in
systems revenue was primarily the result of our extension of this business into the European market.

Asia-Pacific
reported increases of $9,461,000 in software revenue, $11,103,000 in services revenue and $7,645,000 in systems revenue. The increase in revenue for
Asia-Pacific was primarily due to the acquisitions of MDI and AES, increases in non-MDI recurring software revenue of $1,878,000, non-MDI paid-up software licenses of
$1,184,000 and non-MDI consulting services of $1,560,000. Revenue in Asia-Pacific generated from the recently acquired MDI was $6,399,000 of software revenue and $8,496,000 of services
revenue. While AES was essentially a domestic operation prior to our acquisition, the increase in systems revenue was primarily the result of our extension of this business into the Asian-Pacific
market.

Revenue
growth in 2002 was also impacted by favorable foreign currency translation rates for the Euro and the Japanese Yen as compared to the prior year. Revenue for 2002 would have been
approximately $343,168,000 if translated using the prior year's foreign currency translation rates. Revenue in local currencies increased 18% and 55% in Europe and Asia-Pacific,
respectively. Our international operations in Europe and Asia-Pacific are sales organizations with high gross profit margins, which is due to these operations having minimal software
development expenses. As a result, we are exposed to the effects of foreign currency fluctuations of the United States Dollar versus the Japanese Yen and the Euro.

Risks
inherent in international revenue include the impact of longer payment cycles, greater difficulty in accounts receivable collection, unexpected changes in regulatory requirements,
seasonality due to the slowdown in European business activity during the third quarter, tariffs and other trade barriers, and difficulties staffing and managing foreign operations. These factors may
have a material adverse effect on our future international revenue.

Our
future profitability and rate of growth, if any, will be directly affected by increased price competition and an increasingly higher revenue base from which to grow. Our growth rate
and net revenue depend significantly on renewals of existing orders as well as our ability to respond successfully to the pace of technological change and expand our customer base. If our renewal rate
or our pace of new customer acquisition slows, our net revenues and operating results would be adversely affected.

Cost of RevenueIn accordance with Statement of Financial Accounting Standards ("SFAS") No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed", cost of revenue expense includes period expenses directly
related to revenue as well as the amortization of capitalized software costs. Total cost of revenue was $158,126,000, or 46% of total revenue for 2002, compared to $81,610,000, or 35% of total
revenue, for the prior year.

Cost of RevenueSoftwareCost of revenuesoftware was $22,468,000, or 14% of software revenue, for
2002 compared to $26,193,000, or 17% of software revenue, for the prior year. The decrease was primarily attributable to a decrease in royalty expense of $3,603,000 due to product revenue mix and a
decrease in software amortization of $1,427,000 offset by an increase in product packaging and delivery of $1,305,000. Software amortization was $9,933,000 and $11,360,000 for 2002 and 2001,
respectively.

Cost of RevenueSoftwareImpairment of Capitalized Development CostsCapitalized product development
costs and projected revenues are reviewed quarterly to determine if any impairment in value has occurred that would require an adjustment in the carrying value or change in expected useful lives under
the guidelines established under SFAS No. 86 and SFAS No. 144. During 2002, $4,751,000 of capitalized software development costs were deemed to be impaired and were written off and
included in cost of revenue in accordance with SFAS No. 86. The impairment was primarily due to the abandonment of

27

---

certain
products as a result of the acquisition of MDI as well as our restructuring during the second quarter of 2002.

Cost of RevenueServicesCost of revenueservices was $54,299,000 or 62% of services revenue, for 2002
compared to $33,292,000, or 56% of services revenue, for the prior year. The increase in cost of revenueservices was primarily due to an increase in headcount during 2002, including
headcount additions as a result of the acquisition of MDI. Cost of revenueservices, as a percentage of services revenue, will vary from period to period based upon actual projects being
performed. We expect such percentage to continue to approximate 55% to 65% in the future.

Cost of RevenueSystemsCost of revenuesystems was $81,359,000 or 85% of systems revenue, for 2002
compared to $22,125,000, or 83% of systems revenue, for 2001. The increase in costs of revenuesystems is primarily the result of the increase in systems revenue as described above.

Gross ProfitGross profit, which is total revenue less cost of revenue, was $186,025,000, or 54% of total revenue, for 2002,
compared to $154,487,000, or 65% of total revenue, for 2001, an increase of $31,538,000, or 20%. The decrease in gross profit as a percentage of revenue was primarily due to the increase in systems
revenue, which generates lower margins than software and services, and the decreased gross margin on services revenue as described above.

Operating ExpenseOperating expense was $195,657,000 for 2002 compared to $134,093,000 for the prior year, an increase of
$61,564,000, or 46%. As with revenue, our expenses are impacted by foreign currency fluctuations. Operating expenses (including cost of revenue) in 2002 would have been approximately $929,000 lower if
translated using the prior year's foreign currency translation rates.

Research and DevelopmentIn accordance with SFAS No. 86, software development expense is reported net of the amount
capitalized. Research and development expense for 2002 was $27,368,000 compared to $22,068,000 for 2001, an increase of $5,300,000, or 24%. The total gross investment in software development
activities for 2002 was $41,347,000, or 17% of total software and services revenue, compared to $35,820,000, or 17% of total software and services revenue, for the prior year. The increase in research
and development activity in 2002 was primarily due to approximately $6,100,000 of development costs related to MDI which was acquired in April 2002. Excluding the development costs related to MDI, our
gross investment in research and development would have decreased by approximately $800,000, due to headcount reductions. Capitalized software development costs were $13,979,000 for 2002 compared to
$13,752,000 for the prior year, an increase of $227,000, or 2%. The amount of product development capitalized in any given period is a function of many factors, including the number of products under
development at any point in time as well as their stage of development. Our product development process is continually under review to improve efficiency and product quality, and to reduce time to
market. Due to the continual change in the product development process, there can be no assurance that the level of development capitalized in future periods will be comparable to current capitalized
levels.

Selling, General and AdministrativeSelling, general and administrative expense was $145,520,000, or 42% of total revenue, for
2002 compared to $99,253,000, or 42% of total revenue, for 2001, an increase of $46,267,000, or 47%. Selling, general and administrative expenses in 2002 increased as compared to 2001 partially as a
result of the acquisition of AES in July 2001 and the acquisition of MDI in April 2002. In addition, legal fees totaling approximately $9,500,000 were expensed in 2002 in connection with
an FTC administrative proceeding related to two acquisitions we completed in 1999. The FTC proceeding has been settled and we do not expect to incur any significant new legal fees related to this
matter.

Amortization of Goodwill and Other IntangiblesAmortization of goodwill and other intangibles was
$6,574,000 for 2002 compared to $10,878,000 for 2001. In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business
Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets". Upon adoption of SFAS No. 142 in the first
quarter of 2002, we ceased to amortize approximately $56,000,000 of goodwill and other indefinite lived intangibles acquired prior to July 1, 2001. We recorded

28

---

$6,633,000
of amortization on these amounts during 2001. In accordance with SFAS 142, the goodwill resulting from the AES and MDI acquisitions has never been amortized.

Restructuring ChargesRestructuring charges were $9,064,000, or 3% of total revenue, for 2002, compared to $1,894,000, or 1%
of total revenue, for 2001. The restructuring charges in 2002 consist of $7,516,000 of charges related to workforce reductions, $994,000 to the impairment of assets caused by the terms of the MDI
acquisition and $554,000 to the consolidation of office facilities and other costs. In 2001, the restructuring charges consist of $1,389,000 of charges related to the consolidation of office
facilities and $505,000 to asset write-downs.

Write-Off of Acquired In-Process R&DFASB Interpretation No. 4,
"Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method," requires that any portion of the purchase
price allocated to assets to be used in research and development projects that have no alternative future use be charged to expense at the date of the acquisition. Accordingly, during 2002, we wrote
off $2,170,000 of in-process research and development acquired in connection with the acquisition of MDI and $210,000 of in-process research and development acquired in
connection with the acquisition of EASY5. In-process research and development ("IPR&D") projects were identified and valued through analysis of data provided by MDI and EASY5 concerning
developmental products, their stage of development, the time and resources needed to complete them, if applicable, their expected income generating ability, target markets and associated risks. The
primary technique utilized in valuing the acquired IPR&D was the income approach, which includes an analysis of the markets, cash flows and risks associated with achieving such cash flows.

Developmental
projects that had reached technological feasibility were classified as developed technology, and the value was assigned to technology acquired and capitalized as Intangible
Assets. Where the developmental projects had not reached technological feasibility and had no future alternative uses, they were classified as IPR&D and charged to expense upon closing of the
acquisition. As of the acquisition date, all projects classified as IPR&D projects were in the development stage and we expected to incur approximately $4,500,000 in additional costs before these
projects would be complete.

In
valuing the IPR&D, we considered the importance of each project to the overall development plan, estimating costs to develop the purchased IPR&D into commercially viable products,
estimating the resulting net cash flows from the projects when completed and discounting the net cash flows to their
present value. The sales estimates used to value the purchased IPR&D were based on estimates of relevant market sizes and growth factors, expected trends in technology and the nature and expected
timing of new product introductions by MDI and its competitors. The rates utilized to discount the net cash flows to their present value are based on MDI's weighted average cost of capital. Given the
nature of the risks associated with the difficulties and uncertainties in completing each project and thereby achieving technological feasibility, anticipated market acceptance and penetration, market
growth rates and risks related to the impact of potential changes in future target markets, the weighted average cost of capital was adjusted. Based on these factors, discount rates of
15 percent and 20 percent were deemed appropriate for the acquired and in-process technology, respectively. The estimates used in valuing IPR&D were based upon assumptions
believed to be reasonable but which are inherently uncertain and unpredictable.

Operating Income (Loss)Operating loss was ($9,632,000) for 2002 compared to operating income of $20,394,000 for 2001.

Total Other ExpenseTotal other expense was $8,266,000 for 2002 compared to $3,535,000 for 2001, an increase of $4,731,000, or
134%.

Interest ExpenseInterest expense was $8,101,000 for 2002 compared to $5,239,000 for 2001, an increase of $2,862,000, or 55%.
The increase in interest expense is primarily due to our new debt incurred in connection with the acquisition MDI and the write-off of $1,471,000 of unamortized debt issuance costs resulting from the
refinancing of that debt in the fourth quarter of 2002.

29

---

Other Income (Expense)Other expense was ($165,000) for 2002 compared to other income of $1,704,000 for 2001. Other income
(expense) includes interest income, gains and losses on property and equipment, currency transaction gains and losses, and other non-operating income and expense. The change in 2002 was
primarily due to a decrease in interest income due to lower cash balances, increase in banking fees and currency transaction losses.

Provision (Benefit) for Income Taxes-The effective income tax rate for 2002 was 33% as compared with 39% for 2001. The
decrease in the effective income tax rate is due to lower pre-tax earnings in 2002.

Cumulative Effect of Change in Accounting PrincipleDuring the second quarter of 2002, we completed the required transitional
impairment test under SFAS 141 and 142 and recorded a non-cash charge of $39,300,000 to reduce the carrying value of the goodwill related to our Systems reporting unit. The
impairment relates entirely to our Systems reporting unit, which was
almost entirely generated from the AES acquisition. Such charge is reflected as a cumulative effect of change in accounting principle. In calculating the impairment charge, the fair value of the
impaired reporting unit underlying the Systems reporting unit was estimated using a discounted cash flow methodology and recent comparable transactions. The impairment primarily resulted from an
increase in our stock price immediately prior to the date that the AES acquisition was announced and valued for accounting purposes, as well as a decline in market multiples in the information systems
reseller industry.

2001 Compared to 2000

Net IncomeConsolidated net income was $10,271,000, or $0.47 per diluted share, in 2001 compared to
$11,133,000, or $0.76 per diluted share, in 2000.

RevenueWe reported revenue of $236,097,000 in 2001 compared to $178,024,000 in 2000, an increase of $58,073,000, or 33%.

Software RevenueSoftware revenue was $150,342,000 for 2001 compared to $129,746,000 for the prior year, an increase of
$20,596,000, or 16%. The increase was primarily attributed to an increase in paid-up licenses of $24,316,000, offset by a decrease in recurring software revenue of $3,720,000.

Services RevenueServices revenue was $59,224,000 for 2001 compared to $48,278,000 for the prior year, an increase of
$10,946,000, or 23%. Software support revenue was $34,497,000, or 58% of total services revenue, for 2001 compared to $31,621,000, or 65% of total services revenue, for 2000, an increase of
$2,876,000, or 9%. Software support revenue was favorably impacted by the increase in software revenue. Revenue from consulting and training services was $24,727,000, or 42% of total services revenue,
for 2001 compared to $16,657,000, or 35% of total services revenue, for 2000, an increase of $8,070,000, or 48%. Consulting and training services revenue generated from AES was approximately
$3,455,000.

Systems RevenueSystems revenue was $26,531,000 for 2001. Systems revenue generated from the newly acquired AES was
approximately 80% of total systems revenue for 2001, with the remaining 20% primarily attributable to high performance computing (Linux).

30

---

The
following table shows revenue by geographic region and the related growth rates between 2000 and 2001:

|         |              | Years Ended December 31, |   | Revenue Growth |             | % of Total Revenue |           
|-------- | ------------ | ------------------------ | - | -------------- | ----------- | ------------------ | ----------
|
|Revenue: |              |                          |   |                |             |                    |           
|         | The Americas |                          | $ | 116,169,000    |             | $                  | 76,423,000
|         | Europe       |                          |   | 63,380,000     |             |                    | 52,469,000
|         | Asia-Pacific |                          |   | 56,548,000     |             |                    | 49,132,000
|         |              |                          |   |                |             |                    |           
|         |              | Total Revenue            |   | $              | 236,097,000 |                    | $         
|         |              |                          |   |                |             |                    |           

The
increase in revenue for the Americas was primarily due to the acquisition of AES in July 2001. The operations of AES were entirely in the United States. The remaining increase
in the Americas revenue
as well as the increase for the other geographic regions was due primarily to increases in paid-up software licenses and software support and consulting services. The Americas reported
increases of $12,089,000 in software revenue and increases of $5,487,000 in services revenue, which included an increase of $4,250,000 from consulting services. Asia-Pacific reported
increases of $3,157,000 in software revenue and increases of $2,924,000 in services revenue, which included an increase of $715,000 from consulting services. Europe reported increases of $5,350,000 in
software revenue and increases of $2,535,000 in services revenue, which included an increase of $1,505,000 from consulting services. Systems revenues in 2001 totaled $22,170,000, $1,335,000 and
$3,026,000 for the Americas, Asia-Pacific and Europe, respectively.

Revenue
growth in 2001 was also impacted from unfavorable foreign currency translation rates for the Euro and the Japanese Yen. Revenue in 2001 would have been approximately $244,000,000
if translated using the prior year's foreign currency translation rates. Revenue in local currencies increased 30% and 24% in Asia-Pacific and Europe, respectively. Our international
operations in Europe and Asia-Pacific are sales organizations with high gross profit margins, which is due to these operations having minimal software development expenses. As a result, we
are exposed to the effects of foreign currency fluctuations of the United States Dollar versus the Japanese Yen and the Euro.

Cost of RevenueTotal cost of revenue was $81,610,000, or 35% of total revenue, compared to $44,853,000, or 25% of total
revenue, for the prior year.

Cost of RevenueSoftwareCost of revenuesoftware was $26,193,000, or 17% of software revenue, for
2001 compared to $22,648,000, or 17% of software revenue, for the prior year. These amounts include software amortization of $11,360,000 and $11,317,000 for 2001 and 2000, respectively.

Cost of RevenueServicesCost of revenueservices was $33,292,000, or 56% of services revenue, for
2001 compared to $22,205,000, or 46% of services revenue, for the prior year. The increase in cost of revenueservices, as a percentage of service revenue, was primarily due to an increase
in consulting and training revenue, which typically have lower margins than software support revenue.

Cost of RevenueSystemsCost of revenuesystems was $22,125,000, or 83% of systems revenue, for 2001.
The Company anticipates that cost of revenuesystems, as a percentage of systems revenue, will continue to approximate 85%.

Gross ProfitGross profit was $154,487,000, or 65% of total revenue, for 2001, compared to $133,171,000, or 75% of total
revenue, for 2000, an increase of $21,316,000, or 16%. The decrease in gross profit as a percentage of revenue was primarily due to the lower margins on systems revenue as compared with software and
services as described above.

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Operating ExpenseOperating expense was $134,093,000 for 2001 compared to $110,030,000 for the prior year, an increase of
$24,063,000, or 22%. As with revenue, our expenses are impacted by foreign currency fluctuations. Operating expenses (including cost of revenue) in 2001 would have been approximately $6,600,000 higher
if translated using the prior year's foreign currency translation rates.

Research and DevelopmentResearch and development expense for 2001 was $22,068,000 compared to $16,656,000 for 2000, an
increase of $5,412,000, or 32%. The total gross investment in software development activities for 2001 was $35,820,000, or 17% of total software and services revenue, compared to $30,311,000, or 17%
of total software and services revenue, for the prior year. The increase in total gross software development costs was due to additional projects in process in 2001 as compared to the prior year.
Capitalized product development costs and projected revenues are reviewed quarterly to determine if any impairment in value has occurred that would require an adjustment in the carrying value or
change in expected useful lives under the guidelines established under SFAS No. 86. Capitalized software development costs were $13,752,000 for 2001 compared to $13,655,000 for the prior year,
an increase of $97,000, or 1%. The amount of product development capitalized in any given period is a function of many factors, including the number of products under development at any point in time
as well as their stage of development. Our product development process is continually under review to improve efficiency and product quality, and to reduce time to market. Due to the continual change
in the product development process, there can be no assurance that the level of development capitalized in future periods will be comparable to current capitalized levels.

Selling, General and AdministrativeSelling, general and administrative expense was $99,253,000, or 42% of total revenue, for
2001 compared to $82,325,000, or 46% of total revenue, for 2000, an increase of $16,928,000, or 21%. Selling, general and administrative expenses in 2001 were impacted by the acquisition of AES and
the relocation of our corporate headquarters during 2001 to Santa Ana, California and Munich, Germany. The decrease in expense as a percentage of revenue can be attributed to economies of scale from
higher revenue volumes.

Amortization of Goodwill and Other IntangiblesAmortization of goodwill and other intangibles was $10,878,000 for 2001
compared to $11,049,000 for 2000. In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,"Business Combinations"and
SFAS No. 142,"Goodwill and Other Intangible Assets".Upon adoption of SFAS No. 142 in 2002, we ceased to amortize approximately
$56,000,000 of goodwill acquired prior to July 1, 2001. We recorded $6,633,000 of amortization on these amounts during 2001. In accordance with SFAS 142, the goodwill resulting from
the AES acquisition of $119,929,000 is not being amortized. Additionally, certain other intangible assets were classified as "indefinite lived intangibles" and are no longer amortized beginning on
January 1, 2002.

Restructuring ChargesRestructuring charges were $1,894,000, or 1% of total revenue, for 2001. In addition, we recorded a
restructuring accrual of $563,000 as part of the cost of acquisition of AES. These restructuring accruals and other write-downs consist of $1,807,000 of charges related to the consolidation of office
facilities and $650,000 to asset write-downs.

Operating IncomeOperating income was $20,394,000 for 2001 compared to $23,141,000 for 2000.

Total Other ExpenseTotal other expense was $3,535,000 for 2001 compared to $6,573,000 for 2000, a decrease of $3,038,000, or
46%.

Interest ExpenseInterest expense was $5,239,000 for 2001 compared to $6,679,000 for the prior year, a decrease of $1,440,000,
or 22%. The reduction in interest expense is primarily due to the conversion and redemption of our convertible subordinated debentures in the third quarter of 2001 and lower outstanding balances on
our bank term loan in 2001 as compared to the prior year. These decreases were partially offset by the interest expense on our new notes payable in connection with the acquisition of AES.

Other IncomeOther income was $1,704,000 for 2001 compared to $106,000 for 2000. Other income includes interest income, gains
and losses on property and equipment, currency translation gains and

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losses,
and other non-operating income or expense. The increase in 2001 was primarily the result of an increase in interest income of $590,000 from higher cash balances during 2001 and a
decrease in currency translation expense of $717,000.

Provision for Income TaxesThe effective income tax rate in 2001 was 39% as compared with 33% in 2000. The tax provision in
2000 was benefited by a net reduction in our valuation allowance of approximately $2,256,000 due to the reversal of $3,410,000 related to certain foreign deferred taxes, offset by an increase in the
valuation allowance on undistributed earnings of foreign subsidiaries.

CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the Untied States of
America. These accounting principles require us to make estimates, judgments and assumptions that affect the reported amounts of revenues, expenses, assets, liabilities and contingencies. All
significant estimates, judgments and assumptions are developed based on the best information available to us at the time made and are regularly reviewed and updated when necessary. Actual results will
generally differ from these estimates. Changes in estimates are reflected in our financial statements in the period of change based upon on-going actual experience trends or subsequent
settlements and realizations depending on the nature and predictability of the estimates and contingencies. Interim changes in estimates are generally applied prospectively within annual periods.

We
have identified the following as critical accounting policies to our company: revenue recognition, allowance for doubtful accounts and litigation, capitalized software costs and
valuation of long-lived and intangible assets and goodwill. These accounting policies are considered to be critical in evaluating and understanding our financial results because they
involve inherently uncertain matters and their application requires the most difficult and complex judgments and estimates.

Revenue Recognition on Software and Related ServiceWe provide a variety of licensing alternatives for
the use of our software products. Our software products have been primarily offered on an annual non-cancelable, pre-paid license basis. An annual non-cancelable,
pre-paid license is set at a fixed rate for the period and provides for payment in advance of use. In recent years, demand has also increased for paid-up licenses for software
products. A paid-up license provides significant revenue at the original time of sale of the product, with smaller payments for maintenance following the time of sale.

We
apply Statement of Position 97-2,"Software Revenue Recognition", as amended by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain
Transactions", to all transactions involving the sale of
software products.

For
the time-based licenses, maintenance services are included in the license fee and are for the same duration as the license term. As a result, the Company does not have
vendor specific objective evidence of fair value of each element (VSOE) and the entire fee of a time-based license is recognized ratably over the term of the lease. Revenue from the sale
of paid-up licenses is recognized when we receive persuasive evidence of an arrangement (generally a contract or purchase order), the software has been delivered to the customer, the price
charged the customer is fixed or determinable, and collection is probable. Software arrangements can include multiple elements consisting of the software license and maintenance, which includes
upgrades and technical support. Company specific objective evidence of the fair value of maintenance is determined based upon prices when sold separately or the renewal rate specified in the contract
with the customer. For multiple element arrangements when specific objective evidence of fair value does exist for all of the undelivered elements of the arrangement, but does not exist for one or
more of the delivered elements in the arrangement, we recognized revenue under the residual method. Under the residual method, at the outset of the arrangement with a customer, we defer revenue for
the fair value of the undelivered elements such as maintenance, and recognize the revenue for the remainder of the arrangement fee attributable to the elements initially delivered, such as software
licenses, when the criteria in SOP 97-2 have been met. Maintenance and support revenue is deferred and recognized ratably over the

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service
period. Due to our settlement with the FTC, for our arrangements with customers that convert to a paid-up license after November 1, 2002, we defer revenue for the fair value
of the Nastran paid-up license because the arrangement is cancelable under certain circumstances pursuant to the FTC settlement and, as a result, the fee is not considered to be fixed or
determinable. As of December 31, 2002, we have deferred approximately $6,400,000 of such revenue (which is included in the $26,600,000 above), which will be recognized ratably over a
48 month term until the customer requests a refund or the twelve month period to request such a refund lapses, at which time the remaining deferred revenue will be recognized. The twelve month
period to request a refund begins on the date we complete the divestiture of assets to one or more acquirers approved by the FTC.

Revenue
to be recognized from software arrangements is driven to a large extent by the nature of our contractual commitments to customers. If those commitments change in the future such
that we are required to provide services that are essential to the functionality of the software purchased by us or we commit to future deliverables for which specific objective evidence of fair value
does not exist, the timing of when we will be able to recognize revenue will be delayed. In addition, significant management judgments must be made and used in connection with the revenue recognized
in any accounting period. Material differences may result in the amount and timing of our revenue for any period if our management made different judgments.

Allowance for Doubtful Accounts and LitigationThe preparation of financial statements requires our
management to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reported period. Specifically, our management must make estimates of the uncollectibility of our accounts receivable. Management analyzes specific customer
accounts, historical bad debt, trends, customer concentrations, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts.
Significant management judgments and estimates must be made and used in connection with establishing the allowance for doubtful accounts in any accounting period. Material differences may result in
the amount and timing of our losses for any period if management made different judgments or utilized different estimates. The allowance for doubtful accounts was $3,249,000 at December 31,
2002.

We
do not currently maintain a reserve for any potential liability related to litigation. Management estimates the likelihood of loss and the range of liability related to pending
litigation based on claims for which our management can estimate the amount and range of loss. We record the minimum estimated liability related to those claims, where there is a range of probable
loss. Because of the uncertainties related to both the amount and range of loss on litigation, management may be unable to make a reasonable estimate of the liability that could result from an
unfavorable outcome. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of
the potential liability could materially impact our results of operations and financial position.

Capitalized Software CostsThe Company capitalizes software developed for sale or lease in accordance
with SFAS No. 86,"Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed". Software costs incurred subsequent to
the determination of the technological feasibility of the software product are capitalized. Significant management judgment is required in determining whether technological feasibility has been
achieved for a particular software project. Capitalization ceases and amortization of capitalized costs begins when the software product is available for general release to customers. Capitalized
software development costs, net of related amortization, are compared to management's estimate of projected revenues quarterly to determine if any impairment in value has occurred that would require
an adjustment in the carrying value or change in expected useful lives under the guidelines established under SFAS No. 86. The Company has $25,957,000 of capitalized software as of
December 31, 2002, net of accumulated amortization of $93,082,000. Capitalized software amortization expense is included in cost of license revenue. The amortization period for the software
costs capitalized is the economic life of the related products, typically two to three years.

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During the third quarter of fiscal 2002, we determined that $4,751,000 of capitalized software development costs were impaired and were written off and included in cost of revenue in
accordance with SFAS No. 86. The impairment was primarily due to the abandonment of certain products as a result of the acquisition of MDI as well as our restructuring during 2002. Significant
management judgment is required in evaluating capitalized software development costs for impairment because of the estimates involved in projecting future related product revenues.

Valuation of Long-Lived and Intangible Assets and GoodwillIn accordance with SFAS
No. 144,"Accounting for the Impairment or Disposal of Long-Lived Assets", except for goodwill and other indefinite lived
intangibles, we recognize impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by
those assets are less than the assets' carrying amounts. Factors considered important which could trigger an impairment review include, but are not limited to, significant underperformance relative to
expected historical or projected future operating results, significant changes in the manner of use of the assets or the strategy for our overall business and significant negative industry or economic
trends. If such assets are identified to be impaired, the impairment to be recognized is the amount by which the carrying value of the asset exceeds the fair value of the asset.

When
we determine that the carrying value of long-lived assets, excluding goodwill and other indefinite lived intangibles, may not be recoverable based upon the existence of
one or more of the above indicators of impairment and the carrying value of the asset cannot be recovered from projected undiscounted cash flows, we measure any impairment based on the present value
of estimated expected future cash flows using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. Long-lived assets,
excluding goodwill and other indefinite lived intangibles, amounted to $121,839,000 as of December 31, 2002. Significant management judgment is required in determining whether an indicator of
impairment exists and projecting cash flows. Any changes in the assumptions used in projecting cash flows or determining an appropriate discount rate could impact the assessed value of an asset and
result in an impairment charged equal to the amount by which its carrying value exceeds its actual or estimated fair value.

Goodwill
and other indefinite lived intangibles are tested annually or on an interim basis if events or circumstances indicate that the fair value of the asset has decreased below its
carrying value. The impairment review consists of a two step process:



Goodwill
and other indefinite lived intangibles amounted to $216,058,000 as of December 31, 2002.

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In
2002, Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" became effective and
as a result, we ceased to amortize approximately $56,000,000 of goodwill acquired prior to July 1, 2001. Additionally, certain other intangible assets were classified as "indefinite lived
intangibles" and are no longer amortized beginning on January 1, 2002. We recorded $6,633,000 of amortization on goodwill and indefinite lived intangibles during 2001. In lieu of amortization,
we will be required to perform an annual impairment review of the goodwill and indefinite lived intangible balance. Effective January 1, 2002, we completed the transitional impairment test
required upon the initial adoption of SFAS No. 142 and recorded a $39,300,000 non-cash charge to reduce the carrying value of existing goodwill.

Accounting for Income TaxesWe estimate our income tax provision to recognize our tax expense for the current year and our
deferred tax liabilities and assets for future tax consequences of events that have been recognized in our financial statements using current enacted tax laws. Deferred tax assets must be assessed
based upon the likelihood of recoverability from future taxable income and to the extent that recovery is not likely, a valuation allowance is established. The allowance is regularly reviewed and
updated for changes in circumstances that would cause a change in judgment about the realizability of the related deferred tax assets. These calculations and assessments involve complex estimates and
judgments because the ultimate tax outcome can be uncertain or future events unpredictable.

LIQUIDITY AND CAPITAL RESOURCES

In the past, working capital needed to finance our operations has been provided by cash on hand and from cash flow from operations. We believe that cash generated
from operations will continue to provide sufficient capital for normal working capital needs in the foreseeable future. We may engage in additional financing methods that we believe are advantageous,
particularly to finance acquisitions. Net cash provided by operating activities was $30,284,000 and $32,810,000 for the years ended December 31, 2002 and 2001, respectively. Our working capital
(current assets minus current liabilities) at December 31, 2002 was $7,789,000 compared to $93,822,000 at December 31, 2001, a decrease of $86,033,000. The decrease in working capital
was primarily caused by the acquisition of MDI, which was acquired through the use of existing cash and additional debt, as discussed below.

Net
cash provided by operating activities was $30,284,000 for 2002 compared to $32,810,000 for 2001. Cash flow from operating activities was impacted by the decrease in net income (loss)
to a net loss of $51,329,000 for 2002 compared to net income of $10,271,000 in 2001. Net loss for 2002 includes non-cash impairment charges and write-offs including impairment of goodwill of
$39,300,000, impairment of capitalized software costs of $4,751,000, write-off of acquired in-process technology of $2,380,000 and write-off of capitalized debt issuance costs of $1,471,000.

Cash
flow from operating activities was also impacted by an increase in depreciation and amortization of property and equipment of $4,135,000 and a decrease in amortization of goodwill
and other intangibles of $4,304,000. Depreciation and amortization of property and equipment increased primarily due to the acquisitions of AES in July 2001 and MDI in April 2002 and the relocation of
our corporate headquarters in 2001. Amortization of goodwill and other intangibles decreased due to the adoption of SFAS No. 142 effective January 1, 2002.

Changes
in our balance sheet, excluding the effect of acquisitions, also affected cash flow from operations. The net change of accounts receivable increased by $23,282,000 which was
impacted by an increase in Systems revenues in 2001 due to the acquisition of AES and to several significant paid-up software license agreements in the fourth quarter of 2001. The net change of other
current liabilities increased by $7,248,000 which was primarily due to an increase in accruals. A decrease in deferred income taxes and tax benefit of stock options of $12,223,000 was primarily due to
a change in business credits, foreign tax credits and other temporary differences. The decrease in the net change of other current assets of $3,024,000 was primarily due to an increase in prepaid
expenses. The decrease in the net change of

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deferred
revenue of $2,448,000 was primarily due to more customers purchasing paid-up software licenses instead of time-based licenses. The net change in the restructuring reserve decreased by
$2,062,000 as amounts previously reserved for were paid.

Net
cash used in investing activities was $142,204,000 in 2002 compared to $44,076,000 in 2001. The increase in cash used in investing activities was primarily due to the acquisition of
MDI in the second quarter of 2002, offset by a reduction in the acquisition of property and equipment. The acquisition of property and equipment in 2001 included purchases related to the relocation of
our corporate headquarters to Santa Ana, California.

Net
cash provided by financing activities was $53,088,000 in 2002 compared to $70,296,000 in 2001. During 2002, financing activities included debt incurred in connection with the
acquisition of MDI. During 2001, we received proceeds of $67,356,000 from a public offering of our common stock. In addition, proceeds from the exercise of common stock options and warrants decreased
to $4,802,000 in 2002 from $10,415,000 in 2001.

In
connection with the acquisition of MDI in April 2002, we entered into a Revolving Credit and Term Loan Agreement, as amended ("Loan Agreement"), with a bank. The Loan Agreement
included a $6,728,000 revolving line of credit and a $65,000,000 term loan. In November 2002, we replaced the Loan Agreement with a new Loan and Security Agreement, including subsequent
amendments ("New Loan Agreement"), with a new lender ("Lender"). The New Loan Agreement includes a $15,000,000 revolving line of credit and a $55,000,000 term loan. Borrowings under the revolving line
of credit are limited to a borrowing base of up to 85% of eligible domestic accounts receivable, as defined. All amounts outstanding under the previous Loan Agreement were repaid.

The
term loan is secured by substantially all of our assets and bears interest at the greater of 7% or the Lender's prime rate (4.25% as of December 31, 2002) plus 5%. Advances on
the revolving line of credit bear interest at the greater of 7% or the Lender's prime rate plus 2.25%. The New Loan Agreement expires in November 2006. As of December 31, 2002,
$53,854,000 of the term loan was outstanding and no amount was outstanding on the line of credit. We had $13,214,000 of availability on the line of credit as of December 31, 2002. The New Loan
Agreement requires maintenance of certain financial covenants, including minimum EBITDA, minimum recurring revenue and minimum liquidity, as those terms are defined in the New Loan Agreement, and
non-financial covenants including requirements to provide various financial statements, reports and certifications in the forms and at the times specified in the New Loan Agreement. We are
in compliance with all such covenants, as amended.

The
New Loan Agreement required an origination fee of approximately $2,100,000, which is being amortized to expense over the 48 months of the term loan. In addition, an annual
facility fee of 1.50% of the total outstanding commitment will be paid and expensed quarterly. In connection with the New Loan Agreement, $1,471,000 of capitalized loan fees related to the Loan
Agreement were written off in November 2002 and included as interest expense in the accompanying consolidated statements of operations.

In
connection with the Loan Agreement, $533,000 related to prior bank debt was repaid.

On
August 1, 2001, we completed the sale of 4,025,000 shares of our common stock in a public offering. The net proceeds to us, after the underwriter discount and estimated
expenses, were approximately $67,356,000. We also received cash in the aggregate amount of $4,802,000 and $10,415,000 from the exercise of common stock options and warrants during 2002 and 2001,
respectively.

In
1994, we issued $56,608,000 of convertible subordinated debentures in connection with an acquisition. An additional $2,000,000 principal amount of convertible subordinated debentures
was issued, at a discount, in 1999 in connection with the MARC acquisition. The debentures bore interest at 77/8% with interest payments due semi-annually on March 15
and September 15. The conversion feature permitted the holder to convert the debentures into shares of our common stock at a conversion price of $15.15 per

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share.
The debentures were to mature August 18, 2004, but were redeemable at our option at any time after August 18, 1997 upon payment of a premium. On July 31, 2001, we gave
notice to the holders of our convertible subordinated debentures of our intent to redeem all such debentures. The holders continued to have the right to convert the debentures into shares of our
common stock at $15.15 per share until August 31, 2001. Holders converted $57,515,000 principal of the debentures into 3,796,320 shares of common stock and the remaining debentures were
redeemed for $1,041,000 (or 100.89% of the principal balance) plus accrued interest. Holders who elected to convert forfeited their rights to receive accrued interest that would otherwise be paid on
the redemption date. The forfeited interest of approximately $2,059,000 was recorded as expense and such accrued and unpaid interest, net of the tax effect of $858,000, was credited to common stock as
part of the conversions.

In
1999, we also issued subordinated notes payable in connection with the MARC acquisition in the aggregate principal amount of $14,236,000. The subordinated notes payable bear interest
at 8% with interest payments due semi-annually in January and July. The estimated interest payment to be paid in January 2003 is $320,000. In February 2002, the holder of
these subordinated debentures used $3,000,000 of such debt as payment for the exercise of warrants. The entire remaining principal balance as of December 31, 2002 of $8,000,000 is due by
June 2009.

In
connection with the acquisition of AES, we issued notes payable to the former shareholders of AES in the aggregate principal amount of $20,000,000. The notes bear interest at 7% with
interest only payments due semi-annually in January and July. The estimated interest payment to be paid in January 2003 is $700,000. The entire principal balance as of
December 31, 2002 of $20,000,000 is due in July 2004. We also assumed a note payable to Dassault Systemes of America Corporation ("DSA") as part of the acquisition of AES. The note bears
interest at 3.2%. We will repay the principal balance of the loan from commissions earned by selling DSA products. Any remaining unpaid principal balance will be due in June 2003. The
outstanding principal of the DSA note payable at December 31, 2002 was $4,897,000.

We
expect to continue to invest a substantial portion of our revenues in the development of new computer software technologies and products and the enhancement of certain existing
products. During 2001 and 2000, we expended a total of $41,347,000 and $35,820,000, respectively, on development efforts, of which $13,979,000 and $13,752,000, respectively, were capitalized. Product
development costs and the capitalization rate may vary depending, in part, on the number of products and the stage of development of the products in process.

During
2002 and 2001, we acquired $11,515,000 and $22,833,000, respectively, of new property and equipment. The decrease in 2002 was primarily due to additional costs in 2001 associated
with the relocation of our Corporate Headquarters to a new facility in Santa Ana, California. Capital expenditures also included upgrades in computer equipment in order to keep current with
technological advances and upgrades of facilities worldwide. Our capital expenditures vary from year to year, as required by business needs. We intend to continue to expand the capabilities of our
computer equipment used in the development and support of our proprietary software products.

We
do not plan to pay dividends in the foreseeable future. In addition, our New Loan Agreement contains restrictions on the payment of dividends.

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The
following summarizes our contractual obligations at December 31, 2002, and the effect such obligations are expected to have on our liquidity and cash flow in future periods:

|                         |                                    | As of December 31, 2002
|------------------------ | ---------------------------------- | -----------------------
|
|Contractual Obligations: |                                    |                        
|                         | Note Payable                       |                        
|                         | Subordinated Notes Payable         |                        
|                         | Notes Payable to Shareholders      |                        
|                         | Operating Lease Obligations        |                        
|                         |                                    |                        
|                         | Total Contractual Cash Obligations |                        
|                         |                                    |                        

EURO CONVERSION

On January 1, 1999, eleven of the fifteen member countries of the European Union (the "participating countries") established fixed conversion rates between
their existing sovereign currencies (the "legacy currencies") and the Euro currency, adopting the Euro as their common legal currency on that date. The legacy currencies remained legal tender in the
participating countries as denominations of the Euro between January 1, 1999 and January 1, 2002. During this transition period, public and private parties paid for goods and services
using either the Euro or the participating country's legacy currency on a "no compulsion, no prohibition" basis whereby recipients accepted Euros or the legacy currency as offered by the payer.
Beginning January 1, 2002, the participating countries issued new Euro-denominated bills and coins and replaced the legacy currencies as legal tender in cash transactions by
July 1, 2002.

We
have implemented an upgrade to our management information system, which includes the ability to simultaneously record transactions in Euros, perform the prescribed currency conversion
computations and convert legacy currency amounts to Euro. As a result, the impact of the conversion on currency risk and taxable income has not been significant.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In April 2002, the Financial Accounting Standards Board ("FASB") issued Statement No. 145, "Rescission of the FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145 eliminates the requirements to
classify gains and losses from the extinguishment of indebtedness as extraordinary, requires certain lease modifications to be treated the same as a sale-leaseback transaction, and makes
other non-substantive technical corrections to existing pronouncements. SFAS 145 is effective for fiscal years beginning after May 15, 2002, with earlier adoption encouraged.
Management does not believe that the adoption of this standard will have a material impact on our financial position.

In
July 2002, the FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities"
("SFAS 146"). SFAS 146 requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal
plan. Examples of costs covered by SFAS 146 include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operations, plant closing
or other exit or disposal activities. SFAS 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged. Management
does not believe that the adoption of this standard will have a material impact on our financial position.

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In
December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure, an Amendment to FASB
Statement No. 123" ("SFAS 148"). SFAS 148 provides alternative methods of transition for an entity that voluntarily changes to the fair value based method
of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS 123 to require prominent disclosure about the effects on reported net income of an entity's
accounting policy decisions with respect to stock-based employee compensation. Finally, SFAS 148 amends APB Opinion No. 28, Interim Financial Reporting, to require disclosures about
those effects in interim financial information. The amendments to SFAS No. 123 that provide alternative methods of transition for an entity that voluntarily changes to the fair value based
method of accounting for stock-based employee compensation are effective for financial statements for fiscal years ending after December 31, 2002. The amendment to SFAS No. 123 relating
to the disclosures and the amendment to Opinion 28 is effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. The
adoption of this standard did not have a material impact on our financial statements.

In
November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby
letters of credit, and provides new disclosure requirements regarding indemnification provisions typically included in a software license arrangement. FIN 45 also clarifies that at the time a company
issues a guarantee, it must recognize an initial liability for the fair value of the obligation it
assumes under that guarantee, including its ongoing obligation to stand ready to perform over the term of the guarantee in the event that specified triggering events or conditions occur. The
provisions related to recognizing a liability at inception of the guarantee do not apply to product warranties, indemnification provisions in software license arrangements, or guarantees accounted for
as derivatives. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements for
FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of FIN 45 did not have a material impact on our financial position or
results of operations.

In
January 2003 the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), an
interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements". FIN 46 explains how to identify variable interest
entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. This interpretation requires existing unconsolidated variable interest
entities to be consolidated by their primary beneficiaries if the primary beneficiary is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive
a majority of the entity's residual returns, or both. FIN 46 is effective immediately for variable interest entities created after January 31, 2003, and to variable interest entities in which
an enterprise obtains an interest after that date. The Interpretation applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an
enterprise holds a variable interest that it acquired before February 1, 2003. We do not expect the adoption of FIN 46 to have a material impact on our financial position or results of
operations.

The
Emerging Issues Task Force "EITF" recently reached a consensus on its tentative conclusions for EITF 00-21, "Revenue Arrangements with Multiple
Deliverables." EITF 00-21 provides accounting guidance for the allocation of revenue where delivery or performance of products, services and/or performance may
occur at different points in time or over different periods of time. Companies are required to adopt this consensus for fiscal periods beginning after June 15, 2003. We believe the adoption of
EITF 00-21 will not have a material impact on our financial position or results of operations.

40

---



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                                                                     |  | Page
|---------------------------------------------------------------------------------------------------- |  | ----
|Consolidated Balance Sheets as of December 31, 2002 and 2001                                         |  | 42  
|Consolidated Statements of Operations for the Years Ended
December 31, 2002, 2001 and 2000           |  | 43  
|Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 2002, 2001 and 2000 |  | 44  
|Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002, 2001 and 2000           |  | 45  
|Notes to Consolidated Financial Statements                                                           |  | 46  
|Report of KPMG LLP, Independent Auditors                                                             |  | 87  
|Report of Ernst & Young LLP, Independent Auditors                                                    |  | 88  

41

---



MSC.SOFTWARE CORPORATION        CONSOLIDATED BALANCE SHEETS        DECEMBER 31, 2002 AND 2001

|                                                    |                                                                                                                | 2002                       |                                            | 2001        |            
|--------------------------------------------------- | -------------------------------------------------------------------------------------------------------------- | -------------------------- | ------------------------------------------ | ----------- | -----------
|ASSETS                                              |                                                                                                               
|Current Assets:                                     |                                                                                                                |                            |                                            |             |            
|                                                    | Cash and Cash Equivalents                                                                                      |                            | $                                          | 29,387,000  |            
|                                                    | Investments                                                                                                    |                            |                                            | 5,177,000   |            
|                                                    | Trade Accounts Receivable, Net of Allowance of $3,249,000 and $2,548,000                                       |                            |                                            | 97,636,000  |            
|                                                    | Deferred Tax Assets                                                                                            |                            |                                            | 19,839,000  |            
|                                                    | Other Current Assets                                                                                           |                            |                                            | 17,338,000  |            
|                                                    |                                                                                                                |                            |                                            |             |            
|                                                    |                                                                                                                | Total Current Assets       |                                            |             | 169,377,000
|Property and Equipment, Net                         |                                                                                                                |                            | 35,511,000                                 |             |            
|Capitalized Software Costs, Net                     |                                                                                                                |                            | 25,957,000                                 |             |            
|Goodwill and Indefinite Lived Intangibles, Net      |                                                                                                                |                            | 216,058,000                                |             |            
|Other Intangible Assets, Net                        |                                                                                                                |                            | 48,730,000                                 |             |            
|Other Assets                                        |                                                                                                                |                            | 11,641,000                                 |             |            
|                                                    |                                                                                                                |                            |                                            |             |            
|                                                    |                                                                                                                | Total Assets               |                                            | $           | 507,274,000
|                                                    |                                                                                                                |                            |                                            |             |            
|LIABILITIES AND SHAREHOLDERS' EQUITY                |                                                                                                               
|Current Liabilities:                                |                                                                                                                |                            |                                            |             |            
|                                                    | Accounts Payable                                                                                               |                            | $                                          | 32,706,000  |            
|                                                    | Current Portion of Note Payable                                                                                |                            |                                            | 13,750,000  |            
|                                                    | Current Portion of Notes Payable to Shareholders                                                               |                            |                                            | 4,590,000   |            
|                                                    | Deferred Revenue                                                                                               |                            |                                            | 67,327,000  |            
|                                                    | Compensation and Related Expenses                                                                              |                            |                                            | 14,732,000  |            
|                                                    | Restructuring Reserve                                                                                          |                            |                                            | 4,207,000   |            
|                                                    | Other Current Liabilities                                                                                      |                            |                                            | 24,276,000  |            
|                                                    |                                                                                                                |                            |                                            |             |            
|                                                    |                                                                                                                | Total Current Liabilities  |                                            |             | 161,588,000
|Deferred Income Taxes                               |                                                                                                                |                            | 29,243,000                                 |             |            
|Note Payable, Less Current Portion                  |                                                                                                                |                            | 40,104,000                                 |             |            
|Notes Payable to Shareholders, Less Current Portion |                                                                                                                |                            | 19,880,000                                 |             |            
|Subordinated Notes Payable, Less Current Portion    |                                                                                                                |                            | 6,817,000                                  |             |            
|Other Long-Term Liabilities                         |                                                                                                                |                            | 7,162,000                                  |             |            
|Commitments and Contingencies (Note 15)             |                                                                                                                |                            |                                            |             |            
|Shareholders' Equity:                               |                                                                                                                |                            |                                            |             |            
|                                                    | Preferred Stock, $0.01 Par Value, 10,000,000 Shares Authorized; No Shares Issued and Outstanding               |                            |                                            |            |            
|                                                    | Common Stock, $0.01 Par Value, 100,000,000 Shares Authorized; 29,776,100 and 28,653,100 Issued and Outstanding |                            |                                            | 298,000     |            
|                                                    | Additional Paid-in Capital                                                                                     |                            |                                            | 282,058,000 |            
|                                                    | Accumulated Other Comprehensive Loss                                                                           |                            |                                            | (3,367,000  | )          
|                                                    | Retained Earnings (Accumulated Deficit)                                                                        |                            |                                            | (36,232,000 | )          
|                                                    | Treasury Shares, At Cost (40,000 Shares)                                                                       |                            |                                            | (277,000    | )          
|                                                    |                                                                                                                |                            |                                            |             |            
|                                                    |                                                                                                                | Total Shareholders' Equity |                                            |             | 242,480,000
|                                                    |                                                                                                                |                            |                                            |             |            
|                                                    |                                                                                                                |                            | Total Liabilities and Shareholders' Equity |             | $          
|                                                    |                                                                                                                |                            |                                            |             |            

See accompanying notes to consolidated financial statements.

42

---



MSC.SOFTWARE CORPORATION        CONSOLIDATED STATEMENTS OF OPERATIONS        YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

|                                                                                                                  |                                                      | 2002                              |             | 2001        |             | 2000        |            
|----------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------- | --------------------------------- | ----------- | ----------- | ----------- | ----------- | -----------
|REVENUE:                                                                                                          |                                                      |                                   |             |             |             |             |            
|                                                                                                                  | Software                                             |                                   | $           | 160,361,000 |             | $           | 150,342,000
|                                                                                                                  | Services                                             |                                   |             | 87,790,000  |             |             | 59,224,000 
|                                                                                                                  | Systems                                              |                                   |             | 96,000,000  |             |             | 26,531,000 
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|                                                                                                                  |                                                      | Total Revenue                     |             |             | 344,151,000 |             |            
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|COST OF REVENUE:                                                                                                  |                                                      |                                   |             |             |             |             |            
|                                                                                                                  | Software                                             |                                   |             | 22,468,000  |             |             | 26,193,000 
|                                                                                                                  | SoftwareImpairment of Capitalized Development Costs |                                   |             | 4,751,000   |             |             |           
|                                                                                                                  | Services                                             |                                   |             | 54,299,000  |             |             | 33,292,000 
|                                                                                                                  | Systems                                              |                                   |             | 81,359,000  |             |             | 22,125,000 
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|                                                                                                                  |                                                      | Total Cost of Revenue             |             |             | 162,877,000 |             |            
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|GROSS PROFIT                                                                                                      |                                                      |                                   | 181,274,000 |             |             | 154,487,000 |            
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|OPERATING EXPENSE:                                                                                                |                                                      |                                   |             |             |             |             |            
|                                                                                                                  | Research and Development                             |                                   |             | 27,368,000  |             |             | 22,068,000 
|                                                                                                                  | Selling, General and Administrative                  |                                   |             | 145,520,000 |             |             | 99,253,000 
|                                                                                                                  | Amortization of Goodwill and Other Intangibles       |                                   |             | 6,574,000   |             |             | 10,878,000 
|                                                                                                                  | Restructuring Charges                                |                                   |             | 9,064,000   |             |             | 1,894,000  
|                                                                                                                  | Write-Off of Acquired In-Process Technology          |                                   |             | 2,380,000   |             |             |           
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|                                                                                                                  |                                                      | Total Operating Expense           |             |             | 190,906,000 |             |            
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|OPERATING INCOME (LOSS)                                                                                           |                                                      |                                   | (9,632,000  | )           |             | 20,394,000  |            
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|OTHER EXPENSE (INCOME):                                                                                           |                                                      |                                   |             |             |             |             |            
|                                                                                                                  | Interest Expense                                     |                                   |             | 8,101,000   |             |             | 5,239,000  
|                                                                                                                  | Other Income, Net                                    |                                   |             | 165,000     |             |             | (1,704,000 
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|                                                                                                                  |                                                      | Total Other Expense, Net          |             |             | 8,266,000   |             |            
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|INCOME (LOSS) BEFORE PROVISION (BENEFIT) FOR INCOME TAXES AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE |                                                      |                                   | (17,898,000 | )           |             | 16,859,000  |            
|Provision (Benefit) for Income Taxes                                                                              |                                                      |                                   | (5,869,000  | )           |             | 6,588,000   |            
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE                                          |                                                      |                                   | (12,029,000 | )           |             | 10,271,000  |            
|CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE                                                               |                                                      |                                   | (39,300,000 | )           |             |            |            
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|NET INCOME (LOSS)                                                                                                 |                                                      | $                                 | (51,329,000 | )           | $           | 10,271,000  |            
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|EARNINGS (LOSS) PER SHARE BEFORE CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE:                             |                                                      |                                   |             |             |             |             |            
|                                                                                                                  |                                                      | BASIC EARNINGS (LOSS) PER SHARE   |             | $           | (0.41       | )           | $          
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|                                                                                                                  |                                                      | DILUTED EARNINGS (LOSS) PER SHARE |             | $           | (0.41       | )           | $          
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|EARNINGS (LOSS) PER SHARE:                                                                                        |                                                      |                                   |             |             |             |             |            
|                                                                                                                  |                                                      | BASIC EARNINGS (LOSS) PER SHARE   |             | $           | (1.75       | )           | $          
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|                                                                                                                  |                                                      | DILUTED EARNINGS (LOSS) PER SHARE |             | $           | (1.75       | )           | $          
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|Basic Weighted-Average Shares Outstanding                                                                         |                                                      |                                   | 29,379,000  |             |             | 20,606,000  |            
|                                                                                                                  |                                                      |                                   |             |             |             |             |            
|Diluted Weighted-Average Shares Outstanding                                                                       |                                                      |                                   | 29,379,000  |             |             | 21,900,000  |            
|                                                                                                                  |                                                      |                                   |             |             |             |             |            

See accompanying notes to consolidated financial statements.

43

---

MSC.SOFTWARE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

|                             |                                                                             | Shares of
Common Stock      |           | Shareholders' Equity |      
|---------------------------- | --------------------------------------------------------------------------- | --------------------------- | --------- | -------------------- | -----
|
|
|Balance at January 1, 2000   |                                                                             | 13,841,600                  |           | (49,000              | )    
|                             | Net Income                                                                  |                             |          |                      |     
|                             | Currency Translation Adjustment                                             |                             |          |                      |     
|                             | Unrealized Investment Gain, Net of Tax                                      |                             |          |                      |     
|                             |                                                                             |                             |           |                      |      
|                             |                                                                             | Comprehensive Income        |           |                      |      
|                             | Treasury Shares Used for Compensation                                       |                             |          |                      | 9,000
|                             | Shares Issued Under Employee Stock Option and Employee Stock Purchase Plans |                             | 331,800   |                      |     
|                             |                                                                             |                             |           |                      |      
|Balance at December 31, 2000 |                                                                             | 14,173,400                  |           | (40,000              | )    
|Net Income                   |                                                                             |                            |           |                     |      
|                             | Currency Translation Adjustment                                             |                             |          |                      |     
|                             | Unrealized Investment Gain, Net of Tax                                      |                             |          |                      |     
|                             |                                                                             |                             |           |                      |      
|                             |                                                                             | Comprehensive Income        |           |                      |      
|                             | Shares and Options Issued for Business Acquired                             |                             | 5,281,100 |                      |     
|                             | Shares Issued for Cash, Net of Costs                                        |                             | 4,025,000 |                      |     
|                             | Shares Issued Upon Conversion of Debentures                                 |                             | 3,796,300 |                      |     
|                             | Shares Issued Upon Exercise of Warrants                                     |                             | 177,200   |                      |     
|                             | Shares Issued as Compensation                                               |                             | 28,500    |                      |     
|                             | Shares Issued Under Employee Stock Option and Employee Stock Purchase Plans |                             | 1,171,600 |                      |     
|                             |                                                                             |                             |           |                      |      
|Balance at December 31, 2001 |                                                                             | 28,653,100                  |           | (40,000              | )    
|                             | Net Income (Loss)                                                           |                             |          |                      |     
|                             | Currency Translation Adjustment                                             |                             |          |                      |     
|                             | Unrealized Investment Gain, Net of Tax                                      |                             |          |                      |     
|                             |                                                                             |                             |           |                      |      
|                             |                                                                             | Comprehensive Income (Loss) |           |                      |      
|                             | Shares Issued for Business Acquired                                         |                             | 68,000    |                      |     
|                             | Shares Issued Upon Exercise of Warrants                                     |                             | 300,000   |                      |     
|                             | Shares and Warrants Issued as Compensation                                  |                             | 61,500    |                      |     
|                             | Shares Issued Under Employee Stock Option and Employee Stock Purchase Plans |                             | 693,500   |                      |     
|                             |                                                                             |                             |           |                      |      
|Balance at December 31, 2002 |                                                                             | 29,776,100                  |           | (40,000              | )    
|                             |                                                                             |                             |           |                      |      

See accompanying notes to consolidated financial statements.

44

---



MSC.SOFTWARE CORPORATION        CONSOLIDATED STATEMENTS OF CASH FLOWS        YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

|                                                             |                                                                                          | 2002                                                               |                                           | 2001                                                |             | 2000        |             
|------------------------------------------------------------ | ---------------------------------------------------------------------------------------- | ------------------------------------------------------------------ | ----------------------------------------- | --------------------------------------------------- | ----------- | ----------- | ------------
|CASH FLOWS FROM OPERATING ACTIVITIES:                        |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|                                                             | Net Income (Loss)                                                                        |                                                                    | $                                         | (51,329,000                                         | )           | $           | 10,271,000  
|                                                             | Adjustments to Reconcile Net Income (Loss) to Net Cash Provided By Operating Activities: |                                                                    |                                           |                                                     |             |             |             
|                                                             |                                                                                          | Provision for Doubtful Accounts                                    |                                           |                                                     | 1,815,000   |             |             
|                                                             |                                                                                          | Depreciation and Amortization of Property and Equipment            |                                           |                                                     | 10,951,000  |             |             
|                                                             |                                                                                          | Amortization of Capitalized Software Costs                         |                                           |                                                     | 9,933,000   |             |             
|                                                             |                                                                                          | Impairment of Goodwill                                             |                                           |                                                     | 39,300,000  |             |             
|                                                             |                                                                                          | Impairment of Capitalized Software Costs                           |                                           |                                                     | 4,751,000   |             |             
|                                                             |                                                                                          | Amortization of Goodwill and Other Intangibles                     |                                           |                                                     | 6,574,000   |             |             
|                                                             |                                                                                          | Write-Off of Acquired In-Process Technology                        |                                           |                                                     | 2,380,000   |             |             
|                                                             |                                                                                          | Amortization of Discounts                                          |                                           |                                                     | 522,000     |             |             
|                                                             |                                                                                          | (Gain) Loss on Disposal of Property and Equipment                  |                                           |                                                     | 64,000      |             |             
|                                                             |                                                                                          | Write-Off of Capitalized Debt Issuance Costs                       |                                           |                                                     | 1,471,000   |             |             
|                                                             |                                                                                          | Common Stock and Warrants Issued as Compensation                   |                                           |                                                     | 1,400,000   |             |             
|                                                             |                                                                                          | Deferred Income Taxes and Tax Benefit of Stock Options             |                                           |                                                     | (8,618,000  | )           |             
|                                                             |                                                                                          | Non-Cash Interest Expense, Net of Tax                              |                                           |                                                     |            |             |             
|                                                             |                                                                                          | Changes in Assets and Liabilities, Net of Effects of Acquisitions: |                                           |                                                     |             |             |             
|                                                             |                                                                                          |                                                                    | Trade Accounts Receivable                 |                                                     |             | (2,149,000  | )           
|                                                             |                                                                                          |                                                                    | Other Current Assets                      |                                                     |             | (3,179,000  | )           
|                                                             |                                                                                          |                                                                    | Accounts Payable                          |                                                     |             | 3,492,000   |             
|                                                             |                                                                                          |                                                                    | Deferred Revenue                          |                                                     |             | 7,459,000   |             
|                                                             |                                                                                          |                                                                    | Compensation and Related Expenses         |                                                     |             | 2,086,000   |             
|                                                             |                                                                                          |                                                                    | Restructuring Reserve                     |                                                     |             | (2,062,000  | )           
|                                                             |                                                                                          |                                                                    | Other Current Liabilities                 |                                                     |             | 5,423,000   |             
|                                                             |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|                                                             |                                                                                          |                                                                    |                                           | Net Cash Provided By Operating Activities           |             |             | 30,284,000  
|                                                             |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|CASH FLOWS FROM INVESTING ACTIVITIES:                        |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|                                                             | Acquisition of Property and Equipment                                                    |                                                                    |                                           | (11,515,000                                         | )           |             | (22,833,000 
|                                                             | Businesses Acquired, Net of Cash Received                                                |                                                                    |                                           | (115,701,000                                        | )           |             | (5,767,000  
|                                                             | Purchase of Software                                                                     |                                                                    |                                           | (150,000                                            | )           |             | (381,000    
|                                                             | Capitalized Software Development Costs                                                   |                                                                    |                                           | (13,979,000                                         | )           |             | (13,752,000 
|                                                             | Other                                                                                    |                                                                    |                                           | (859,000                                            | )           |             | (1,343,000  
|                                                             |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|                                                             |                                                                                          |                                                                    |                                           | Net Cash Used In Investing Activities               |             |             | (142,204,000
|                                                             |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|CASH FLOWS FROM FINANCING ACTIVITIES:                        |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|                                                             | Proceeds/Repayments on Line of Credit, Net                                               |                                                                    |                                           |                                                    |             |             |            
|                                                             | Proceeds from Note Payable                                                               |                                                                    |                                           | 120,000,000                                         |             |             |            
|                                                             | Repayments of Note Payable                                                               |                                                                    |                                           | (67,479,000                                         | )           |             | (6,436,000  
|                                                             | Debt Issuance Costs                                                                      |                                                                    |                                           | (4,235,000                                          | )           |             |            
|                                                             | Redemption of Convertible Debentures                                                     |                                                                    |                                           |                                                    |             |             | (1,039,000  
|                                                             | Issuance of Common Stock in Public Offering                                              |                                                                    |                                           |                                                    |             |             | 67,356,000  
|                                                             | Exercise of Common Stock Options and Warrants                                            |                                                                    |                                           | 4,802,000                                           |             |             | 10,415,000  
|                                                             |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|                                                             |                                                                                          |                                                                    |                                           | Net Cash Provided By (Used In) Financing Activities |             |             | 53,088,000  
|                                                             |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|EFFECT OF EXCHANGE RATE CHANGES ON CASH                      |                                                                                          |                                                                    | 2,163,000                                 |                                                     |             | (1,780,000  | )           
|                                                             |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS         |                                                                                          |                                                                    | (56,669,000                               | )                                                   |             | 57,250,000  |             
|Cash and Cash Equivalents at Beginning of the Year           |                                                                                          |                                                                    | 86,056,000                                |                                                     |             | 28,806,000  |             
|                                                             |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|CASH AND CASH EQUIVALENTS AT END OF THE YEAR                 |                                                                                          | $                                                                  | 29,387,000                                |                                                     | $           | 86,056,000  |             
|                                                             |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|Supplemental Cash Flow Information:                          |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|                                                             | Income Taxes Paid                                                                        |                                                                    | $                                         | 925,000                                             |             | $           | 2,202,000   
|                                                             | Interest Paid                                                                            |                                                                    | $                                         | 5,323,000                                           |             | $           | 3,692,000   
|Reconciliation of Businesses Acquired, Net of Cash Received: |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|                                                             | Fair Value of Assets Acquired                                                            |                                                                    | $                                         | 143,557,000                                         |             | $           | 138,053,000 
|                                                             | Non-Cash Financing of Purchase Price and Liabilities Assumed:                            |                                                                    |                                           |                                                     |             |             |             
|                                                             |                                                                                          | Issuance of Common Stock and Common Stock Options                  |                                           |                                                     |            |             |             
|                                                             |                                                                                          | Issuance of Notes Payable to Shareholders                          |                                           |                                                     |            |             |             
|                                                             |                                                                                          | Liabilities Assumed                                                |                                           |                                                     | (27,856,000 | )           |             
|                                                             |                                                                                          |                                                                    |                                           |                                                     |             |             |             
|                                                             |                                                                                          |                                                                    | Businesses Acquired, Net of Cash Received |                                                     | $           | 115,701,000 |             
|                                                             |                                                                                          |                                                                    |                                           |                                                     |             |             |             

See accompanying notes to consolidated financial statements.

45

---



MSC.SOFTWARE CORPORATION        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        DECEMBER 31, 2002, 2001 AND 2000

NOTE 1SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BusinessMSC.Software Corporation (the "Company") is an information software, services and systems
provider. The Company designs, produces and markets proprietary computer software products and provides related services for use in computer-aided engineering. With the acquisition of Advanced
Enterprise Solutions, Inc. ("AES") in 2001, the Company also became a reseller and integrator of information systems and software. The Company's products and services are marketed
internationally to several industries, including aerospace, automotive and other industrial concerns, computer and electronics manufacturers, and universities.

Principles of ConsolidationThe accounting and reporting policies of the Company conform to generally accepted accounting
principles ("GAAP") in the United States of America. The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated.

Business AcquisitionsThe Company acquired Mechanical Dynamics, Inc. ("MDI") in 2002 and acquired Advanced Enterprise
Solutions, Inc. in 2001. The results of the operations of the acquired companies have been included from the dates of acquisition.

Use of EstimatesThe preparation of financial statements in conformity with GAAP in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes, including disclosure
of contingent liabilities at the date of the financial statements. Significant judgments and estimates include those required in the valuation of long-lived assets, allowances for doubtful
accounts, vendor specific objective evidence of the fair value of the various elements of the Company's multiple element software transactions and valuation allowances for deferred tax assets. Actual
results could differ materially from those estimates.

ReclassificationsCertain amounts in the 2001 and 2000 consolidated financial statements have been reclassified to conform to
the 2002 presentation.

Revenue RecognitionSoftware revenue consists of licensing fees, which are fees charged for the right to use the Company's or
a third parties' software. Software is sold through 1) monthly, annual or longer lease (time-based) arrangements and through 2) paid-up (perpetual) license arrangements
whereby the customer purchases a long-term license for the use of the Company's software, which is typically purchased with maintenance for a period of time. Services revenue includes
maintenance, support, consulting and training services.    Consulting and training services range from installation, training, and basic consulting to software modification and
customization to meet specific customer needs. Systems revenue includes the resale and integration of computer hardware and operating systems.

The
Company applies Statement of Position 97-2,"Software Revenue Recognition", as amended by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain
Transactions", to all transactions involving the sale of
software products.

For
systems sales, the Company applies the provisions of Staff Accounting Bulletin 101,"Revenue Recognition."Revenue is recognized when
the Company receives persuasive evidence of an arrangement, the price charged the customer is fixed or determinable, collectibility is reasonably assured and title and risk of loss pass to the
customer, generally at the time of shipment.

For
the time-based licenses, maintenance services are included in the license fee and are for the same duration as the license term. As a result, the Company does not have
vendor specific objective evidence of

46

---

fair
value of each element (VSOE) and the entire fee of a time-based license is recognized ratably over the term of the lease. Revenue from the sale of paid-up licenses is
recognized when the Company receives persuasive evidence of an arrangement (generally a contract or purchase order), the software has been delivered to the customer, the price charged the customer is
fixed or determinable, and collection is probable. Software arrangements can include multiple elements consisting of the software license and maintenance, which includes upgrades and technical
support. Company specific objective evidence of the fair value of maintenance is determined based upon prices when sold separately or the renewal rate specified in the contract with the customer. For
multiple element arrangements when the Company-specific objective evidence does exist for all of the undelivered elements of the arrangement, but does not exist for one or more of the delivered
elements in the arrangement, the Company recognizes revenue under the residual method. Under the residual method, at the outset of the arrangement with a customer, the Company defers revenue for the
fair value of its undelivered elements such as maintenance and support, and recognizes the revenue for the remainder of the arrangement fee attributable to the elements initially delivered, such as
software licenses, when the criteria in SOP 97-2 have been met. Maintenance and support revenue is deferred and recognized ratably over the service period. Due to the Company's settlement
with the FTC, for arrangements with customers that convert to a paid-up license after November 1, 2002, the Company defers revenue for the fair value of the Nastran
paid-up license because the arrangement is cancelable under certain circumstances pursuant to the FTC settlement and, as a result, the fee is not considered to be fixed or determinable. As
of December 31, 2002, the Company has deferred approximately $6,400,000 of such revenue, which will be recognized ratably over a 48 month term until the customer requests a refund or the
twelve month period to request such a refund lapses, at which time the remaining deferred revenue will be recognized. The twelve month period to request a refund begins on the date the Company
completes the divestiture of assets to one or more acquirers approved by the FTC.

Service
revenue is recognized when the service is provided and the revenue has been earned. The arrangement fees related to fixed priced consulting contracts are recognized using the
percentage of completion method. Percentage of completion is measured monthly based primarily on input measures, such as on hours incurred to date compared to total estimated hours to complete, with
consideration given to output measures, such as contract milestones, when applicable. Anticipated losses on fixed-priced contracts are recognized in the period when they become known.

Revenue
is derived through the Company's direct sales force, a network of value-added resellers and other sales agents. Revenue from the sale of products by other sales agents, for which
a commission is due to the sales agent, is reported as net revenue (gross sales price less commission due to the sales agent) earned from the product sale. Revenue from the sale of products provided
by other suppliers, for which a royalty is due to the suppliers, is reported as gross revenue earned from the product sale. Royalties due to these other suppliers represent an operating expense and
are recorded as royalty expense in cost of software revenue. The Company does not offer any rights of return, rebates, stock balancing rights or price protection on the Company's software products.

In
accordance with Emerging Issues Task Force 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent", revenue
from the sale of certain maintenance agreements, where the Company acts as an agent, is reported on a net basis.

Cash and Cash EquivalentsThe Company considers investments with original maturities of three months or less to be cash
equivalents.

47

---

InvestmentsMarketable equity securities and debt securities are classified as trading,
held-to-maturity or available-for-sale. Management determines the appropriate classification of securities at the time of purchase and
re-evaluates such designation as of each balance sheet date. Securities available-for-sale are carried at fair value, with temporary unrealized gains and losses,
net of tax, reported as a separate component of shareholders' equity. Realized gains and losses on sales of investment securities and declines in value judged to be other than temporary are included
in the consolidated statements of operations. The cost of securities sold is based on the specific identification method. Refer to Note 4Financial Instruments.

Trade Accounts ReceivableGross Accounts receivable are reduced to net realizable value by an allowance for doubtful accounts
receivable. The Company's revenue is generated from customers in diversified industries, primarily in North America, Europe and Asia-Pacific. The Company performs ongoing credit
evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses and such losses have been within management's expectations. Refer to
Note 5Trade Accounts Receivable.

Property and EquipmentProperty and equipment are recorded at cost, less accumulated depreciation and amortization.
Depreciation is computed on the straight-line method over the estimated useful lives of the assets, ranging from two to five years. Amortization of leasehold improvements is calculated on
the straight-line method over the shorter of the estimated useful lives of the assets or the corresponding lease term. Refer to Note 6Property and Equipment.

Capitalized Software CostsCapitalized software costs are comprised of purchased software and internal software development
costs. In accordance with SOP 98-1,"Accounting for the Cost of Computer Software Developed or Obtained for Internal Use", the Company
capitalizes qualifying computer software costs which are incurred during the application development stage and amortizes them over the software's estimated useful life. Amounts capitalized have not
been material to the Company's consolidated financial statements.

Software
developed for sale or lease is capitalized under Statement of Financial Accounting Standards ("SFAS") No. 86,"Accounting for the Costs of
Computer Software to Be Sold, Leased or Otherwise Marketed". Software costs incurred subsequent to the determination of the technological feasibility of the software product
are capitalized. Significant management judgment is required in determining whether technological feasibility has been achieved for a particular software project. Capitalization ceases and
amortization of capitalized costs begins when the software product is available for general release to customers. Capitalized product development costs, net of related amortization, are compared to
management's estimate of projected revenues are reviewed quarterly to determine if any impairment in value has occurred that would require an adjustment in the carrying value or change in expected
useful lives under the guidelines established under SFAS No. 86. Amortization is provided on a product by product basis on either the straight-line method over the economic life of
the related products, typically two to three years, or the sales ratio method that is based on expected unit sales and the estimated life of the product. Capitalized software amortization expense is
included in cost of software revenue. Refer to Note 7Capitalized Software Costs.

Other Long-Lived AssetsIn accordance with SFAS No. 144,"Accounting for the
Impairment or Disposal of Long-Lived Assets", the Company evaluates long-lived assets, including intangibles assets other than

48

---

goodwill,
for impairment when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less then the assets' carrying amounts. Factors
considered important which could trigger an impairment review include, but are not limited to, significant underperformance relative to expected historical or projected future operating results,
significant changes in the manner of use of the assets or the strategy for the Company's overall business and significant negative industry or economic trends. If such assets are identified to be
impaired, the impairment to be recognized is the amount by which the carrying value of the asset exceeds the fair value of the asset.

Assets
to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer
depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.

Prior
to the adoption of SFAS No. 144, the Company accounted for long-lived assets in accordance with SFAS 121, "Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets of be Disposed Of".

Goodwill and Other Indefinite Lived IntangiblesIn accordance with SFAS No. 141, "Business Combinations"and SFAS
No. 142,"Goodwill and Other Intangible Assets", goodwill and
other indefinite lived intangibles are not amortized, but are tested annually or on an interim basis if events or circumstances indicate that the fair value of the asset has decreased below its
carrying value. Prior to
the adoption of SFAS No. 141, the Company compared the estimated undiscounted cash flows on an enterprise wide basis to its carrying value to determine if goodwill was recoverable. Refer to
Note 2Cumulative Change in Accounting Principle and Note 8Goodwill and Other Intangible Assets.

Advertising ExpenseThe cost of advertising is expensed as incurred. The Company incurred $1,764,000, $2,030,000 and
$2,020,000 in advertising costs during the years ended December 31, 2002, 2001 and 2000, respectively.

Royalties to Third PartiesThe Company has agreements with third parties requiring the payment of royalties for sales of third
party products or inclusion of such products as a component of the Company's products. Royalties are charged to cost of software revenue when incurred. The Company does not consider any royalty
expense related to individual agreements to be material.

Stock-Based CompensationThe Company grants stock options for a fixed number of shares to employees with an exercise price
equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants using the intrinsic method in accordance with Accounting Principles Board ("APB") Opinion
No. 25,"Accounting for Stock Issued to Employees"and FASB Interpretation No. 44 ("FIN 44"),Accounting for
Certain Transactions Involving Stock-Based Compensation, an Interpretation of APB Opinion No. 25"and related interpretations in accounting for its stock-based
compensation plans. The Company has adopted the disclosure only provisions of SFAS No. 123,"Accounting for Stock-Based Compensation".
Accordingly, no compensation expense is recognized for the stock option grants. Had compensation cost for the Company's stock option plans and Employee Stock Purchase Plan ("ESPP") been determined
based on the fair value at the grant date for awards during the years ended December 31, 2002, 2001 and 2000 consistent with the provisions of SFAS No. 123, the

49

---

Company's
Net Income (Loss), Basic Earnings (Loss) Per Share and Diluted Earnings (Loss) Per Share would have been reduced to the pro forma amounts as follows:

Years Ended December 31,2002

2001

2000Net Income (Loss), As Reported

$
(51,329,000
)
$
10,271,000

$
11,133,000Deduct:  Total Stock-Based Employee Compensation Expense Determined under Fair Value Based Method for All Awards, Net of Related Tax Effects


(8,098,000
)

(7,675,000
)

(1,553,000
)Pro Forma Net Income (Loss)

$
(59,427,000
)
$
2,596,000

$
9,580,000Earnings (Loss) Per Share:BasicAs Reported

$
(1.75
)
$
0.50

$
0.79BasicPro Forma

$
(2.02
)
$
0.13

$
0.68DilutedAs Reported

$
(1.75
)
$
0.47

$
0.76DilutedPro Forma

$
(2.02
)
$
0.12

$
0.66


Using
the Black-Scholes valuation model, the estimated per share weighted-average fair value of stock options granted during the years ended December 31, 2002, 2001 and 2000 was
$7.13, $7.94 and $4.75, respectively.

The
pro forma effect on the Company's Net Income (Loss) and Basic Earnings (Loss) Per Share for 2002, 2001 and 2000 is not representative of the pro forma effect in future years. The pro
forma effect does not take into consideration compensation expense related to grants made prior to 1996 or additional grants in future years, which are anticipated. The fair value of each option
(including ESPP shares) is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for the periods indicated:

Years Ended December 31,2002

2001

2000Dividend Yield

0.0
%
0.0
%
0.0
%Expected Volatility (Stock Options)

65.6
%
51.7
%
51.3
%Expected Volatility (ESPP Shares)

78.9
%
62.1
%
51.3
%Risk-Free Interest Rate (Stock Options)

4.23
%
5.28
%
5.38
%Risk-Free Interest Rate (ESPP Shares)

1.85
%
4.23
%
5.38
%Estimated Life (Stock Options)

5 years

5 years

5 yearsEstimated Life (ESPP Shares)

0.5 years

0.5 years

0.5 years


The
Company has also made available an Employee Stock Purchase Plan for eligible employees. Such eligible employees are entitled semi-annually to purchase common stock, by
means of limited payroll deductions, at a 10% discount from the fair market value of the common stock as of specific dates. This qualified Employee Stock Purchase Plan under Sections 421 and 423 of
the Internal Revenue Code is offered to all eligible employees and is non-compensatory under APB Opinion No. 25. Refer to Note 14Stock Option Plans, Warrants and
Stock Based Compensation.

50

---

Income TaxesThe Company uses the liability method of accounting for income taxes. Provision is made in the Company's
consolidated financial statements for current income taxes payable and deferred income taxes arising primarily from temporary differences in accounting for intangible assets, capitalized software
costs, undistributed earnings of international subsidiaries, compensation and depreciation. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income
in the years in which those temporary differences are expected to be realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. The Company records a valuation allowance to reduce deferred tax assets to an amount whose realization is more likely than not. Refer to
Note 11Taxes Based on Income.

Effect of Foreign CurrencyThe Company translates the assets and liabilities of its foreign subsidiaries at the rate of
exchange in effect at the end of the period. Revenues and expenses are translated using an average of exchange rates in effect during the period. Translation adjustments are recorded in Accumulated
Other Comprehensive Income (Loss) as a separate component of shareholders' equity in the consolidated balance sheets. Transaction gains and losses, other than on intercompany accounts deemed to be of
a long-term nature, are included in net income in the period in which they occur. The aggregate foreign currency transaction losses included in the accompanying consolidated statements of
operation were $345,000, $542,000 and $1,259,000 for the years ended December 31, 2002, 2001 and 2000, respectively.

Earnings (Loss) Per ShareBasic Earnings (Loss) Per Share is computed by dividing net income (loss) by the weighted-average
number of common shares outstanding for the period. Diluted Earnings Per Share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or
converted into common stock, or resulted in the issuance of common stock. Diluted Earnings Per Share is computed by using the weighted-average number of common and potentially dilutive shares
outstanding during each period. Potentially dilutive shares are not included in the per share calculations where their inclusion would be anti-dilutive. Refer to
Note 18Earnings (Loss) Per Share.

Comprehensive Income (Loss)Comprehensive income (loss) includes unrealized gains and losses on marketable securities
categorized as available-for-sale and foreign currency translation adjustments. Comprehensive income (loss) and its components are presented in the accompanying consolidated
statements of shareholders' equity. Refer to Note 16Accumulated Other Comprehensive Income (Loss).

Concentrations of Credit RiskThe markets in which the Company competes are highly competitive and rapidly changing.
Significant technological changes, changes in customer requirements, or the emergence of competitive products with new capabilities or technologies could adversely affect operating results.

The
Company has historically derived a significant portion of its net revenue from computer software products for use in computer-aided engineering. These products are expected to
continue to account
for a significant portion of net revenue for the foreseeable future. As a result of this revenue concentration, the Company's business could be harmed by a decline in demand for, or in the prices of,
these products as a result of, among other factors, any change in pricing model, a maturation in the markets for these products, increased price competition or a failure by the Company to keep up with
technological change.

Impact of Recently Issued Accounting StandardsIn April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement No. 145, "Rescission of the FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" ("SFAS 145"). SFAS 145 eliminates the

51

---

requirements
to classify gains and losses from the extinguishment of indebtedness as extraordinary, requires certain lease modifications to be treated the same as a sale-leaseback
transaction, and makes other non-substantive technical corrections to existing pronouncements. SFAS 145 is effective for fiscal years beginning after May 15, 2002, with
earlier adoption encouraged. Management does not believe that the adoption of this standard will have a material impact on the Company's financial position.

In
July 2002, the FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities"
("SFAS 146"). SFAS 146 requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal
plan. Examples of costs covered by SFAS 146 include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operations, plant closing
or other exit or disposal activities. SFAS 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged. Management
does not believe that the adoption of this standard will have a material impact on the Company's financial position.

In
December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based Compensation, Transition and Disclosure, an Amendment to FASB Statement No. 123"
("SFAS 148"). SFAS 148 provides alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee
compensation. It also amends the disclosure provisions of SFAS 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with
respect to stock-based employee compensation. Finally, SFAS 148 amends APB Opinion No. 28 ("Opinion 28"), Interim Financial Reporting, to require disclosures about those effects in
interim financial information. The amendments to SFAS No. 123 that provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting
for stock-based employee compensation are effective for financial statements for fiscal years ending after December 31, 2002. The amendment to SFAS No. 123 relating to the disclosures
and the amendment to Opinion 28 is effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. The adoption of this standard
did not have a material impact on the Company's financial statements. The Company does not anticipate changing to the fair value method of accounting for stock-based employee compensation. However, if
the Company did change to the fair value method, it would have a material impact on the Company's financial statements.

In
November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby
letters of credit, and provides new disclosure requirements regarding indemnification provisions typically included in a software license arrangement. FIN 45 also clarifies that at the time a company
issues a guarantee, it must recognize an initial liability for the fair value of the obligation it assumes under that guarantee, including its ongoing obligation to stand ready to perform over the
term of the guarantee in the event that specified triggering events or conditions occur. The provisions related to recognizing a liability at inception of the guarantee do not apply to product
warranties, indemnification provisions in software license arrangements, or guarantees accounted for as derivatives. The initial recognition and initial measurement provisions apply on a prospective
basis to guarantees issued or modified after December 31, 2002. The disclosure requirements for FIN 45 are effective for financial statements of interim or annual

52

---

periods
ending after December 15, 2002. The adoption of FIN 45 did not have a material impact on the Company's financial position or results of operations.

In
January 2003 the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), an
interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements". FIN 46 explains how to identify variable interest
entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. This interpretation requires existing unconsolidated variable interest
entities to be consolidated by their primary beneficiaries if the primary beneficiary is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive
a majority of the entity's residual returns, or both. FIN 46 is effective immediately for variable interest entities created after January 31, 2003, and to variable interest entities in which
an enterprise obtains an interest after that date. The Interpretation applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an
enterprise holds a variable interest that it acquired before February 1, 2003. The Company does not expect the adoption of FIN 46 to have a material impact on its financial position or results
of operations.

The
Emerging Issues Task Force "EITF" recently reached a consensus on its tentative conclusions for EITF 00-21, "Revenue Arrangements with Multiple
Deliverables." EITF 00-21 provides accounting guidance for customer solutions where delivery or performance of products, services and/or performance may occur at
different points in time or over different periods of time. Companies are required to adopt this consensus for fiscal periods beginning after June 15, 2003. The Company believes the adoption of
EITF 00-21 will not have a material impact on the Company's financial position or results of operations.

NOTE 2CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE

In June 2001, the FASB issued Statements of Financial Accounting Standards No. 141 ("SFAS No. 141"), "Business
Combinations", and No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets." Under the new rules, goodwill
and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. Under SFAS No. 142, goodwill impairment is deemed to exist if the net
book value of a reporting unit exceeds its estimated fair value. The Company's reporting units are generally consistent with the operating segments underlying the segments identified in
Note 12Segment Information. This methodology differs from the Company's previous policy, as permitted under accounting standards existing at that time, of using undiscounted cash
flows on an enterprisewide basis to determine if goodwill is recoverable.

During
the second quarter of 2002, the Company completed the transitional impairment test required under the new rules and recorded a non-cash charge of $39,300,000 to reduce
the carrying value of goodwill, effective in the first quarter of 2002. The impairment relates entirely to the Company's Systems reporting unit, which was almost entirely generated from the AES
acquisition. Such charge is nonoperational in nature and is reflected as a cumulative effect of change in accounting principle in the accompanying consolidated statement of operations. In calculating
the impairment charge, the fair value of the impaired reporting unit underlying the System segment was estimated using either a discounted cash flow methodology or recent comparable transactions. The
impairment primarily resulted from an increase in the Company's stock price immediately prior to the date that the AES acquisition was announced and valued for accounting purposes, as well as a
decline in market multiples in the information systems reseller industry.

53

---

NOTE 3BUSINESS ACQUISITIONS

Mechanical Dynamics, Inc.

On April 19, 2002, the Company, through a wholly owned subsidiary, completed the acquisition of the outstanding common stock of Mechanical
Dynamics, Inc. ("MDI") through a tender offer. MDI developed, marketed and supported functional virtual prototyping solutions. The Company believes that the acquisition of MDI will expand the
Company's core software offerings, complement the Company's existing product and service offerings, and increase the Company's presence in the product lifecycle management market to better serve
customers. It is for these reasons that the purchase price exceeds the fair value of net tangible and intangible assets, resulting in goodwill.

To
accomplish the acquisition of MDI, the Company entered into the Agreement and Plan of Merger dated March 15, 2002 (the "Merger Agreement"), with MDI, pursuant to which,
following the consummation of a tender offer at $18.85 per share in cash and the satisfaction or waiver of certain conditions, all of the remaining outstanding shares of common stock of MDI were
converted into the right to receive $18.85 per share in cash. The tender offer and merger resulted in the Company acquiring approximately 6,200,000 shares of common stock of MDI, representing
100 percent of the outstanding shares of MDI, at an aggregate price of approximately $116,877,000. The Company also agreed to redeem all outstanding MDI stock options (922,340 options) for
total consideration of $10,531,000 (the difference between $18.85 and the exercise price of the options).

A
condensed unaudited balance sheet reflecting the acquired assets and liabilities as assumed as of the date of acquisition of MDI was as follows:

Cash and Cash Equivalents

$
16,455,000Accounts Receivable


13,300,000Other Current Assets


3,954,000Property and Equipment, Net


4,723,000Other Assets


3,694,000$
42,126,000Accounts Payable

$
2,638,000Accrued Liabilities


4,518,000Deferred Revenue


9,732,000Other Current Liabilities


7,330,000Other Liabilities


444,00024,662,000Shareholders' Equity


17,464,000$
42,126,000


The acquisition of MDI has been accounted for as a purchase, and accordingly, the results of operations of MDI since April 19, 2002 are included in the
Company's consolidated statement of

54

---

operations.
An independent valuation of the intangible assets acquired has been performed and the allocation of the purchase price is as follows:

Net Tangible Assets Acquired

$
17,464,000
(1)Fair Value of Intangible Assets Acquired, net of deferred tax


34,458,000Fair Value of In-Process R&D


2,170,000Goodwill


77,412,000Total Cost of Acquisition

$
131,504,000Cash Paid for outstanding MDI common shares

$
116,877,000Cash Paid for outstanding MDI stock options


10,531,000Direct Costs of Acquisition


4,096,000$
131,504,000


---

Intangible assets acquired include $31,110,000 of technology acquired to be amortized over ten years and $23,100,000 of identified intangibles. Identified
intangibles consist primarily of trademark and trade name and were deemed to have indefinite lives, in accordance with SFAS No. 142.

The
goodwill of $77,412,000 was assigned to the software and services segments in the amounts of $54,963,000 and $22,449,000, respectively. No portion of the total amount is expected to
be deductible for tax purposes.

A
portion of the purchase price totaling $2,170,000 was allocated to acquired in-process research and development. In-process research and development ("IPR&D")
projects were identified and valued through analysis of data provided by MDI concerning developmental
products, their stage of development, the time and resources needed to complete them, if applicable, their expected income generating ability, target markets and associated risks. The primary
technique utilized in valuing the acquired IPR&D was the income approach, which includes an analysis of the markets, cash flows and risks associated with achieving such cash flows.

Developmental
projects that had reached technological feasibility were classified as developed technology, and the value was assigned to technology acquired and capitalized as Intangible
Assets. Where the developmental projects had not reached technological feasibility and had no future alternative uses, they were classified as IPR&D and charged to expense upon closing of the
acquisition. As of the acquisition date, all projects classified as IPR&D projects were in the development stage and the Company expected to incur approximately $4,500,000 in additional costs before
these projects would be complete.

In
valuing the IPR&D, the Company considered the importance of each project to the overall development plan, estimating costs to develop the purchased IPR&D into commercially viable
products, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows to their present value. The sales estimates used to value the purchased IPR&D were
based on estimates of relevant market sizes and growth factors, expected trends in technology and the nature and

55

---

expected
timing of new product introductions by MDI and its competitors. The rates utilized to discount the net cash flows to their present value are based on MDI's weighted average cost of capital.
Given the nature of the risks associated with the difficulties and uncertainties in completing each project and thereby achieving technological feasibility, anticipated market acceptance and
penetration, market growth rates and risks related to the impact of potential changes in future target markets, the weighted average cost of capital was adjusted. Based on these factors, discount
rates of 15 percent and 20 percent were deemed appropriate for the acquired and in-process technology, respectively. The estimates used in valuing IPR&D were based upon
assumptions believed to be reasonable but which are inherently uncertain and unpredictable.

The
following summarized unaudited pro forma consolidated results of operations reflects the effect of the MDI acquisition as if it had occurred at the beginning of the periods
presented. The unaudited pro forma consolidated results of operations presented below are not necessarily indicative of operating results which would have been achieved had the acquisition been
consummated as of the beginning of the periods presented and should not be construed as representative of future operations.

Years Ended December 31,2002

2001Revenue

$
358,562,000

$
292,100,000Operating Expense

$
369,369,000

$
269,798,000Income (Loss) before Cumulative Effect of Change in Accounting Principle

$
(15,041,000
)
$
7,898,000Net Income (Loss)

$
(54,341,000
)
$
7,898,000Basic Earnings (Loss) Per Share Before Cumulative Effect of Cumulative Change in Accounting Principle

$
(0.51
)
$
0.38Diluted Earnings (Loss) Per Share Before Cumulative Effect of Cumulative Change in Accounting Principle

$
(0.51
)
$
0.36Basic Earnings (Loss) Per Share

$
(1.85
)
$
0.38Diluted Earnings (Loss) Per Share

$
(1.85
)
$
0.36


EASY5

In May 2002, the Company acquired certain assets and technology known as EASY5 ("EASY5") for cash of $4,418,000 and the assumption of certain liabilities.
The Company believes this transaction will increase existing simulation capabilities. As a result of this transaction, the Company recognized goodwill of approximately $2,714,000, indefinite lived
intangibles of $400,000 and other identifiable intangibles of $2,540,000, to be amortized over ten years. Goodwill from this transaction was assigned to the software segment and the amount is expected
to be fully deductible for income tax purposes. The Company also acquired $210,000 of in-process research and development costs, which were expensed in 2002. The pro forma effect of this
acquisition as if it had occurred on January 1, 2002 or 2001 is immaterial to the consolidated financial statements presented herein.

56

---

Advanced Enterprise Solutions, Inc.

On July 20, 2001, the Company completed the acquisition of Advanced Enterprise Solutions, Inc. AES is a systems and software integrator and an IBM
Product Lifecycle Management business partner in the Americas, selling Dassault Systemes' Product Lifecycle Management software portfolio comprised of CATIA, ENOVIA, DELMIA and Smart Solutions. The
Company acquired AES in order to expand the market served by enabling the Company to distribute products to a wider customer base and will provide the Company with an expanded product
line-up. It is for these reasons that the purchase price exceeds the fair value of net tangible and intangible assets, resulting in goodwill.

To
accomplish the acquisition of AES, the Company entered into a Stock Purchase Agreement with Dassault Systemes of America Corp. ("DSA"), pursuant to which the Company purchased from
DSA all of the shares of AES held by DSA. The Company issued to DSA 1,763,400 shares of the Company's common stock for DSA's minority interest in AES. The Company also entered into an Agreement and
Plan of Merger with AES pursuant to which AES was merged with the Company's wholly owned subsidiary, which resulted in AES becoming the Company's wholly owned subsidiary. In this transaction, the
stockholders of AES, other than DSA, received:



The
Company also assumed outstanding options to acquire AES common stock, which were converted into fully vested options, with time based exercise restrictions, to acquire 718,898 shares
of the Company's common stock.

The
5,281,096 shares of common stock issued as part of the transaction were valued at $80,695,000 based upon the fair value of the Company's common stock immediately prior and subsequent
to May 2, 2001, the date of the signing and announcement of the definitive acquisition agreement. The options were valued at approximately $10,927,000 based on a calculation using the
Black-Scholes pricing model with the following assumptions: no dividend yield; expected volatility of 53%; a risk free rate of 5%; and an expected life of 5 years.

The
promissory notes were recorded at their estimated fair value at time of issuance, net of a discount of $411,000. The promissory notes bear interest at 7% with interest payments due
semi-annually in January and July. The entire principal amount of the notes of $20,000,000 is due in July 2004.

57

---

A
condensed unaudited balance sheet stating the assigned values for each major asset, liability and equity account of AES as of the date of the acquisition was as follows:

Cash and Cash Equivalents

$
14,233,000Accounts Receivable


13,702,000Other Current Assets


3,357,000Property and Equipment, Net


446,000Other Assets


233,000$
31,971,000Accounts Payable

$
12,306,000Compensation and Related Expenses


827,000Other Current Liabilities


2,556,000Note Payable to DSA


5,000,00020,689,000Shareholders' Equity


11,282,000$
31,971,000


The
acquisition of AES has been accounted for as a purchase, and accordingly, the results of operations of AES since July 1, 2001 (the designated effective date when control of
AES was passed to the Company) are included in the Company's consolidated statement of income. An independent valuation of the intangible assets acquired was performed in 2001 and the purchase price
was allocated as follows:

Net Tangible Assets Acquired

$
11,282,000
(1)Goodwill


119,929,000Total Cost of Acquisition

$
131,211,000


---

As
part of the acquisition, the Company assumed a note payable to DSA. The note bears interest at 3.2%. The Company will repay the principal balance of the loan from commissions earned
by selling certain DSA products. Any remaining unpaid principal balance will be due in June 2003. Refer to Note 4Financial Instruments.

The
summarized unaudited pro forma consolidated results of operations presented below reflects the effect of the AES acquisition as if it had occurred at the beginning of the periods
presented. The amounts presented below exclude the amortization of goodwill and indefinite lived intangibles in accordance with SFAS No. 142. The summarized unaudited pro forma consolidated
results of operations are not necessarily

58

---

indicative
of operating results which would have been achieved had the acquisition been consummated at the beginning of the periods presented and should not be construed as representative of future
operations.

Years Ended December 31,2001

2000Revenue

$
272,955,000

$
275,688,000Operating Expense

$
250,758,000

$
242,339,000Net Income

$
10,987,000

$
16,550,000Basic Earnings Per Share

$
0.47

$
0.86Diluted Earnings Per Share

$
0.44

$
0.81


NOTE 4FINANCIAL INSTRUMENTS

InvestmentsAs of December 31, 2002 and 2001, all investments were equity securities and had a
cost of $68,000 and $177,000, respectively, and a fair market value of $5,177,000 and $3,484,000, respectively.

Line of Credit and Term LoanIn connection with the acquisition of MDI in April 2002, the Company entered into a
Revolving Credit and Term Loan Agreement, and subsequent amendments, ("Loan Agreement") with a bank. The Loan Agreement included a $6,728,000 revolving line of credit and a $65,000,000 term loan. In
November 2002, the Company replaced the Loan Agreement with a new Loan and Security Agreement, as amended ("New Loan Agreement") with a new lender ("Lender"). The New Loan Agreement includes a
$15,000,000 revolving line of credit and a $55,000,000 term loan. Borrowings under the revolving line of credit are limited to a borrowing base of up to 85% of eligible domestic accounts receivable,
as defined.    The term loan is payable in 48 equal principal payments plus interest. All amounts outstanding under the previous Loan Agreement were repaid.

The
term loan is secured by substantially all of the Company's assets and bears interest at the greater of 7% or the Lender's prime rate (4.25% as of December 31, 2002) plus 5%.
Advances on the revolving line of credit bear interest at the greater of 7% or the Lender's prime rate plus 2.25%. The New Loan Agreement expires in November 2006. As of December 31,
2002, $53,854,000 of the term loan was outstanding and no amount was outstanding on the line of credit. The Company had $13,214,000 of availability on the line of credit as of December 31,
2002. The new Loan Agreement requires maintenance of certain financial covenants, including minimum EBITDA, minimum recurring revenue and minimum liquidity, as those terms are defined in the New Loan
Agreement, and non-financial covenants including requirements to provide various financial statements, reports and certifications in the forms and at the times specified in the New Loan
Agreement. The Company is in compliance with all such covenants, as amended.

The
New Loan Agreement required an origination fee of approximately $2,100,000, which is being amortized to expense over the 48 months of the term loan. In addition, an annual
facility fee of 1.50% of the total outstanding commitment will be paid and expensed quarterly. In connection with the New Loan Agreement, $1,471,000 of capitalized loan fees related to the Loan
Agreement were written off in November 2002 and included as interest expense in the accompanying consolidated statements of operations.

59

---

In
connection with the Loan Agreement, $533,000 related to prior bank debt was repaid.

Convertible Subordinated DebenturesIn 1994, the Company issued $56,608,000 of convertible subordinated debentures in
connection with an acquisition. In June 1999, in connection with an acquisition, the Company issued additional convertible subordinated debentures in the aggregate principal amount of
$2,000,000. The convertible subordinated debentures were recorded at their estimated fair value at the time of issuance, net of a discount of $300,000. The debentures bore interest at
77/8% with interest payments due semi-annually on March 15th and September 15th. The conversion feature permitted the holder to convert the debentures into
shares of the Company's common stock at a conversion price of $15.15 per share. The debentures were to mature on August 18, 2004, but were redeemable at the Company's option at any time after
August 18, 1997 upon payment of a premium.

On
July 31, 2001, the Company gave notice to the holders of the convertible subordinated debentures of the Company's intent to redeem all such debentures on or about
August 31, 2001. The holders continued to have the option to convert the principal amount of the debentures into shares of the Company's common stock at $15.15 per share until August 31,
2001. Holders converted $57,515,000 principal of the debentures into 3,796,300 shares of common stock. The remaining unconverted debentures were redeemed for $1,041,000 (or 100.89% of the principal
balance) plus accrued interest in September 2001. Holders who elected to convert forfeited their rights to receive accrued interest that would otherwise be paid on the redemption date. However,
in accordance with EITF Issue No. 85-17, "Accrued Interest upon Conversion of Convertible Debt", the forfeited interest of
approximately $2,059,000 was recorded as interest expense by the Company and such accrued and unpaid interest, net of the tax effect of $858,000, was credited to additional paid-in capital
as part of the conversions.

Subordinated Notes PayableIn June 1999, in connection with an acquisition, the Company issued subordinated notes
payable, at a discount, in the aggregate principal amount of $14,236,000. The subordinated notes payable were recorded at their estimated fair value at the time of issuance, net of a discount of
$2,596,000. The subordinated notes payable bear interest at 8% with interest payments due semi-annually in January and July. At December 31, 2002, the principal balance of the
subordinated notes payable was $8,000,000 and their carrying amount was $6,817,000, net of an unamortized discount of $1,183,000. The unamortized discount is being amortized to interest expense using
the effective-interest method over the term of the notes payable.

Notes Payable to ShareholdersIn July 2001, in connection with the AES acquisition, the Company issued promissory
notes, at a discount, in the aggregate principal amount of $20,000,000. The notes were recorded at their estimated fair value at time of issuance, net of a discount of $411,000. The promissory notes
bear interest at 7% with interest payments due semi-annually in January and July. The entire principal amount of the notes is due in July 2004. As of December 31, 2002, the
principal balance of the notes was $20,000,000 and their carrying amount was $19,880,000, net of an unamortized discount of $120,000. The unamortized discount is being amortized to interest expense
using the effective-interest method over the term of the note payable. The notes are subordinate to the New Loan Agreement. Of the $20,000,000 of outstanding notes payable to shareholders, $13,153,000
is due to officers of the Company or their dependents.

As
part of the AES acquisition, the Company also assumed a note payable to DSA with a remaining principal balance of $5,000,000 at the time of acquisition. The note was recorded at its
estimated fair value

60

---

at
time of issuance, net of a discount of $567,000. The note bears interest at 3.2%. The Company will repay the principal balance of the loan from commissions earned by selling DSA products. Any
remaining unpaid principal balance will be due in June 2003. As of December 31, 2002, the principal balance of the notes was $4,897,000 and the carrying amount was $4,590,000, net of an
unamortized discount of $307,000. The unamortized discount is being amortized to interest expense using the effective-interest method over the term of the subordinated notes payable.

The
maturities of the Company's debt are as follows:

Year Ending December 31,

Maturities2003

$
18,647,0002004


33,750,0002005


13,750,0002006


12,604,0002007


2008 and Thereafter


8,000,000$
86,751,000


Fair Value of Financial InstrumentsThe following methods and assumptions were used by the Company in estimating its fair
value disclosures for financial instruments:

Cash and Cash Equivalents, Trade Accounts Receivable and Accounts PayableThe carrying amount reported in the consolidated
balance sheets for cash and cash equivalents, trade accounts receivable and accounts payable approximates their fair value.

InvestmentsThe fair values for investments are based on quoted market prices.

Term LoanThe carrying amount reported in the consolidated balance sheets for the term loan approximates its fair value since
the interest rate on the term loan is adjusted on a monthly basis.

Subordinated Notes Payable and Notes Payable to ShareholdersThe fair value of the subordinated notes payable and notes
payable to shareholders is based on the present value of their future cash flows using a discount rate that approximates the Company's current borrowing rate.

61

---

The
carrying amounts and estimated fair values of the Company's financial instruments are as follows:

|                                  |                                                       | December 31, 2002 |   | December 31, 2001 |  
|--------------------------------- | ----------------------------------------------------- | ----------------- | - | ----------------- | -
|
|Financial Instrument Assets:      |                                                       |                   |   |                   |  
|                                  | Cash and Cash Equivalents                             |                   | $ | 29,387,000        |  
|                                  | Investments                                           |                   | $ | 5,177,000         |  
|                                  | Trade Accounts Receivable, Net                        |                   | $ | 97,636,000        |  
|Financial Instrument Liabilities: |                                                       |                   |   |                   |  
|                                  | Accounts Payable                                      |                   | $ | (32,706,000       | )
|                                  | Term Loan, including Current Portion                  |                   | $ | (53,854,000       | )
|                                  | Notes Payable to Shareholders                         |                   | $ | (24,470,000       | )
|                                  | Subordinated Notes Payable, including Current Portion |                   | $ | (6,817,000        | )

NOTE 5TRADE ACCOUNTS RECEIVABLE

The following is the activity in the allowance for doubtful accounts receivable for the periods indicated.

Years Ended December 31,2002

2001

2000Beginning Balance

$
2,548,000

$
4,355,000

$
3,182,000Additions Due to Acquisitions


379,000


180,000


Amounts Charged to Expense


1,815,000


(195,000
)

1,421,000Write-Downs and Other Adjustments


(1,493,000
)

(1,792,000
)

(248,000
)Ending Balance

$
3,249,000

$
2,548,000

$
4,355,000


During
2001, the Company reversed approximately $1,000,000 of previously established reserves for possible bad debts based upon revised estimates on collectibility.

62

---



NOTE 6PROPERTY AND EQUIPMENT

Property and equipment, at cost, consists of the following:

December 31,2002

2001Computers and Other Equipment

$
50,121,000

$
44,867,000Leasehold Improvements


11,490,000


9,329,000Furniture and Fixtures


11,735,000


7,866,00073,346,000


62,062,000Less Accumulated Depreciation and Amortization


(37,835,000
)

(30,853,000
)Property and Equipment, Net

$
35,511,000

$
31,209,000


Depreciation
and amortization expense on property and equipment for the years ended December 31, 2002, 2001 and 2000 was $10,951,000, $6,816,000 and $4,368,000, respectively. In
connection with restructuring, the Company wrote down property and equipment, net of depreciation and amortization, by $1,943,000 and $650,000 during 2002 and 2001, respectively. Refer to
Note 9Restructuring Reserve.

NOTE 7CAPITALIZED SOFTWARE COSTS

Capitalized software costs consist of the following:

December 31,2002

2001Capitalized Software Costs

$
119,039,000

$
109,101,000Less Accumulated Amortization


(93,082,000
)

(83,149,000
)Capitalized Software Costs, Net

$
25,957,000

$
25,952,000


The
components of capitalized software costs, as they affected operating income, are as follows:

Years Ended December 31,2002

2001

2000Capitalized Internal Software Development Costs

$
(13,979,000
)
$
(13,752,000
)
$
(13,655,000
)Amortization of Capitalized Software Costs


9,933,000


11,360,000


11,317,000Impairment of Capitalized Software Costs


4,751,000





$
705,000

$
(2,392,000
)
$
(2,338,000
)


Capitalized
software development costs and projected revenues are reviewed quarterly to determine if any impairment in value has occurred that would require an adjustment in the carrying
value or change in expected useful lives under the guidelines established under SFAS No. 86. During 2002, the Company recognized a non-cash, pre-tax impairment charge of
$4,751,000 related to capitalized software development costs. This charge has been included in cost of revenue in the accompanying consolidated statement of operations. The impairment was primarily
due to the abandonment of certain products as a result of the acquisition of MDI as well as the Company's restructuring during the second and third quarter.

63

---

In
addition, the Company purchased certain software that was capitalized in 2002, 2001 and 2000 amounting to $150,000, $381,000 and $1,249,000, respectively.

NOTE 8GOODWILL AND OTHER INTANGIBLE ASSETS

In June 2001, the FASB issued Statements of Financial Accounting Standards No. 141 ("SFAS No. 141"), "Business
Combinations", and No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets." Under the new rules, goodwill
and intangible assets deemed to have indefinite lives are no longer amortized but are subject to impairment tests annually or on an interim basis if events or circumstances indicate that the fair
value of the asset has decreased below its carrying value. In 2002, the Company recorded a $39,300,000 non-cash charge to reduce the carrying value of existing goodwill, refer to
Note 2Cumulative Change In Accounting Principle. Other intangible assets continue to be amortized over their useful lives. In connection with the adoption of SFAS 142, the
useful lives of such intangibles were evaluated and no changes were deemed necessary. The Company performed the first required annual impairment test as of October 1, 2002. No impairment was
indicated.

Upon
adoption of SFAS No. 142 in 2002, the Company ceased to amortize approximately $56,000,000 of goodwill and other indefinite lived intangibles acquired prior to July 1,
2001. The Company recorded $6,633,000 and $6,698,000 of amortization on these amounts in 2001 and 2000. SFAS No. 142 does not require retroactive restatement for all periods presented.

The
following information reflects the Company's results of operations as if SFAS 142 had been adopted on January 1, 2000:

Years Ended December 31,2002

2001

2000Reported Net Income (Loss)

$
(51,329,000
)
$
10,271,000

$
11,133,000Amortization of Goodwill and Indefinite Lived Intangibles





6,633,000


6,698,000Adjusted Net Income (Loss)

$
(51,329,000
)
$
16,904,000

$
17,831,000Basic Earnings (Loss) Per Share

$
(1.75
)
$
0.82

$
1.27Diluted Earnings (Loss) Per Share

$
(1.75
)
$
0.77

$
1.22


As
of December 31, 2002 and 2001, other indefinite lived intangibles was $26,768,000 and $3,268,000, respectively, net of accumulated amortization of $4,731,000. Other indefinite
lived intangibles, net of accumulated amortization, includes trademarks and trade names of $23,986,000 and $1,986,000, at December 31, 2002 and 2001, respectively.

64

---

The
changes in the carrying amount of goodwill (exclusive of other indefinite lived intangibles), net of $20,451,000 of accumulated amortization, for each of our reporting units for the
year ended December 31, 2002, are as follows:

|                               |                                     | Software
Segment |             | Services
Segment |   | Systems Segment |            | Total |           
|------------------------------ | ----------------------------------- | ---------------- | ----------- | ---------------- | - | --------------- | ---------- | ----- | ----------
|Balance at Beginning of Period |                                     | $                | 71,169,000  |                  | $ | 19,589,000      |            | $     | 57,706,000
|                               | Goodwill Acquired During the Period |                  |             | 57,677,000       |   |                 | 22,449,000 |       |           
|                               | Impairment Losses                   |                  |             |                 |   |                 |           |       |           
|                               |                                     |                  |             |                  |   |                 |            |       |           
|Balance at End of Period       |                                     | $                | 128,846,000 |                  | $ | 42,038,000      |            | $     | 18,406,000
|                               |                                     |                  |             |                  |   |                 |            |       |           

As
of December 31, 2002 and 2001, other intangible assets consist of the following:

December 31,2002

2001Developed Technology

$
57,324,000

$
23,674,000Customer List


6,322,000


6,322,000Value-Added Reseller Distribution Channel


5,200,000


5,200,000Other


235,000


204,00069,081,000


35,400,000Less Accumulated Amortization


(20,351,000
)

(13,777,000
)Other Intangible Assets, Net

$
48,730,000

$
21,623,000


For
the year ended December 31, 2002, amortization expense was $6,574,000. Estimated amortization expense for the following years is as follows:

Years Ended December 31,

Estimated
Amortization
Expense2003

$
7,584,0002004


5,489,0002005


5,314,0002006


5,314,0002007


5,314,000


NOTE 9RESTRUCTURING RESERVE

Due to the weakened economic conditions in all three world areas in which the Company operates, management determined in 2002 that current and future revenue
could not support the Company's existing cost structure. A review of the Company's structure indicated several areas in which the Company could reduce costs. It was determined that workforce
reductions and facility consolidations would be necessary to return the Company to profitability. In addition, the acquisition of MDI created certain redundant expenses that needed to be eliminated.
The Company accrued $5,794,000 of restructuring costs

65

---

related
to the integration of MDI, including severance and related charges associated with a worldwide reduction in force of MDI employees, transaction costs, costs related to closing redundant
facilities and terminating contracts and other exit costs associated with the acquisition. In accordance with Emerging Issuance Task Force Issue No. 95-3,
"Recognition of Liabilities in Connection with a Purchase Business Combination" ("EITF 95-3"), the costs related to the integration of MDI
were included as assumed liabilities in the net tangible assets acquired. In addition, the Company recorded a restructuring charge of $9,064,000 in 2002 related to the Company's existing business
operations. These additional restructuring charges related to workforce reductions, impairment of assets caused by the MDI acquisition, the consolidation of existing office facilities and other costs.

The
acquisition of AES in 2001 created certain redundant expenses that needed to be eliminated. In the third quarter of 2001, the Company recorded a restructuring charge of $1,894,000.
In addition, the Company recorded $563,000 of additional acquisition costs related to the integration of AES. In accordance with EITF 95-3, the costs relating to the consolidation of AES
office facilities were included in the purchase price allocation, resulting in additional goodwill. The restructuring charge that related to the Company's business of $1,894,000 was recorded as a
charge to income in 2001. These restructuring charges related to the impairment of an asset caused by the terms of the AES acquisition and the consolidation of existing office facilities.

Prior
to the date of the financial statements, management with the appropriate level of authority, approved and committed the Company to a plan of termination which included the benefits
terminated employees would receive. Expected termination benefits were communicated to employees in detail sufficient to enable them to determine the nature and amounts of their individual severance
benefits.

The
Company estimated the cost of exiting and terminating the facility leases based on the contractual terms of the agreements and then current real estate market conditions. The Company
determined that it would take approximately six to twenty-four months to sublease the various properties that will be vacated in connection with the consolidation program. Amounts related
to the lease expense (net of anticipated sublease proceeds) related to the consolidation of facilities will be paid over the respective lease terms. The Company anticipates completing implementation
of its restructuring program within twelve months of recording the related restructuring charge.

The
following is the activity in the restructuring reserve for the periods indicated:

|                             |                               | 1999 Plan |           | 2001 Plan  |   | 2002 Plan |           |   |  
|---------------------------- | ----------------------------- | --------- | --------- | ---------- | - | --------- | --------- | - | -
|
|Balance at December 31, 2000 |                               | $         | 1,340,000 |            | $ |          |           | $ | 
|                             | Restructuring Charges         |           |           |           |   |           | 1,389,000 |   |  
|                             | Acquisition Related Additions |           |           |           |   |           | 418,000   |   |  
|                             | Cash Payments                 |           |           | (1,075,000 | ) |           | (668,000  | ) |  
|                             | Non-Cash Write-Offs           |           |           |           |   |           |          |   |  
|                             |                               |           |           |            |   |           |           |   |  
|Balance at December 31, 2001 |                               | $         | 265,000   |            | $ | 1,139,000 |           | $ | 
|                             | Restructuring Charges         |           |           |           |   |           |          |   |  
|                             | Acquisition Related Additions |           |           |           |   |           |          |   |  
|                             | Cash Payments                 |           |           | (265,000   | ) |           | (966,000  | ) |  
|                             | Non-Cash Write-Offs           |           |           |           |   |           |          |   |  
|                             |                               |           |           |            |   |           |           |   |  
|Balance at December 31, 2002 |                               | $         |          |            | $ | 173,000   |           | $ | 
|                             |                               |           |           |            |   |           |           |   |  

66

---

NOTE 10OTHER CURRENT LIABILITIES

Other current liabilities consist of the following:

December 31,2002

2001Sales Taxes Payable

$
4,516,000

$
2,681,000Contribution to Profit Sharing Plan


3,258,000


2,509,000Commissions Payable


2,642,000


2,634,000Royalties Payable


1,703,000


1,192,000Interest Payable


1,599,000


1,078,000Income Taxes Payable





5,308,000Other


10,558,000


2,405,000Total Other Current Liabilities

$
24,276,000

$
17,807,000


NOTE 11TAXES BASED ON INCOME (LOSS)

The provision (benefit) for taxes based on income (loss) consists of the following:

Years Ended December 31,2002

2001

2000Current:Federal

$
(523,000
)
$
2,562,000

$
2,450,000State


(354,000
)

278,000


1,568,000Foreign


4,319,000


4,090,000


3,485,000Current Provision


3,442,000


6,930,000


7,503,000Deferred:Federal


(5,443,000
)

1,427,000


713,000State


(1,824,000
)

(692,000
)

(1,430,000
)Foreign


(2,044,000
)

(1,077,000
)

(1,351,000
)Deferred Benefit


(9,311,000
)

(342,000
)

(2,068,000
)Provision (Benefit) for Income Taxes

$
(5,869,000
)
$
6,588,000

$
5,435,000


A
charge in lieu of taxes from employee stock options of $2,337,000, $2,510,000 and $330,000 was recorded in stockholders' equity in 2002, 2001 and 2000, respectively. The foreign tax
provision for 2002, 2001 and 2000 includes withholding taxes of $2,941,000, $2,662,000 and $2,886,000, respectively, assessed to the Company by foreign authorities on amounts remitted to the United
States.

67

---

For
the years ended December 31, 2002, 2001 and 2000, the Company's foreign and domestic operations realized combined income (loss) before taxes, including intercompany charges,
as follows:

Years Ended December 31,2002

2001

2000Foreign

$
(1,903,000
)
$
943,000

$
1,960,000Domestic


(15,995,000
)

15,916,000


14,608,000$
(17,898,000
)
$
16,859,000

$
16,568,000


Deferred
income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax
purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31, 2002 and 2001 are as follows:

December 31,2002

2001Deferred Tax Liabilities:Intangible Assets

$
25,519,000

$
6,727,000Capitalized Software


10,460,000


10,340,000Unrealized Gain on Investment


1,993,000


1,290,000Depreciation


1,380,000


769,000State Taxes


649,000


Other


627,000


201,000Total Deferred Tax Liabilities


40,628,000


19,327,000Deferred Tax Assets:Deferred Revenue


9,770,000


8,501,000Foreign Deferred Taxes


7,647,000


5,603,000Business Credits


4,356,000


1,416,000Foreign Tax Credits


3,900,000


Undistributed Earnings of Foreign Subsidiaries


3,780,000


3,941,000Benefits and Compensation


2,985,000


1,741,000Net Operating Losses


1,524,000


1,524,000Restructuring Reserve


1,421,000


339,000Allowance for Doubtful Accounts


689,000


319,000State Taxes





183,000Other


411,000


65,000Total Deferred Tax Assets


36,483,000


23,632,000Valuation Allowance


(5,259,000
)

(4,919,000
)Net Deferred Tax Assets


31,224,000


18,713,000Net Deferred Tax Liabilities

$
9,404,000

$
614,000


68

---

In
2002 and 2001, the Company recorded as a charge to shareholders' equity a deferred tax liability on unrealized gains from an investment of $703,000 and $676,000, respectively. In
connection with the acquisition of MDI in 2002, a net deferred tax liability of $19,752,000 was charged against goodwill. These items are not reflected in the provision for income taxes.

The
balance sheet presentation of the net deferred tax liabilities (assets) is as follows:

December 31,2002

2001Long-Term Deferred Income Taxes, Net

$
29,243,000

$
14,489,000Current Deferred Tax Assets, Net


(19,839,000
)

(13,875,000
)Net Deferred Tax Liabilities

$
9,404,000

$
614,000


At
December 31, 2002, the Company had net operating loss carryforwards for federal income tax purposes of approximately $4,355,000. The federal net operating loss carryforwards
expire at various dates through the year 2013. An acquisition by the Company in 1993 constituted an ownership change for federal income tax purposes and, as a result, the amount of net operating loss
carryforwards that may be utilized in any given year may be limited. At December 31, 2002, the Company had tax credit carryforwards of $5,371,000 for federal income tax purposes and $2,885,000
for California franchise tax purposes. The federal credits expire at various dates through 2021.

The
valuation allowance for the deferred tax asset was $5,259,000 and $4,919,000 as of December 31, 2002 and 2001, respectively. The increase in 2002 was due to a valuation
allowance of $340,000 related to MDI's deferred tax asset for foreign tax credits.

69

---

The
following table reconciles the provision for income taxes based on income before taxes to the statutory federal income tax rate of 35% for the years ended December 31, 2002,
2001 and 2000.

Years Ended December 31,2002

2001

2000Income Tax Provision (Benefit) from Income (Loss) Before Cumulative Effect of Change in Accounting Principle at Statutory Federal Income Tax Rate

$
(6,264,000
)
$
5,913,000

$
5,799,000Increase (Decrease) Related To:Amortization of Goodwill and Intangibles


637,000


1,859,000


1,872,000Income of Foreign Sales Corporation








(1,203,000
)Other Changes in the Valuation Allowance








1,154,000Foreign Tax Credits Not Benefited








680,000State Income Taxes, Net of Federal Benefits


(333,000
)

785,000


651,000Federal and State Research and Development Tax Credits


(1,035,000
)

(1,604,000
)

(325,000
)Valuation Allowance Related to Foreign Deferred Taxes








(3,410,000
)Extraterritorial Income Exclusion





(853,000
)

Acquired In-Process Technology


759,000





Other, Net


367,000


488,000


217,000Provision (Benefit) from Income (Loss) Before Cumulative Effect of Change in Accounting Principle for Income Taxes


(5,869,000
)

6,588,000


5,435,000Provision for Income Taxes From Cumulative Effect of Change in Accounting Principle








Provision (Benefit) for Income Taxes

$
(5,869,000
)
$
6,588,000

$
5,435,000


NOTE 12SEGMENT INFORMATION

The Company's chief operating decision maker reviews financial information to manage the business consistent with the presentation in the consolidated financial
statements, focusing on the revenues and gross profit for each segment. The Company does not allocate research and development, selling, or general and administrative expenses to each segment, as
management does not use this information to measure the performance of the operating segments. The Company chief operating decision maker does not review assets by operating segment. Consequently,
such information is not provided herein. Services

70

---

includes
maintenance, support, consulting and training. The revenues and gross margins attributable to these segments are included in the following table:

Years Ended December 31,2002

2001

2000Revenue:Software

$
160,361,000

$
150,342,000

$
129,746,000Services


87,790,000


59,224,000


48,278,000Systems


96,000,000


26,531,000


$
344,151,000

$
236,097,000

$
178,024,000Gross Profit:Software

$
137,893,000

$
124,149,000

$
107,098,000Services


33,491,000


25,932,000


26,073,000Systems


14,641,000


4,406,000


$
186,025,000

$
154,487,000

$
133,171,000


International
Operations consists primarily of foreign sales offices selling software developed in the United States combined with local service revenue. Revenue is attributed to the
country in which the customer is located. The following tables summarize consolidated financial information of the Company's operations by geographic location:

Years Ended December 31,2002

2001

2000Revenue:The Americas

$
180,514,000

$
116,169,000

$
76,423,000Europe


78,880,000


63,380,000


52,469,000Asia-Pacific


84,757,000


56,548,000


49,132,000Total Revenue

$
344,151,000

$
236,097,000

$
178,024,000


December 31,2002

2001Identifiable Assets:The Americas

$
408,463,000

$
369,352,000Europe


43,036,000


37,238,000Asia-Pacific


55,775,000


27,065,000Total Identifiable Assets

$
507,274,000

$
433,655,000


The
net assets of the Company's foreign subsidiaries totaled $46,551,000 and $34,329,000 as of December 31, 2002 and 2001, respectively, excluding intercompany items.
Long-lived assets included in these amounts were $8,805,000 and $10,296,000 as of December 31, 2002 and 2001, respectively. The income (loss) before taxes of the Company's foreign
subsidiaries is reported in Note 11Taxes Based on Income (Loss).

71

---

NOTE 13EMPLOYEE BENEFITS

The Company contributes an amount, integrated with Social Security, to a defined contribution plan, covering substantially all North American
full-time employees who have completed a specified term of service with the Company. For the years ended December 31, 2002, 2001 and 2000, contributions charged to expense in
connection with this plan were $2,694,000, $2,392,000 and $2,087,000, respectively. The plan has a 401(k) feature to permit voluntary employee contributions, which does not affect the Company's
expenses.

In
1995, the Company adopted a non-qualified supplemental retirement plan. The Company contributes an amount, integrated with Social Security and the Company's defined
contribution plan, covering certain key employees who have completed a specified term of service with the Company. For the years ended December 31, 2002, 2001 and 2000, contributions charged to
expense in connection with this plan were $126,000, $117,000 and $94,000, respectively.

NOTE 14STOCK OPTION PLANS, WARRANTS AND STOCK BASED COMPENSATION

1991 PlanThe MSC.Software Corporation 1991 Stock Option Plan ("the 1991 Plan"), as amended, consists
of two parts: a "Key Employee Program" that allowed for discretionary awards of non-transferable incentive stock options and non-qualified stock options to officers and other
key employees, and a "Non-Employee Director Program" that provides for automatic annual grants of non-transferable, non-qualified stock options to
non-employee directors.

The
"Key Employee Program" section of the 1991 Plan provided for the granting of both incentive stock options and non-qualified options for the purchase of up to 2,500,000
authorized but unissued shares of the Company's common stock at the fair market value of such shares on the date the option is granted, or for non-qualified options at such price as the
Compensation Committee may determine.

The
"Non-Employee Director Program" section of the 1991 Plan provided for automatic grants to members of the Company's Board of Directors who are not officers or employees of
the
Company or its subsidiaries. A maximum of 500,000 shares of authorized but unissued shares of the Company's common stock may be issued upon the exercise of options under the "Non-Employee
Director Program". All eligible directors received annual non-discretionary grants of non-qualified stock options for the purchase of 3,000 shares of the Company's common
stock.

Options
under the 1991 Plan are exercisable up to ten years from the date of grant, subject to vesting provisions outlined at the grant date. Generally, options vest and become
exercisable one year after the grant date.

72

---

A
summary of stock option activity for the 1991 Plan is as follows:

Options

Option Price
Per Share

Weighted-Average
Exercise PriceOutstanding at December 31, 1999

2,172,600

$5.38 to $15.88

$
10.15Granted

540,549

$8.38 to $25.00

$
14.47Exercised

(160,533
)
$5.50 to $  9.88

$
8.20Cancelled

(308,800
)
$5.50 to $15.38

$
10.92Outstanding at December 31, 2000

2,243,816

$5.38 to $25.00

$
11.20Granted

184,014

$7.75 to $20.50

$
12.75Exercised

(671,742
)
$5.50 to $15.38

$
9.13Canceled

(45,250
)
$5.94 to $15.88

$
10.11Outstanding at December 31, 2001

1,710,838

$5.38 to $25.00

$
12.22Granted



$ to $

$
Exercised

(225,867
)
$6.94 to $15.38

$
10.15Canceled

(84,239
)
$8.63 to $20.50

$
15.13Outstanding at December 31, 2002

1,400,732

$5.38 to $25.00

$
12.37


As
of December 31, 2002, the number of options outstanding and exercisable under the 1991 Plan, by range of exercise prices, was as follows:

Options Outstanding

Options ExercisableRange of Exercise Prices

Number
of
Options

Weighted-
Average
Exercise
Price

Weighted-
Average
Remaining
Contractual
Life

Number
of
Options

Weighted-
Average
Exercise
Price$  5.38 to $  5.94

125,050

$
5.50

6.1

117,300

$
5.50$  6.94 to $  7.75

28,500

$
7.38

3.2

24,750

$
7.45$  8.10 to $  8.94

173,082

$
8.56

6.6

141,503

$
8.55$  9.00 to $  9.88

334,550

$
9.53

4.3

333,050

$
9.54$10.00 to $10.75

97,750

$
10.36

7.3

93,250

$
10.38$11.00 to $11.00

30,000

$
11.00

0.8

30,000

$
11.00$12.31 to $12.31

75,000

$
12.31

7.2

37,500

$
12.31$13.75 to $13.75

100,000

$
13.75

1.1

100,000

$
13.75$14.00 to $14.00

35,300

$
14.00

8.7

9,575

$
14.00$15.38 to $15.38

194,500

$
15.38

1.9

194,500

$
15.38$19.95 to $19.95

7,000

$
19.95

8.4

3,667

$
19.95$20.00 to $20.00

100,000

$
20.00

7.2



$
$25.00 to $25.00

100,000

$
25.00

7.2



$
Total

1,400,732

$
12.37

5.0

1,085,095

$
10.64


73

---

At
December 31, 2002, 2001 and 2000, the number of options exercisable under the 1991 Plan, the per-share weighted-average exercise prices of the stock options
exercisable under the 1991 Plan and the number of options available for future grant under the 1991 Plan were as follows:

Options ExercisableOptions
Available
for Future
GrantsNumber of
Options

Weighted-Average
Exercise PriceDecember 31, 2000

1,484,991

$
10.54

456,201December 31, 2001

1,145,316

$
10.91

December 31, 2002

1,085,095

$
10.64




1998 PlanThe MSC.Software Corporation 1998 Stock Option Plan ("the 1998 Plan"), as amended, consists of two parts: a "Key
Employee Program" that allows discretionary awards of non-transferable incentive stock options and non-qualified stock options to officers and other key employees, and a
"Non-Employee Director Program" that provided for automatic annual grants of non-transferable, non-qualified stock options to non-employee directors.

The
"Key Employee Program" section of the 1998 Plan provides for the granting of both incentive stock options and non-qualified options for the purchase of up to 3,440,000
authorized but unissued shares of the Company's common stock at the fair market value of such shares on the date the option is granted, or for non-qualified options at such price as the
Compensation Committee may determine.

The
"Non-Employee Director Program" section of the 1998 Plan provided for automatic grants to members of the Company's Board of Directors who are not officers or employees of
the Company or its subsidiaries. A maximum of 60,000 shares of authorized but unissued shares of the Company's common stock may be issued upon the exercise of options under the
"Non-Employee Director Program". All eligible directors received annual non-discretionary grants of non-qualified stock options for the purchase of 3,000 shares of
the Company's common stock. Options to be granted to non-employee directors under the 1998 Plan did not begin until 2000 and ceased on May 15, 2002. Directors received only 3,000
shares of the Company's common stock per year from either the 1991 or 1998 Plans.

Options
under the 1998 Plan are exercisable up to ten years from the date of grant, subject to transfer restrictions and vesting provisions outlined at the grant date. Generally, options
vest and become exercisable one year after the grant date. The 1998 Plan provides that vesting may be accelerated in certain events related to changes in control of the Company, unless prior to such
change in control the Compensation Committee determines otherwise. Similarly, the 1998 Plan provides that the Compensation Committee has discretion, subject to certain limits, to modify the terms of
outstanding options. No amendment or cancellation and re-grant, subject to permitted adjustments, shall reduce the per share exercise price to a price less than 100% of the fair market
value of the Company's common stock on the option date of the initial option.

74

---

A
summary of stock option activity for the 1998 Plan is as follows:

Options

Option Price
Per Share

Weighted-Average
Exercise PriceOutstanding at December 31, 1999

1,815,850

$
5.00 to $9.00

$
6.36Granted

875,704

$
7.94 to $15.00

$
10.20Exercised

(54,767
)
$
5.00 to $9.00

$
6.14Cancelled

(306,698
)
$
5.00 to $9.63

$
6.72Outstanding at December 31, 2000

2,330,089

$
5.00 to $15.00

$
7.76Granted

1,196,400

$
9.45 to $27.50

$
18.89Exercised

(374,966
)
$
5.00 to $10.13

$
6.64Canceled

(150,076
)
$
5.00 to $11.04

$
7.04Outstanding at December 31, 2001

3,001,447

$
5.00 to $27.50

$
12.38Granted

122,955

$
4.68 to $22.02

$
9.56Exercised

(138,690
)
$
5.00 to $11.04

$
7.11Canceled

(149,067
)
$
4.68 to $22.02

$
12.34Outstanding at December 31, 2002

2,836,645

$
4.68 to $27.50

$
12.51


75

---

As
of December 31, 2002, the number of options outstanding and exercisable under the 1998 Plan, by range of exercise prices, was as follows:

Options Outstanding

Options ExercisableRange of Exercise Prices

Number
of
Options

Weighted-
Average
Exercise
Price

Weighted-
Average
Remaining
Contractual
Life

Number
of
Options

Weighted-
Average
Exercise
Price$  4.68 to $  4.99

49,605

$
4.72

9.8

6,000

$
4.99$  5.00 to $  5.94

600,607

$
5.60

6.3

517,607

$
5.55$  6.38 to $  6.75

142,333

$
6.41

5.8

142,333

$
6.41$  7.22 to $  7.94

12,400

$
7.52

8.7

3,734

$
7.91$  8.19 to $  8.88

174,576

$
8.64

7.5

131,414

$
8.61$  9.00 to $  9.98

493,624

$
9.21

6.1

346,682

$
9.14$10.00 to $10.99

33,500

$
10.42

8.2

14,050

$
10.21$11.04 to $11.04

5,400

$
11.04

7.7

5,400

$
11.04$12.27 to $12.27

300

$
12.27

9.3



$
$13.00 to $13.56

102,000

$
13.01

7.2

102,000

$
13.01$14.00 to $14.00

25,100

$
14.00

8.7

9,636

$
14.00$15.00 to $15.98

452,000

$
15.74

8.0

185,000

$
15.45$16.23 to $16.69

16,700

$
16.63

9.0

2,200

$
16.23$17.18 to $17.60

348,500

$
17.18

8.4

118,668

$
17.18$19.35 to $19.35

5,000

$
19.35

9.1

5,000

$
19.35$21.95 to $21.95

187,500

$
21.95

8.6

187,500

$
21.95$27.50 to $27.50

187,500

$
27.50

8.6

187,500

$
27.50Total

2,836,645

$
12.51

7.3

1,964,724

$
12.27


At
December 31, 2002, 2001 and 2000, the number of options exercisable under the 1998 Plan, the per-share weighted-average exercise prices of the stock options
exercisable under the 1998 Plan and the number of options available for future grant under the 1998 Plan were as follows:

Options ExercisableOptions
Available
for Future
GrantsNumber of
Options

Weighted-Average
Exercise PriceDecember 31, 2000

765,319

$
6.43

1,116,144December 31, 2001

1,440,149

$
12.10

69,820December 31, 2002

1,964,724

$
12.27

94,932


2001 PlanThe MSC.Software Corporation 2001 Stock Option Plan ("the 2001 Plan") consists of two parts: a "Key Employee
Program" that allows discretionary awards of non-transferable incentive stock options and non-qualified stock options to officers and other key employees, and a
"Non-Employee

76

---

Director
Program" that provides for automatic annual grants of non-transferable, non-qualified stock options to non-employee directors.

The
"Key Employee Program" section of the 2001 Plan provides for the granting of both incentive stock options and non-qualified options for the purchase of up to 2,690,000
authorized but unissued shares of the Company's common stock at the fair market value of such shares on the date the option is granted, or for non-qualified options at such price as the
Compensation Committee may determine.

The
"Non-Employee Director Program" section of the 2001 Plan provides for automatic grants to members of the Company's Board of Directors who are not officers or employees of
the Company or its subsidiaries. A maximum of 60,000 shares of authorized but unissued shares of the Company's common stock may be issued upon the exercise of options under the
"Non-Employee Director Program". All eligible directors will receive annual non-discretionary grants of non-qualified stock options for the purchase of 5,000 shares
of the Company's common stock. Options to be granted to non-employee directors under the 2001 Plan did not begin until after the termination of the "Non-Employee Director
Program" 1998 Plan on May 15, 2002.

Options
under the 2001 Plan are exercisable up to ten years from the date of grant, subject to transfer restrictions and vesting provisions outlined at the grant date. Generally, options
vest and become exercisable one year after the grant date. The 2001 Plan provides that vesting may be accelerated in certain events related to changes in control of the Company, unless prior to such
change in control the Compensation Committee determines otherwise. Similarly, the 2001 Plan provides that the Compensation Committee has discretion, subject to certain limits, to modify the terms of
outstanding options. No amendment or cancellation and re-grant, subject to permitted adjustments, shall reduce the per share exercise price to a price less than 100% of the fair market
value of the Company's common stock on the option date of the initial option.

A
summary of stock option activity for the 2001 Plan is as follows:

Options

Option Price
Per Share

Weighted-Average
Exercise PriceOutstanding at December 31, 2000



$
 to $     

$
Granted

812,666

$
13.45 to $15.95

$
14.12Exercised



$
 to $     

$
Canceled

(2,200
)
$
14.00 to $14.00

$
14.00Outstanding at December 31, 2001

810,466

$
13.45 to $15.95

$
14.12Granted

944,612

$
4.68 to $22.60

$
14.02Exercised



$
 to $     

$
Canceled

(128,086
)
$
4.68 to $22.60

$
13.26Outstanding at December 31, 2002

1,626,992

$
4.68 to $22.60

$
14.13


77

---

As of December 31, 2002, the number of options outstanding and exercisable under the 2001 Plan, by range of exercise prices, was as follows:

Options Outstanding

Options ExercisableRange of Exercise Prices

Number
of
Options

Weighted-
Average
Exercise
Price

Weighted-
Average
Remaining
Contractual
Life

Number
of
Options

Weighted-
Average
Exercise
Price$  4.68 to $  4.68

132,379

$
4.68

9.8



$
$  6.80 to $  6.80

2,830

$
6.80

10.0



$
$  7.22 to $  7.22

750

$
7.22

9.9



$
$10.51 to $10.51

250

$
10.51

9.6



$
$11.40 to $11.40

230,000

$
11.40

9.4

9,230

$
11.40$13.45 to $13.59

4,500

$
13.47

8.8

2,500

$
13.48$14.00 to $14.95

689,650

$
14.03

8.5

456,645

$
14.01$15.00 to $15.95

329,333

$
15.11

9.3

20,583

$
15.92$16.18 to $16.18

33,000

$
16.18

8.9

12,000

$
16.18$19.35 to $19.35

4,000

$
19.35

9.1

4,000

$
19.35$21.96 to $21.96

200,000

$
21.96

9.2



$
$22.60 to $22.60

300

$
22.60

9.2



$
Total

1,626,992

$
14.13

9.0

504,958

$
14.13


At
December 31, 2002 and 2001, the number of options exercisable under the 2001 Plan, the per-share weighted-average exercise prices of the stock options exercisable
under the 2001 Plan and the number of options available for future grant under the 2001 Plan were as follows:

Options ExercisableOptions
Available
for Future
GrantsNumber of
Options

Weighted-Average
Exercise PriceDecember 31, 2001



$


1,189,534December 31, 2002

504,958

$
14.13

1,123,008


AES OptionsAs part of the acquisition of AES, the Company assumed outstanding options to acquire AES common stock, which were
converted into fully vested options, with time based exercise restrictions, to acquire 718,898 shares of the Company's common stock (the "AES Options"). All such options have an

78

---

exercise
price of $0.10 and were immediately exercisable. A summary of stock option activity for the AES Options is as follows:

Options

Option Price
Per Share

Weighted-Average
Exercise PriceOutstanding at December 31, 2000



$
 to $     

$
Granted

718,898

$
0.10 to $0.10

$
0.10Exercised

(48,354
)
$
0.10 to $0.10

$
0.10Canceled



$
 to $     

$
Outstanding at December 31, 2001

670,544

$
0.10 to $0.10

$
0.10Granted



$
 to $     

$
Exercised

(211,326
)
$
0.10 to $0.10

$
0.10Canceled



$
 to $     

$
Outstanding at December 31, 2002

459,218

$
0.10 to $0.10

$
0.10


The
weighted average remaining contractual life of the AES Options was 8.3 and 9.6 years as of December 31, 2002 and 2001, respectively.

Employee Stock Purchase PlanIn September 1996, the Company's Board of Directors adopted the MSC.Software Corporation
1996 Employee Stock Purchase Plan ("the Employee Stock Purchase Plan"). The Employee Stock Purchase Plan was approved by the Company's shareholders at the 1997 Annual Meeting of Shareholders. Under
the Employee Stock Purchase Plan, a maximum of 1,250,000 shares of the Company's common stock has been made available for purchase by eligible employees electing to participate in the Employee Stock
Purchase Plan. The Employee Stock Purchase Plan is intended to provide participating eligible employees an additional incentive to advance the best interests of the Company through ownership of common
stock. This qualified Employee Stock Purchase Plan under Sections 421 and 423 of the Internal Revenue Code is offered to all eligible employees and is non-compensatory under APB Opinion
No. 25. As of December 31, 2002, a total of 281 eligible employees

79

---

elected
to participate in the Employee Stock Purchase Plan with total payroll deductions as of that date equal to $818,000. Purchases were as follows for the periods indicated:

Shares

Price
Per Share

Total
PurchasesJuly 31, 1997

89,986

$
6.98

$
628,000January 31, 1998

48,876

$
8.38


410,000July 31, 1998

54,119

$
7.14


387,000January 31, 1999

59,734

$
5.85


349,000July 31, 1999

71,177

$
4.89


348,000January 31, 2000

75,470

$
4.84


365,000July 31, 2000

48,584

$
7.65


372,000January 31, 2001

39,156

$
9.00


352,000July 31, 2001

42,809

$
9.44


404,000January 31, 2002

38,408

$
18.15


697,000July 31, 2002

80,352

$
9.46


760,000648,671

$
7.82

$
5,072,000


There
are 601,329 remaining shares eligible for purchase under the Employee Stock Purchase Plan as of December 31, 2002. On January 31, 2003, purchases of 112,661 shares
totaling $815,000 were exercised.

Stock-Based CompensationDuring the year ended December 31, 2002, and 2001, the Company issued a total of 61,500 and
28,500 shares of its common stock, respectively, to certain of its officers pursuant to the MSC.Software Corporation 2000 Executive Cash or Stock Bonus Plan. The Company has recognized stock based
compensation charge of $1,303,000 and $285,000 for the years ended December 31, 2002, and 2001, respectively.

WarrantsIn March 1998, the Company entered into a joint-development and marketing arrangement with Kubota Solid
Technology Corporation ("KSTC"). This arrangement allowed KSTC to purchase warrants with an aggregate exercise price of up to $3,000,000 to purchase shares of the Company's common stock. As of
December 31, 2002, all warrants were purchased under the arrangement. The exercise price is equal to the fair market value of the common stock on the date of issuance of the warrants. The
warrants are non-transferable, have a five-year term and become exercisable two years after the date of issuance. The warrants issued have exercise prices ranging between
$5.8125 per share and $11.375 per share. In 2001, 177,160 of such warrants were exercised to purchase shares of the Company's common stock for $1,125,000. As of December 31, 2002 and 2001,
warrants to purchase 226,547 shares of the Company's common stock were outstanding under the arrangement, with a weighted average exercise price of $8.28 per share.

In
June 1999, in connection with an acquisition, the Company issued five-year warrants to purchase 1,400,000 shares of the Company's common stock at an exercise price
of $10.00 per share. In 2002, 300,000 of such warrants were exercised. The exercise price of $3,000,000 was paid through a reduction of the principal amount of the Company's subordinate notes payable.

80

---

In
November 1999, in connection with an acquisition, the Company issued five-year warrants to purchase 110,000 shares of the Company's common stock at an exercise
price of $10.00 per share.

In
May 2002, the Company issued five-year warrants to purchase 15,000 shares of the Company's common stock at an exercise price of $15.00 per share. The warrants were
recorded at fair value based on the Black-Scholes valuation method using the following assumptions: dividend yield of 0.0%; expected volatility of 57%; and a risk free interest rate of 4.56%. The
warrants were issued to the former President of MDI in exchange for consulting services and the fair value of $97,000 was expensed on the issuance date.

NOTE 15COMMITMENTS AND CONTINGENCIES

LeasesThe Company leases facilities and equipment under various lease agreements, which range from
one to twelve years, which require the following minimum annual rental commitments:

Operating Leases
Years Ending December 31,2003

$
12,335,0002004


10,236,0002005


8,542,0002006


8,104,0002007


8,240,000Thereafter


36,614,000$
84,071,000


For
the years ended December 31, 2002, 2001 and 2000, the combined annual rental cost for various facilities and equipment under operating leases approximated $15,968,000,
$11,432,000 and $8,356,000, respectively. In most cases, management expects that, in the normal course of business, leases will be renewed or replaced by others.

LitigationThe Company is involved in various pending or threatened litigation matters arising out of the normal conduct of
our business. Additionally, the Company is periodically audited by various taxing authorities in the United States of America and in other countries in which the Company does business. In our opinion,
these matters will not have a material adverse effect on our financial position or results of operations.

In
October 2001, the Federal Trade Commission ("FTC") issued an administrative challenge to the Company's acquisition of two competitors in 1999, alleging that the Company had
substantially lessened competition in the Nastran market as a result of the acquisitions. In July 2002, a settlement was proposed, which was accepted by the FTC and made available for public
comment in August 2002. On November 1, 2002, the FTC approved the settlement. The settlement requires the Company to divest to up to two acquirers ("Acquirers") all intellectual property
(including computer code) related to the most current version of MSC.Nastran, as of the date of the settlement, all intellectual property acquired in the 1999 acquisitions, and all information related
to customers using MSC.Nastran in the United States. In addition, for all customers that converted or convert to a paid-up license after June 24, 1999 through the first

81

---

anniversary
after the divestiture, the Company is required to allow the customer to terminate the paid-up agreement and to obtain a refund of a pro-rata portion of the
consideration for the paid-up license if the customer decides to change from MSC.Nastran to the Acquirer's version of Nastran. The Company does not believe it will sustain a material loss
as a result of the FTC settlement. However, the value of the related contracts subject to potential refund was approximately $26,600,000 as of December 31, 2002. The Company is currently in
negotiations with an Acquirer. Until a final agreement has been reached with one or more Acquirers and the customers who are entitled to a refund have requested such refund or the refund period has
expired, the effect of the settlement on the Company's financial statements cannot be determined. Accordingly, no amounts have been recorded in the accompanying consolidated financial statements
related to the settlement. However, for arrangements with customers that convert to a paid-up license after November 1, 2002, the Company defers revenue for the fair value of the
Nastran paid-up license because the arrangement is cancelable in certain circumstances pursuant to the FTC settlement and, as a result, the fee is not considered to be fixed or
determinable. As of December 31, 2002, the Company has deferred approximately $6,400,000 of such revenue (which is included in the $26,600,000 above), which is included in deferred revenue in
the accompanying consolidated balance sheet. Such revenue will be recognized ratably over a 48 month term until the customer requests a refund or the twelve month period to request such a
refund lapses, at which time the remaining deferred revenue will be recognized. The twelve month period to request a refund begins on the date we complete the divestiture of assets to one or more
acquirers approved by the FTC.

IndemnificationsThe Company indemnifies its software customers against claims that software or documentation purchased from
the Company infringes upon a copyright, patent or the proprietary rights of others. In the event of such a claim, the Company agrees to obtain the rights for continued use of the software for the
customer, to replace or modify the software or documentation to avoid such claim or to provide a credit to the customer for the unused portion of the software license. Due to the nature of this
indemnification and the various options in which the Company can satisfy the indemnification, it is not possible to calculate the maximum potential amount of future payments that may be required.

NOTE 16ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The components of accumulated other comprehensive income (loss) are as follows:

Currency
Translation
Adjustment

Unrealized
Investment
Gain,
Net of Tax

Accumulated
Other
Comprehensive
Income (Loss)Balance at December 31, 2001

$
(10,224,000
)
$
2,018,000

$
(8,206,000
)Other Comprehensive Income (Loss)


3,741,000


1,098,000


4,839,000Balance at December 31, 2002

$
(6,483,000
)
$
3,116,000

$
(3,367,000
)


The
Company does not provide any deferred tax benefit for the currency translation adjustment because the recoverability of the benefit is not anticipated in the foreseeable future. The
amount of tax associated with the unrealized investment gain as of December 31, 2002 and 2001 was $1,993,000 and $1,290,000, respectively.

82

---

NOTE 17SHAREHOLDERS' EQUITY

Public OfferingDuring 2001, the Company completed the sale of 4,025,000 shares of the Company's
common stock in a public offering. The net proceeds to the Company, after the underwriter discount and expenses, was approximately $67,356,000

Shareholder Rights PlanIn October 1998, the Company adopted a Shareholder Rights Plan ("the Rights Plan"). As part of
the Rights Plan, a special type of dividend was declared on the common stock of the Company distributing these rights to all stockholders of record on October 16, 1998. These rights, which do
not have any shareholder rights, including voting or dividend rights, will expire on October 5, 2008, unless earlier redeemed by the Company prior to expiration at a price of $.01 per right.
The rights automatically transfer with a transfer of common stock until the time they become exercisable, which happens when certain specified events occur. If the rights become exercisable, they
entitle the holders thereof to purchase stock of the Company at a price of $35.00, subject to certain other provisions of the Rights Plan.

As
of December 31, 2002, excluding shares that may be issued under the Rights Plan, shares of common stock reserved for issuance were as follows:

Common Stock Warrants

1,451,547Employee Stock Option Plans:1991 Plan

1,400,7321998 Plan

2,931,5772001 Plan

2,750,000AES Options

459,218Employee Stock Purchase Plan

601,3299,594,403


83

---

NOTE 18EARNINGS (LOSS) PER SHARE

The following table sets forth the computation of Basic and Diluted Earnings (Loss) Per Share:

|                              |                                               | Net Income |   | Average
Shares
Outstanding |   | Per Share
Amount | 
|----------------------------- | --------------------------------------------- | ---------- | - | -------------------------- | - | ---------------- | 
|Year Ended December 31, 2002: |                                               |            |   |                            |   |                  | 
|                              | Basic Earnings Per Share                      |            | $ | (51,329,000                | ) | 29,379,000       | 
|                              | Effect of Dilutive Stock Options and Warrants |            |   |                           |   |                 | 
|                              |                                               |            |   |                            |   |                  | 
|                              | Diluted Earnings Per Share                    |            | $ | (51,329,000                | ) | 29,379,000       | 
|                              |                                               |            |   |                            |   |                  | 
|Year Ended December 31, 2001: |                                               |            |   |                            |   |                  | 
|                              | Basic Earnings Per Share                      |            | $ | 10,271,000                 |   | 20,606,000       | 
|                              | Effect of Dilutive Stock Options and Warrants |            |   |                           |   | 1,294,000        | 
|                              |                                               |            |   |                            |   |                  | 
|                              | Diluted Earnings Per Share                    |            | $ | 10,271,000                 |   | 21,900,000       | 
|                              |                                               |            |   |                            |   |                  | 
|Year Ended December 31, 2000: |                                               |            |   |                            |   |                  | 
|                              | Basic Earnings Per Share                      |            | $ | 11,133,000                 |   | 14,025,000       | 
|                              | Effect of Dilutive Stock Options and Warrants |            |   |                           |   | 589,000          | 
|                              |                                               |            |   |                            |   |                  | 
|                              | Diluted Earnings Per Share                    |            | $ | 11,133,000                 |   | 14,614,000       | 
|                              |                                               |            |   |                            |   |                  | 

In
accordance with SFAS No. 123, the Company does not include shares purchasable under its employee stock purchase plan in the calculation of Basic Earnings (Loss) per Share as
all conditions for issuing the shares have not been met as of year-end. Shares purchasable under the employee stock purchase plan are included in the calculation of Diluted Earnings (Loss)
per Share.

For
additional disclosures regarding the convertible subordinated debentures, employee stock options and common stock warrants, refer to Note 4Financial Instruments
and Note 14Stock Option Plans, Warrants and Stock Based Compensation.

The
following table shows the common stock equivalents that were outstanding as of December 31, 2002, 2001 and 2000, but were not included in the computation of Diluted Earnings
(Loss) Per Share because the options' or warrants' exercise price was greater than the average market price of the common

84

---

shares
and, therefore, the effect would be anti-dilutive, or the effect of the conversion would be anti-dilutive:

Number of
Shares

Option Price
Per ShareAnti-Dilutive Stock Options:As of December 31, 2000

1,530,624

$
9.69

to

$
25.00As of December 31, 2001

1,735,730

$
14.95

to

$
27.50As of December 31, 2002

6,323,587

$
0.10

to

$
27.50Anti-Dilutive Common Stock Warrants:As of December 31, 2000

1,619,399

$
9.81

to

$
11.38As of December 31, 2001



$


to

$
As of December 31, 2002

1,451,547

$
5.81

to

$
15.00Anti-Dilutive ESPP SharesAs of December 31, 2002

107,574

$
6.95Anti-Dilutive Convertible Subordinated Debentures:As of December 31, 2000

3,865,100

$
15.15


NOTE 19RELATED PARTY TRANSACTION

The
Company utilizes, in the normal course of business, the services of Geometric Software Solutions Co. Ltd. ("GSSL"), a public company headquartered in India that
provides CAD/CAM/CAE/PDM software applications, component technology and development services. The Chairman and Chief Executive Officer of the Company is a director of GSSL. For the years ended
December 31, 2002, 2001 and 2000, the amounts paid by the Company to GSSL were approximately $890,000, $1,477,000 and $1,442,000, respectively. As of December 31, 2002, the Company also
owns 520,000 shares of GSSL stock with an original cost of $68,000 and a fair market value of $5,177,000.

Of
the $20,000,000 of outstanding notes payable to shareholders related to the AES acquisition, $13,153,000 is due to officers of the Company or their dependents.

85

---

NOTE 20QUARTERLY FINANCIAL DATA (UNAUDITED)

The following is selected unaudited quarterly financial data for the years ended December 31, 2002 and 2001.

|                                                                                                                  |  | Quarter Ended
|----------------------------------------------------------------------------------------------------------------- |  | -------------
|
|Revenue                                                                                                           |  | $            
|Cost of Revenue                                                                                                   |  |              
|                                                                                                                  |  |              
|Gross Profit                                                                                                      |  |              
|Operating Expense                                                                                                 |  |              
|                                                                                                                  |  |              
|Operating Income (Loss)                                                                                           |  |              
|Other Expense, Net                                                                                                |  |              
|                                                                                                                  |  |              
|Income (Loss) Before Provision (Benefit) for Income Taxes and Cumulative Effect of Change in Accounting Principle |  |              
|Provision (Benefit) for Income Taxes                                                                              |  |              
|                                                                                                                  |  |              
|Income (Loss) Before Cumulative Effect of Change in Accounting Principle                                          |  |              
|Cumulative Effect of Change in Accounting Principle                                                               |  |              
|                                                                                                                  |  |              
|Net Income (Loss)                                                                                                 |  | $            
|                                                                                                                  |  |              
|Basic and Diluted Earnings (Loss) Per Share Before Cumulative Effect of Change                                    |  | $            
|Basic and Diluted Earnings (Loss) Per Share                                                                       |  | $            
|Basic Weighted-Average Shares                                                                                     |  |              
|Diluted Weighted-Average Shares                                                                                   |  |              
|                                                                                                                  |  |              
|
|
|Revenue                                                                                                           |  | $            
|Cost of Revenue                                                                                                   |  |              
|                                                                                                                  |  |              
|Gross Profit                                                                                                      |  |              
|Operating Expense                                                                                                 |  |              
|                                                                                                                  |  |              
|Operating Income (Loss)                                                                                           |  |              
|Other Expense, Net                                                                                                |  |              
|                                                                                                                  |  |              
|Income (Loss) Before Provision (Benefit) for Income Taxes                                                         |  |              
|Provision (Benefit) for Income Taxes                                                                              |  |              
|                                                                                                                  |  |              
|Net Income (Loss)                                                                                                 |  | $            
|                                                                                                                  |  |              
|Basic Earnings (Loss) Per Share                                                                                   |  | $            
|Diluted Earnings (Loss) Per Share                                                                                 |  | $            
|Basic Weighted-Average Shares                                                                                     |  |              
|Diluted Weighted-Average Shares                                                                                   |  |              

---

86

---



REPORT OF KPMG LLP, INDEPENDENT AUDITORS

To
the Board of Directors and Shareholders of
MSC.Software Corporation

We
have audited the accompanying consolidated balance sheets of MSC.Software Corporation and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements
of operations, shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion
on these financial statements based on our audits.

We
conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MSC.Software Corporation and subsidiaries at
December 31, 2002 and 2001, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States
of America.

As
discussed in notes 2 and 8 to the consolidated financial statements, effective January 1, 2002, MSC.Software Corporation and subsidiaries adopted the provisions of SFAS
No. 142, "Goodwill and Other Intangible Assets," as required for the accounting for goodwill and other intangible assets.



Costa
Mesa, California
February 14, 2003

87

---



REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

To
the Board of Directors and Shareholders of
MSC.Software Corporation

We
have audited the accompanying consolidated statements of income, shareholders' equity, and cash flows of MSC.Software Corporation for the year ended December 31, 2000. These
financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.

We
conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe
that our audit provides a reasonable basis for our opinion.

In
our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations, changes in shareholders' equity and cash
flows of MSC.Software Corporation for the year ended December 31, 2000, in conformity with accounting principles generally accepted in the United States.



Los
Angeles, California
February 28, 2001

88

---



PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

Item 15(a)1. Financial Statements

The following consolidated financial statements of MSC.Software Corporation, as included in its Annual Report, are included in Item 8.

Consolidated Balance Sheets as of December 31, 2002 and 2001Consolidated Statements of Operations for the Years Ended December 31, 2002, 2001 and 2000Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 2002, 2001 and 2000Consolidated Statements of Cash Flows for the Years Ended December 31, 2002, 2001 and 2000Notes to Consolidated Financial StatementsReport of KPMG LLP, Independent AuditorsReport of Ernst & Young LLP, Independent Auditors


Item 15(a)2. Financial Statement Schedules

All schedules have been omitted because the information either has been shown in the consolidated financial statements or notes thereto, or is not applicable or
required under the instructions.

Item 15(a)3. Exhibits

|Exhibit
Number |  |                                                                                                                                                                                                                                                  
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1            |  | Certificate of Incorporation of MSC.Software Corporation, as amended (filed as Exhibit 3.1 of MSC.Software Corporation's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1999, and incorporated
herein by reference).      
|3.2            |  | Restated Bylaws of MSC.Software Corporation (filed as Exhibit 3.2 to MSC.Software Corporation's Annual Report on Form 10-K filed for the fiscal year ended January 31, 1996, and incorporated herein by reference).                              
|3.3            |  | Certificate of Designations of Junior Participating Preferred Stock (filed as Exhibit 2.2 to The MacNeal-Schwendler Corporation's Registration Statement on Form 8-A filed October 13, 1998, and incorporated herein by reference).              
|4.1            |  | The MacNeal-Schwendler Corporation Indenture dated as of June 17, 1999 with Chase Manhattan Bank & Trust Company N.A. as Trustee (filed as Exhibit 4.1 to a Current Report on Form 8-K filed July 1, 1999, and incorporated herein by
reference).
|               |  |                                                                                                                                                                                                                                                  

89

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|4.2   |  | The MacNeal-Schwendler Corporation Warrant Agreement dated as of June 18, 1999 with The MacNeal-Schwendler Corporation acting in the capacity of Warrant Agent (filed as Exhibit 4.2 to a Current Report on Form 8-K filed July 1, 1999, and incorporated
herein by reference).                                                                                                                                                                                                                                                                              
|----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4.3   |  | Rights Agreement dated as of October 5, 1998 between The MacNeal-Schwendler Corporation and ChaseMellon Shareholder Services, L.L.C., as Rights Agent, including the Form of Right Certificate (Exhibit A), the Summary of Rights to Purchase Junior
Participating Preferred Stock (Exhibit B) and the Form of Certificate of Designations of Junior Participating Preferred Stock (Exhibit C) (filed as Exhibit 2.1 to The MacNeal-Schwendler Corporation's Registration Statement on Form 8-A filed
October 13, 1998 and incorporated herein by reference).
|4.4   |  | Indenture, dated as of August 18, 1994, between MSC.Software Corporation and Chemical Trust Company of California, as trustee (filed as part of MSC.Software Corporation's Registration Statement on Form S-3 (No. 33-83174), and incorporated herein by
reference).                                                                                                                                                                                                                                                                                         
|4.5   |  | First Supplemental Indenture, dated September 22, 1994, between MSC.Software Corporation and Chemical Trust Company of California, as trustee (filed as Exhibit 4.2 of MSC.Software Corporation's Quarterly Report on Form 10-Q for the quarterly period
ended October 31, 1994, and incorporated herein by reference).                                                                                                                                                                                                                                      
|4.6   |  | Second Supplemental Indenture, dated December 14, 1994, between MSC.Software Corporation and Chemical Trust Company of California, as trustee (filed as Exhibit 4.3 of MSC.Software Corporation's Quarterly Report on Form 10-Q for the quarterly period
ended October 31, 1994, and incorporated herein by reference).                                                                                                                                                                                                                                      
|10.1  |  | Agreement of Lease, dated August 25, 1999, between MSC.Software Corporation and Imperial Promenade Associates, LLC, a Delaware limited liability company (filed as Exhibit 10.1 to MSC.Software Corporation's Annual Report on Form 10-K filed for the
fiscal year ended December 31, 1999, and incorporated herein by reference).                                                                                                                                                                                                                           
|10.2* |  | 1998 Incentive Stock Option Plan for Key Employees, as amended (filed as Annex A to The MacNeal-Schwendler Corporation's Annual Proxy Statement for the Annual Meeting of Shareholders held on June 23, 1999, and incorporated herein by
reference).                                                                                                                                                                                                                                                                                                         
|10.3* |  | Employment Agreement Between MSC.Software Corporation and Frank Perna, Jr. (filed as Exhibit 3.1 of MSC.Software Corporation's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1999, and incorporated herein by
reference).                                                                                                                                                                                                                                                                                                            
|10.4  |  | Loan and Security Agreement Dated as of November 18, 2002 Between MSC.Software Corporation, as Borrower and Foothill Capital Corporation, as the Arranger and Administrative Agent (filed as Exhibit 10.4 of MSC.Software Corporate's Quarterly Report of
Form 10-Q for the quarterly period ended September 30, 2002, and incorporated herein by reference).                                                                                                                                                                                                
|      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

90

---

|10.5      |  | First Amendment to Loan and Security Agreement Between MSC.Software Corporation and Foothill Capital Corporation.**                                                                                                                                                                   
|--------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.6      |  | Second Amendment to Loan and Security Agreement Between MSC.Software Corporation and Foothill Capital Corporation.**                                                                                                                                                                  
|10.7      |  | Registration Rights Agreement dated June 18, 1999 among The MacNeal-Schwendler Corporation, Dendron Technology B.V. and Fronos Technology B.V. (filed as Exhibit 4.3 to a Current Report on Form 8-K filed July 1, 1999 and incorporated herein by
reference).                        
|10.8      |  | Form of Agreement for use of MSC.Nastran, as modified to September 1991 (filed as Exhibit 10.1 to MSC.Software Corporation's Annual Report on Form 10-K filed for the fiscal year ended January 31, 1992, and incorporated herein by
reference).                                      
|10.9      |  | Agreement dated October 22, 1982, between MSC.Software Corporation and NASA (filed as Exhibit 10.2 to MSC.Software Corporation's Registration Statement on Form S-1, File No. 2-82719, and incorporated herein by reference).                                                         
|10.10     |  | Agreement of Lease, dated July 31, 1980, between MSC.Software Corporation and Frank De Pietro (filed as Exhibit 10.3 to MSC.Software Corporation's Registration Statement on Form S-1, File No. 2-82719, and incorporated herein by
reference).                                       
|10.11*    |  | Form of Indemnification Agreement between MSC.Software Corporation and directors, officers and agents thereof (filed as Exhibit 10.5 to MSC.Software Corporation's Annual Report on Form 10-K filed for the year ended January 31, 1989, and incorporated
herein by reference).       
|10.12(a)* |  | Form of Severance Agreement between MSC.Software Corporation and executive officers thereof (filed as Exhibit 10.6(a) to The MacNeal-Schwendler Corporation's Transition Report on Form 10-K filed for the fiscal year ended December 31, 1998, and
incorporated herein by reference).
|10.12(b)* |  | Form of Severance Agreement between MSC.Software Corporation and key employees (filed as Exhibit 10.6(a) to The MacNeal-Schwendler Corporation's Transition Report on Form 10-K filed for the fiscal year ended December 31, 1998, and incorporated herein
by reference).             
|10.13*    |  | Amendment 1991-1 to 1983 Incentive Stock Option Plan for Key Employees (filed as Annex A to MSC.Software Corporation's Annual Proxy Statement for the Annual Meeting of Shareholders held on June 12, 1991, and incorporated herein by
reference).                                    
|10.14*    |  | Amendment 1992-1 to 1983 Incentive Stock Option Plan for Key Employees (filed as part of the Annual Proxy Statement for MSC.Software Corporation's Annual Meeting of Shareholders held on June 10, 1992, and incorporated herein by
reference).                                       
|          |  |                                                                                                                                                                                                                                                                                       

91

---

|10.15* |  | 1991 Stock Option Plan (filed as Annex A to MSC.Software Corporation's Annual Proxy Statement for the Annual Meeting of Shareholders held on June 10, 1992, and incorporated herein by reference).                                                                                
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.16* |  | 1991 Stock Option Plan Amendment (filed as part of MSC's definitive Proxy Statement for the Annual Meeting of Shareholders on June 14, 1995, and incorporated herein by reference).                                                                                               
|10.17  |  | Separation Agreement with Thomas Curry (filed as Exhibit 10.12 to The MacNeal-Schwendler Corporation's Transition Report on Form 10-K filed for the fiscal year ended December 31, 1998, and incorporated herein by reference).                                                   
|10.18* |  | Form of Director Change in Control Agreement (filed as Exhibit 10.15 to The MacNeal-Schwendler Corporation's Transition Report on Form 10-K filed for the fiscal year ended December 31, 1998, and incorporated herein by reference).                                             
|10.19  |  | Common Stock Purchase Warrants issued to Kubota Solid Technology Corporation ("KUSCO") in 1998 and 1999 (filed as Exhibit 10.19 to MSC.Software Corporation's Annual Report on Form 10-K filed for the fiscal year ended December 31, 2002, and
incorporated herein by reference).
|10.20  |  | Common Stock Purchase Warrant issued to Michael Korybalski in 2002 (filed as Exhibit 10.20 to MSC.Software Corporation's Annual Report on Form 10-K filed for the fiscal year ended December 31, 2002, and incorporated herein by
reference).                                     
|21     |  | Material Subsidiaries of the Registrant (filed as Exhibit 21 to MSC.Software Corporation's Annual Report on Form 10-K filed for the fiscal year ended December 31, 2002, and incorporated herein by reference).                                                                   
|23**   |  | Consent of KPMG LLP, Independent Auditors.                                                                                                                                                                                                                                        
|23.1** |  | Consent of Ernst & Young LLP, Independent Auditors.                                                                                                                                                                                                                               

---

Item 15(b). Reports on Form 8-K

None

92

---



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

| |                         | MSC.SOFTWARE CORPORATION(Registrant)
| | ----------------------- | ------------------------------------
| | Dated: October 28, 2003 |                                     

93

---

CERTIFICATION

I,
Frank Perna, Jr., certify that:

|Date: October 28, 2003 |  | By: |  | /s/FRANK PERNA, JR.FRANK PERNA, JR.
Chairman of the Board and Chief Executive Officer
|---------------------- |  | --- |  | -------------------------------------------------------------------------------------

94

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CERTIFICATION

I,
Louis A. Greco, certify that:

|Date: October 28, 2003 |  | By: |  | /s/LOUIS A. GRECOLOUIS A. GRECO
Chief Financial Officer
|---------------------- |  | --- |  | -------------------------------------------------------

95

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