MATRIXONE INC - 10-Q Quarterly Report

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 x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

As of February 10, 2003, there were 47,762,958 shares of Common Stock, $0.01 par value per share, outstanding.

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

The accompanying condensed consolidated financial statements of MatrixOne, Inc. (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States. These accounting principles were applied on a basis consistent with those of the consolidated financial statements contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”). The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended June 29, 2002. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal, recurring adjustments, except for the restructuring charges in Note 5) necessary for a fair presentation. The operating results for the three and six month periods ended December 28, 2002 may not be indicative of the results expected for any succeeding quarter or the entire fiscal year ending June 28, 2003.

The Company operates on a 52-to-53 week fiscal year that ends on the Saturday closest to June 30^th. The Company operates on thirteen week fiscal quarters that end on the Saturday closest to September 30^th, December 31^st and March 31^st. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and judgments, which are evaluated on an on-going basis, that affect the amounts reported in the Company’s condensed consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and on various other assumptions that it believes are reasonable at that time under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates and judgments. In particular, significant estimates and judgments include those related to revenue recognition, allowance for doubtful accounts, valuation of prepaid software royalty fees, useful lives of property and equipment, valuation of deferred tax assets and professional services warranty.

No customer represented more than 10% of the Company’s total revenues for the three or six month periods ended December 28, 2002 and December 29, 2001. One customer represented 10.2% of the Company’s accounts receivable at December 28, 2002. No customer represented more than 10% of the Company’s accounts receivable at December 29, 2001.

In connection with certain stock option grants to employees in fiscal 2000 and 1999, the Company recorded deferred stock-based compensation totaling $17,654. Deferred stock-based compensation represents the difference between the option exercise price and the deemed fair value of the Company’s common stock on the date of grant and is reported as deferred stock-based consideration, a component of stockholders’ equity. Deferred stock-based compensation is amortized through charges to operations over the vesting period of the options, which is generally four years. Stock-based compensation was $831 and $973 for the three months ended December 28, 2002 and December 29, 2001, respectively, and $1,695 and $1,961 for the six months ended December 28, 2002 and December 29, 2001, respectively.

Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (loss) by the shares used in the calculation of basic net income (loss) per share plus the dilutive effect of common stock equivalents, such as stock options and warrants, using the treasury stock method. Common stock equivalents are excluded from the computation of diluted net income (loss) per share if their effect is antidilutive.

Potentially dilutive common stock options and warrants aggregating 10,766 and 10,207 shares for the three months ended December 28, 2002 and December 29, 2001, respectively, and 11,058 and 10,142 shares for the six months ended December 28, 2002 and December 29, 2001, respectively, have been excluded from the computation of diluted net loss per share because their inclusion would be antidilutive.

Comprehensive loss includes net loss and other changes in stockholders’ equity, except for stockholders’ investments and distributions and deferred stock-based consideration. The components of comprehensive loss were as follows:

As a result of unfavorable global economic conditions and a reduction in information technology spending around the world and the related impact on the Company’s business, in October 2001 the Company implemented a restructuring program to reduce expenses to align its operations and cost structure with market conditions. The restructuring program included a reduction in the number of employees across all functions and locations, a reduction in the use of independent contractors across all functions and locations, termination of certain contracts and closure of excess facilities.

The significant components of the October 2001 restructuring charge, non-cash adjustments, cash payments and the remaining accrual as of December 28, 2002 were as follows:

The restructuring program was substantially completed during fiscal 2002. The remaining cash payments are expected to be made through February 28, 2003.

As a result of continued weakness in information technology spending and global economic conditions and the related impact on the Company’s business, on October 23, 2002 the Company announced another restructuring program to further reduce expenses to align its operations and cost structure with current and projected market conditions (the “October 2002 restructuring program”). This restructuring program primarily included a reduction in the number of employees across all functions and locations, a reduction in the use of independent contractors across all functions and locations and the closure of excess facilities.

The October 2002 restructuring program included a reduction in workforce of 88 employees, including 32 employees in cost of service revenues, 29 employees in selling and marketing, 18 employees in research and development and nine employees in general and administration. The costs related to the reduction in workforce include severance, fringe benefits and other related costs.

The October 2002 restructuring program also included facility and lease costs related to the closure of certain excess facilities that the Company has exited and the termination of certain automotive lease contracts.

The significant components of the October 2002 restructuring charge, related cash payments and the remaining accrual as of December 28, 2002 were as follows:

The October 2002 restructuring program is expected to be substantially completed during the three months ending March 29, 2003, and the remaining cash payments are expected to be made through June 28, 2003.

On December 24, 2002, the Company amended its $10,000 line of credit to extend the term of the agreement through December 27, 2003. In addition, certain provisions that reduced the maximum borrowing amount were removed and certain financial covenants were eliminated. The line of credit bears interest at the bank’s prime rate plus 0.5% per annum on any outstanding balances.

During fiscal 2002, the Company adopted Emerging Issues Task Force Issue No. 01-14 (“EITF 01-14”), “Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred”, and reclassified such amounts in the Company’s condensed consolidated financial statements for all periods presented. In accordance with EITF 01-14, reimbursements received for out-of-pocket expenses incurred should be characterized as revenue in the statement of operations. The Company had historically accounted for reimbursements received for out-of-pocket expenses incurred as a reduction to cost of service revenues in the statement of operations to offset the costs incurred. Reimbursements received for out-of-pocket expenses incurred were $732 and $907 for the three months ended December 28, 2002 and December 29, 2001, respectively, and $1,617 and $1,909 for the six months ended December 28, 2002 and December 29, 2001, respectively.

In June 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 146 (“SFAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 addresses the accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The Company will adopt SFAS 146 for any exit or disposal activities that are initiated after December 29, 2002. The Company is not required to restate any of the components of the restructuring charges recorded during fiscal 2002 or through the six months ended December 28, 2002 as a result of the issuance of SFAS 146.

In December 2002, the FASB issued Statement of Accounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123.” SFAS 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure provisions of FASB Statement No. 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. SFAS 148 also amends APB Opinion No. 28, “Interim Financial Reporting”, to require disclosure about those effects in interim financial statements. The Company currently does not intend to voluntarily change from the intrinsic value method to the fair value method of accounting for stock-based employee compensation. The Company will provide the required disclosure about the effects on reported net income (loss) of the Company’s accounting policy decisions with respect to stock-based employee compensation beginning with its interim financial statements for the three and nine month periods ending March 29, 2003.

On January 21, 2003, the Board of Directors (the “Board”) approved a stock repurchase program (the “Program”) whereby the Company may repurchase up to $10,000 of its common stock. Any common stock repurchases under the Program may be made over a period of up to twelve months and may be made in the open market, through block trades or otherwise. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time or from time to time without prior notice.

On February 3, 2003, the Company announced that the Board approved a voluntary stock option exchange program (the “option exchange program”). The option exchange program provides eligible holders of outstanding, unexercised options to purchase shares of the Company’s Common Stock issued pursuant to the Company’s 1996 and 1999 Stock Plans with an exercise price of at least $5.00 per share the opportunity to tender such options in exchange for new replacement options currently expected to be issued on or after September 7, 2003. The ratios of new replacement options to options tendered pursuant to the option exchange program will be as follows: 4 for 5 for options with exercise prices of $5.00 to $9.99; 3 for 5 for options with exercise prices of $10.00 to $19.99; and 2 for 5 for options with exercise prices of $20.00 or more. Members of the Company’s Board and its executive officers are not eligible to participate in the option exchange program. The new replacement options will generally have an exercise price equal to the fair market value of MatrixOne Common Stock on the date the new replacement stock options are granted, vest quarterly over a 30-month period and include a 24-month acceleration provision upon change in control. Options to purchase approximately 4,495 shares of the Company’s Common Stock were eligible to be tendered pursuant to the option exchange program. The Company does not expect the option exchange program to result in any additional compensation charges or variable plan accounting.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are subject to a number of risks and uncertainties. These forward-looking statements are typically denoted in this Quarterly Report on Form 10-Q by the phrases “anticipates,” “believes,” “expects,” “plans” and similar phrases (as well as other words or expressions referencing future events, conditions or circumstances). Our actual results could differ materially from those projected in the forward-looking statements as a result of various factors, including the factors set forth in “Cautionary Statements” beginning on page 24 of this Quarterly Report on Form 10-Q. This discussion should be read in conjunction with the condensed consolidated financial statements and related notes for the periods specified. Further reference should be made to the Company’s Annual Report on Form 10-K for the fiscal year ended June 29, 2002.

MatrixOne, Inc. is a provider of collaborative product lifecycle management (“PLM”) solutions. Our solutions enable companies from a broad range of industries to accelerate product innovation and time-to-market by collaboratively developing, building, and managing products. Our interoperable solutions bring together people, processes, content, and systems throughout global value chains of employees, customers, suppliers, and partners to achieve a competitive advantage by bringing the right products and services to market cost-effectively. By unifying and streamlining processes across the product lifecycle, companies can easily work on projects within and outside of their enterprises. In addition, our technology enables companies to adapt and scale quickly to address their ever-changing business requirements.

Our collaborative PLM solutions are based on our suite of software products. Our three major software product groups are the eMatrix^® product collaboration platform, the MatrixOne Value Chain Portfolio^™ of applications and enterprise interoperability products. These products address three specific business issues:

We offer a variety of services that complement our PLM solutions. Our professional services personnel provide rapid and cost-effective implementation, integration and other consulting services. These personnel capture and model the specific business processes that reflect our customers’ planning, design, manufacturing, sales and service practices. We also provide training, maintenance and customer support services to continuously enhance the value of our products to our customers. In addition, we have a global network of systems integrators who are experienced in providing implementation and integration services to our customers. Many of our customers use their preferred systems integrators or perform their own implementation.

We generate revenues from licensing our software and providing professional services, training and maintenance and customer support services through our offices in the United States, Canada, England, France, Germany, Italy, Japan, Singapore, Taiwan and the Netherlands and indirectly through our alliance partner network throughout Europe and Asia/Pacific. Revenues by geographic region fluctuate each period based on the timing and the size of transactions, and we expect revenues by geographic region to continue to fluctuate each period. Our revenues by major geographical region, including exports into such regions, for the three and six month periods ended December 28, 2002 and December 29, 2001 were as follows:

Our international subsidiaries generally invoice their customers in local currency. Therefore, our revenue, when stated in U.S. Dollars, is subject to foreign currency risk. We currently do not enter into contracts or agreements to minimize our exposure to the effects of changes in foreign currency on our revenues. Accordingly, if the dollar weakens relative to foreign currencies, our revenues would increase when stated in U.S. Dollars. Conversely, if the dollar strengthens, our revenues would decrease. If our revenues for the three and six month periods ended December 28, 2002 had been translated at exchange rates for the comparable year ago periods, our revenues would have been $1.0 million and $1.6 million lower during the three and six month periods ended December 28, 2002.

Although we license our software to numerous customers in any quarter, a single customer often represents more than 10% of our quarterly revenues. However, no customer represented more than 10% of the Company’s total revenues for the three or six month periods ended December 28, 2002 and December 29, 2001. We expect that revenues from large orders will continue to account for a significant percentage of our total revenues in future quarters.

As a result of weakness in information technology spending and global economic conditions and the related impact on our business, in October 2001 and October 2002 we implemented restructuring programs to reduce expenses to align our operations and cost structure with current and projected market conditions. These restructuring programs primarily consisted of a reduction in the number of employees across all functions and locations, a significant reduction in the use of independent contractors across all functions and locations and the closure of excess facilities.

We have incurred significant costs to develop our technology and products, market, sell, implement and support our products and services, and maintain an infrastructure to support our global operations. These costs have historically exceeded our total revenues. As of December 28, 2002, we had an accumulated deficit of approximately $74.2 million. We anticipate that our operating expenses in fiscal 2003 will exceed projected revenues. Accordingly, we expect to incur a net loss in fiscal 2003. In addition, if our operating expenses are higher than we anticipate or our revenues are lower than projected, we may incur significant net losses in fiscal 2003 and in the future.

This discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments, which we evaluate on an on-going basis, that affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions that we believe are reasonable at that time under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and judgments under different assumptions or conditions.

We believe the following critical accounting policies affect the more significant estimates and judgments used in the preparation of our condensed consolidated financial statements.

We generate revenues from licensing our software and providing professional services, training and maintenance and customer support services. We execute separate contracts that govern the terms and conditions of each software license and maintenance arrangement and each professional services arrangement. These contracts may be an element in a multiple-element arrangement. Revenues under multiple-element arrangements, which may include several different software products or services sold together, are allocated to each element using the residual method.

We use the residual method when fair value does not exist for one of the delivered elements in an arrangement. Under the residual method, the fair value of the undelivered elements is deferred and subsequently recognized. We have established sufficient vendor specific objective evidence of fair value for professional services, training and maintenance and customer support services based on the price charged when these elements are sold separately. Accordingly, software license revenue is recognized under the residual method in arrangements in which software is licensed with professional services, training and maintenance and customer support services.

We recognize software license revenues upon execution of a signed license agreement, delivery of the software to a customer and determination that collection of a fixed license fee is probable. For delivery over the Internet, the software is considered to have been delivered upon confirmation by the customer of the file transfer. Since we have no obligation to an end user of a distributor, software license revenues from distributors are recognized upon delivery to the distributor.

We recognize revenue from software subscription arrangements ratably over the term of the contract on a straight-line basis. Fees from revenue sharing, royalty and subscriber arrangements with and through third-parties are recognized as revenue when they are fixed and determinable, generally upon receipt of a statement from the third-party.

Service revenues include professional services, training, maintenance and customer support fees and reimbursements received for out-of-pocket expenses incurred. Professional services are not essential to the functionality of the other elements in an arrangement and are accounted for separately. Professional services revenues are primarily derived from time and material contracts and are recognized as the services are performed. Professional services revenues for fixed-price contracts are recognized on a percentage-of-completion basis. If conditions for acceptance are required, professional services revenues are recognized upon customer acceptance. Our customers generally reimburse us for the majority of our out-of-pocket expenses incurred during the course of an engagement. We do not mark-up or add additional fees to the actual out-of-pocket expenses we incur. Training revenues are recognized as the services are provided.

Maintenance and customer support fees include the right to unspecified upgrades on a when-and-if-available basis and ongoing technical support. Maintenance and customer support fees are recognized ratably over the term of the contract, generally one year, on a straight-line basis. When a maintenance and customer support fee is included with a software license fee, we allocate a portion of the software license fee to maintenance and customer support fees based on the renewal rate of maintenance and customer support fees.

We periodically assess the collectibility of customer accounts receivable. We maintain an allowance for estimated losses resulting from uncollectible customer accounts receivable. In estimating this allowance, we consider factors such as historical collection experience, a customer’s current credit worthiness, customer concentrations, age of the receivable and general economic conditions that may affect a customer’s ability to pay. Actual customer collections could differ materially from our estimates. The use of different estimates or assumptions could produce a materially different allowance. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Prepaid software royalty fees, which are included in prepaid expenses and other current assets, are paid to third-party software developers under contractual arrangements for technology integrated into certain of our application and integration products. Amortization of prepaid software royalty fees commences when the software is available for general release. We amortize prepaid software royalty fees to cost of software license revenues based on the greater of the actual royalties incurred to date or the straight-line method of amortization over the estimated useful life of the software product, which is generally two to three years. Management regularly reviews the valuation of each prepaid software royalty fee in order to determine if events and circumstances may require a change in such valuation to reflect the estimated recoverable amount. A reduction in the license or discontinuation of software for which we have prepaid royalty fees may result in additional charges to cost of software license revenues.

We estimate the useful lives of our property and equipment, and we record depreciation on a straight-line basis over the estimated useful lives of our property and equipment. We regularly review our estimate of the useful lives and net book value of our property and equipment in order to determine if events and circumstances, such as changes in technology, product obsolescence and changes in our business, may require a change in the estimated useful lives of our property and equipment or recognition of an impairment loss, both of which would increase our operating expenses.

We record a valuation allowance to reduce our deferred tax assets to the estimated amount that is more likely than not to be realized. During our assessment of the valuation allowance, we consider future taxable income and ongoing tax planning strategies on a consolidated basis and in the tax jurisdictions in which we operate. We have recorded a valuation allowance against our deferred tax assets due to the fact it is more likely than not that the deferred tax assets will not be realized. We regularly evaluate the realizability of our deferred tax assets and may adjust the valuation allowance based on such analysis.

We provide for an estimate of professional services warranty based on historical activity. Warranty expense is included in cost of services. If our actual warranty activities differ from our estimates, revisions to the estimated warranty liability would be required and result in additional charges to cost of services.

The following table sets forth certain statements of operations data as a percentage of total revenues for the periods indicated. The data has been derived from the unaudited condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q. The operating results for any period should not be considered indicative of results for any future period. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 29, 2002.

Software license revenues. We derive our software license revenues principally from licensing our suite of software products including our eMatrix product collaboration platform, Value Chain Portfolio of applications and enterprise interoperability products.

Software license revenues decreased 17.6% to $11.1 million for the three months ended December 28, 2002 from $13.4 million for the three months ended December 29, 2001 due to the continued weakness in information technology spending around the world. As a result, both the total number of software license transactions and the number of software license transactions in excess of $1.0 million each declined during the three months ended December 28, 2002 from the three months ended December 29, 2001. During the three months ended December 29, 2001, we recorded four software license transactions in excess of $1.0 million compared to two during the three months ended December 28, 2002. Software license revenues from our eMatrix product collaboration platform and enterprise interoperability products for the three months ended December 28, 2002 decreased $4.0 million and $0.7 million, respectively, from the three months ended December 29, 2001, which was partially offset by a $2.3 million increase in software license revenue from our Value Chain Portfolio of applications. We expect software license revenues from our Value Chain Portfolio of applications to continue to increase.

Software license revenues decreased 19.4% to $11.1 million for the three months ended December 28, 2002 from $13.7 million for the three months ended September 28, 2002 primarily due to fewer software license transactions in excess of $1.0 million and a decrease in the average value of our software license transactions. During the three months ended December 28, 2002, we recorded two software license transactions in excess of $1.0 million compared to three during the three months ended September 28, 2002. In addition, the average value of our software license transactions decreased to $0.2 million for the three months ended December 28, 2002 from $0.3 million for the three months ended September 28, 2002.

We currently expect continued weakness in information technology spending and global economic conditions, which may impair our ability to record software license transactions in excess of $1.0 million and increase in the number of software transactions and the average value of our software license transactions. Accordingly, our software license revenues may continue to decrease.

Service revenues. We provide services to our customers and systems integrators consisting of professional services, training and maintenance and customer support services. Our professional services, which include implementation and consulting services, are primarily provided on a time and materials basis. Typically, our customers reimburse us for the majority of our out-of-pocket expenses incurred during the course of an engagement. During fiscal 2002, we adopted the provisions of Emerging Issues Task Force Issue No. 01-14 (“EITF 01-14”) relating to the accounting for reimbursements received for out-of-pocket expenses incurred and reclassified such amounts in all previous period financial statements. Accordingly, our service revenues include reimbursements received for out-of-pocket expenses incurred, which had been previously reported as a reduction to cost of services to offset the costs incurred. We do not mark-up or add additional fees to the actual out-of-pocket expenses we incur. We also offer training services to our customers, distributors and systems integrators either in our offices throughout the world or at customer locations. Customers that license our products generally purchase annually renewable maintenance contracts, which provide customers with the right to receive unspecified software upgrades and technical support over the term of the contract.

Service revenues decreased 8.9% to $17.0 million for the three months ended December 28, 2002 from $18.6 million for the three months ended December 29, 2001. The decrease was primarily due to a $2.5 million decrease in professional services revenues as a result of a decrease in the number and scope of professional services engagements due to continued weakness in information technology spending and an increase in the proportion of professional services engagements led by systems integrators. The decrease in professional services revenues was partially offset by a $1.2 million increase in maintenance revenues from new and renewed maintenance contracts. Maintenance revenues represented 48.7% and 38.0% of service revenues for the three months ended December 28, 2002 and December 29, 2001, respectively.

Service revenues decreased 2.5% or $0.4 million from the three months ended September 28, 2002 primarily due to lower professional services revenues as a result of fewer software license transactions with new customers due to a general decrease in global information technology spending. Our service revenues may continue to decrease if we do not license software to more new customers and existing customers do not commence new professional services engagements.

Cost of software licenses. Cost of software licenses primarily consists of royalties paid to third parties for certain application and integration products licensed to our customers. Cost of software licenses also includes the cost of manuals and product documentation, production media used to deliver our products and shipping costs. Our cost of software licenses fluctuates from period to period due to changes in the mix of software licensed, the extent to which we pay royalties to third parties on application and integration products and the amount of amortization of prepaid software royalty fees.

Cost of software licenses decreased 30.8% to $1.1 million for the three months ended December 28, 2002 from $1.6 million for the three months ended December 29, 2001. The decrease in cost of software licenses was primarily due to a decrease in royalties on integration software as a result of decreased licensing of third-party integration software.

Cost of services. Cost of services includes salaries and related expenses for internal services personnel and costs of contracting with independent systems integrators to provide consulting services. Cost of services fluctuates based on the mix of internal professional services personnel and more expensive independent systems integrators used for professional services engagements. Our gross margins may fluctuate based on the actual costs incurred to provide professional services.

Cost of services decreased 19.7% to $11.1 million for the three months ended December 28, 2002 from $13.8 million for the three months ended December 29, 2001 primarily due to a $2.3 million decrease in independent systems integrator costs and lower travel costs due to a reduction in personnel pursuant to our restructuring program and cost saving initiatives.

Gross profit. Gross profit decreased 4.8% to $15.8 million for the three months ended December 28, 2002 from $16.6 million for the three months ended December 29, 2001. However, gross profit as a percentage of total revenues, or gross margin, increased to 56.6% for the three months ended December 28, 2002 from 52.0% for the three months ended December 29, 2001. The increase in gross margin was primarily attributable to a significant increase in gross margin on services. Gross margin on software licenses increased to 90.0% for the three months ended December 28, 2002 from 88.1% for the three months ended December 29, 2001 due to a decrease in the relative proportion of third-party software licensed, which is subject to royalties. During fiscal 2002, we adopted the provisions of EITF No. 01-14 relating to the accounting for reimbursements received for out-of-pocket expenses incurred. Accordingly, our service revenues include reimbursements received for out-of-pocket expenses incurred, which had been previously reported as a reduction to cost of services to offset the costs incurred. This reclassification of out-of-pocket expenses incurred did not affect the amount of our gross profit but did decrease our gross margin. Gross margin on services increased to 34.7% for the three months ended December 28, 2002 from 25.8% for the three months ended December 29, 2001 primarily due to an increase in maintenance revenues, an increase in productivity in our professional services organization and a decrease in independent systems integrator costs.

Selling and marketing. Selling and marketing expenses include marketing costs, such as public relations and advertising, trade shows, marketing materials and customer user group meetings, and selling costs such as sales training events and commissions. Selling and marketing costs may fluctuate based on the timing of trade shows and user group events and the amount of sales commissions, which vary based upon revenues.

Selling and marketing expenses decreased 12.9% to $11.8 million for the three months ended December 28, 2002 from $13.5 million for the three months ended December 29, 2001 due to a decrease in personnel costs as a result of our restructuring program and commission expense related to lower software license revenues, offset by higher marketing costs related to our annual Global Customer Conference, which was not held in fiscal year 2002. Selling and marketing expenses as a percentage of total revenues decreased slightly to 42.1% for the three months ended December 28, 2002 from 42.3% for the three months ended December 29, 2001 as a result of the factors previously discussed.

Research and development. Research and development expenses include costs incurred to develop our intellectual property and are charged to expense as incurred. To date, software development costs have been charged to expense as incurred because the costs incurred from the attainment of technological feasibility to general product release have not been significant. Research and development costs may fluctuate based on the use of third parties to develop specific application and integration products and utilization of domestic and foreign third-party contractors, which are generally more expensive than our internal engineering personnel.

Research and development expenses increased 9.3% to $6.6 million for the three months ended December 28, 2002 from $6.0 million for the three months ended December 29, 2001 primarily due to an increase in third-party contractor costs related to enhancing our existing products and bringing additional products to market. Research and development expenses as a percentage of total revenues increased to 23.5% for the three months ended December 28, 2002 from 18.8% for the three months ended December 29, 2001 due to a lower revenues base and the factors previously discussed.

General and administrative. General and administrative expenses consist primarily of compensation of executive, finance, investor relations, human resource and administrative personnel, legal and accounting services and provisions for doubtful accounts.

General and administrative expenses decreased 11.1% to $2.7 million for the three months ended December 28, 2002 from $3.1 million for the three months ended December 29, 2001. The decrease was primarily due to a $0.3 million reduction in provisions for doubtful accounts due to lower levels of accounts receivable and revenues. General and administrative expenses as a percentage of total revenues increased slightly to 9.7% for the three months ended December 28, 2002 from 9.6% for the three months ended December 29, 2001 primarily due to a lower revenues base.

As a result of unfavorable global economic conditions and a reduction in information technology spending around the world and the related impact on our business, in October 2001 we implemented a restructuring program to reduce expenses to align our operations and cost structure with market conditions. The restructuring program included a reduction in the number of employees across all functions and locations, a reduction in the use of independent contractors across all functions and locations, termination of certain contracts and closure of excess facilities.

The significant components of the October 2001 restructuring charge, non-cash adjustments, cash payments and the remaining accrual as of December 28, 2002 were as follows:

The restructuring program was substantially completed during fiscal 2002. The remaining cash payments are expected to be made through February 28, 2003.

As a result of continued weakness in information technology spending and global economic conditions and the related impact on our business, on October 23, 2002 we announced another restructuring program to further reduce expenses to align our operations and cost structure with current and projected market conditions (the “October 2002 restructuring program”). This restructuring program primarily included a reduction in the number of employees across all functions and locations, a reduction in the use of independent contractors across all functions and locations and the closure of excess facilities.

The October 2002 restructuring program also included facility and lease costs related to the closure of certain excess facilities that we have exited and the termination of certain automotive lease contracts.

The significant components of the October 2002 restructuring charge, related cash payments and the remaining accrual as of December 28, 2002 were as follows:

The October 2002 restructuring program is expected to be substantially completed during the three months ended March 29, 2003, and the remaining cash payments are expected to be made through June 28, 2003.

Stock-based compensation. Stock-based compensation relates to the issuance of stock options to employees with exercise prices below the deemed fair value of our common stock on the date of grant. In connection with certain stock option grants during fiscal 2000 and 1999, we recorded deferred stock-based compensation totaling approximately $17.7 million. Deferred stock-based compensation represents the difference between the option exercise price and the deemed fair value of our common stock on the date of the option grant and is reported as deferred stock-based consideration, a component of stockholders’ equity. Deferred stock-based compensation is amortized through charges to operations over the vesting period of the options, which is generally four years.

Stock-based compensation decreased 14.6% to $0.8 million for the three months ended December 28, 2002 from $1.0 million for the three months ended December 29, 2001 due to cancellation of stock options from terminated employees primarily related to our restructuring programs. We expect to record stock-based compensation of $3.2 million and $0.6 million in fiscal 2003 and 2004, respectively. We expect that the amortization of deferred stock-based compensation will terminate during our fiscal quarter ending April 3, 2004.

Other income (expense). Other income (expense) fluctuates based on the amount of interest income earned on our investments and the amount of cash available for investment, realized and unrealized gains and losses on foreign currency transactions and gains and losses on sales and disposals of fixed assets.

Other income decreased 44.8% to $0.5 million for the three months ended December 28, 2002 from $0.9 million for the three months ended December 29, 2001. The decrease in other income was primarily due to a $0.3 million decrease in interest income from lower yields on our investments resulting from a significant decrease in market interest rates and lower levels of cash available for investment.

Provision for income taxes. No provision for income taxes was recorded for both the three months ended December 28, 2002 and December 29, 2001 due to our accumulated net losses.

Software license revenues. Software license revenues increased 22.0% to $24.8 million for the six months ended December 28, 2002 from $20.3 million for the three months ended December 29, 2001. During the three months ended September 29, 2001, our software license revenue was unusually low due to the tragic events of September 11, 2001, which caused a delay in or postponement of software orders. In addition, during the three months ended September 29, 2001, the average software license transaction value was unusually low and there were no individual software license transactions in excess of $1.0 million. During the six months ended December 28, 2002, we recorded five software license transactions in excess of $1.0 million each compared to four during the six months ended December 29, 2001. During the six months ended December 28, 2002, software license revenue from our Value Chain Portfolio of applications increased $8.1 million from the six months ended December 29, 2001, partially offset by a $2.5 million and $1.1 million decrease in software license revenue from our eMatrix product collaboration platform and enterprise interoperability products, respectively.

Service revenues. Service revenues decreased 6.0% to $34.3 million for the six months ended December 28, 2002 from $36.5 million for the six months ended December 29, 2001. The decrease was primarily due to a $4.2 million decrease in professional services revenues as a result of a decrease in the number and scope of professional services engagements due to continued weakness in information technology spending, an increase in the proportion of professional services engagements led by systems integrators and a delay in our ability to recognize professional services revenue from a customer due to uncertainty of collecting the fees from the customer. The decrease in service revenues also resulted from a decrease in reimbursements received for out-of-pocket expenses incurred of $0.3 million due to the factors previously discussed and a $0.3 million decrease in training revenues due to fewer software license transactions with new customers. These decreases were partially offset by a $2.6 million increase in maintenance revenues from new and renewed maintenance contracts. Maintenance revenues represented 46.5% and 36.6% of service revenues for the six months ended December 28, 2002 and December 29, 2001, respectively.

Cost of software licenses. Cost of software licenses increased 9.3% to $2.5 million for the six months ended December 28, 2002 from $2.3 million for the six months ended December 29, 2001. The increase in cost of software licenses was primarily due to higher royalties as a result of increased licensing of third-party application software, offset by a decrease in royalties on third-party integration software due to decreased licensing of such software.

Cost of services. Cost of services decreased 13.0% to $24.6 million for the six months ended December 28, 2002 from $28.3 million for the six months ended December 29, 2001 primarily due to a $4.3 million decrease in systems integrator costs, partially offset by higher recruiting fees.

Gross profit. Gross profit increased 21.8% to $32.1 million for the six months ended December 28, 2002 from $26.3 million for the six months ended December 29, 2001. Gross profit as a percentage of total revenues, or gross margin, increased to 54.2% for the six months ended December 28, 2002 from 46.3% for the six months ended December 29, 2001. The increase in gross margin was primarily attributable to an increase in higher margin software license revenues, an increase in the relative proportion of our service revenues derived from maintenance and improvement in the gross margins on professional services revenues. Gross margin on software licenses increased to 89.9% for the six months ended December 28, 2002 from 88.7% for the six months ended December 29, 2001 due to a decrease in the relative proportion of third-party application software licensed. During fiscal 2002, we adopted the provisions of EITF No. 01-14 relating to the accounting for reimbursements received for out-of-pocket expenses incurred. Accordingly, our service revenues include reimbursements received for out-of-pocket expenses incurred, which had been previously reported as a reduction to cost of services to offset the costs incurred. This reclassification of out-of-pocket expenses incurred did not affect the amount of our gross profit but did decrease our gross margin. Gross margin on services increased to 28.4% for the six months ended December 28, 2002 from 22.7% for the six months ended December 29, 2001 primarily due to an increase in the proportion of our services revenues derived from maintenance, an increase in productivity in our professional services organization and a decrease in independent systems integrator costs.

Selling and marketing. Selling and marketing expenses decreased 8.0% to $24.3 million for the six months ended December 28, 2002 from $26.4 million for the six months ended December 29, 2001 primarily due to decreases in marketing programs and recruiting costs as a result of our cost saving initiatives. Selling and marketing expenses as a percentage of total revenues decreased to 41.1% for the six months ended December 28, 2002 from 46.4% for the six months ended December 29, 2001 primarily due to the factors previously discussed and a higher revenues base.

Research and development. Research and development expenses increased 8.7% to $13.2 million for the six months ended December 28, 2002 from $12.2 million for the six months ended December 29, 2001 primarily due to increased personnel and recruiting costs and an increase in the use of third-party contractors. Research and development expenses as a percentage of total revenues increased to 22.4% for the six months ended December 28, 2002 from 21.4% for the six months ended December 29, 2001 due to the factors previously discussed.

General and administrative. General and administrative expenses decreased 6.4% to $5.6 million for the six months ended December 28, 2002 from $6.0 million for the six months ended December 29, 2001 primarily due to a decrease in contractor and consultant costs and lower provisions for doubtful accounts due to lower levels of accounts receivable and revenues. General and administrative expenses as a percentage of total revenues decreased to 9.4% for the six months ended December 28, 2002 from 10.5% for the six months ended December 29, 2001 due to the factors previously discussed and a higher revenues base.

Stock-based compensation. Stock-based compensation decreased 13.6% to $1.7 million for the six months ended December 28, 2002 from $2.0 million for the six months ended December 29, 2001 due to cancellation of stock options from terminated employees primarily related to our restructuring programs.

Other income (expense). Other income decreased 54.3% to $1.0 million for the six months ended December 28, 2002 from $2.2 million for the six months ended December 29, 2001. The decrease was primarily due to a $1.1 million decrease in interest income from lower yields on our investments resulting from a significant decrease in market interest rates and lower levels of cash available for investment.

Provision for income taxes. No provision for income taxes was recorded for both the six months ended December 28, 2002 and December 29, 2001 due to our accumulated net losses.

Our principal source of liquidity is our current cash and equivalents. Our ability to generate cash from operations is dependent upon our ability to generate revenue from licensing our software and providing related services, as well as our ability to manage our operating costs. A decrease in the demand for our software and related services or unanticipated increases in our operating costs would likely have an adverse effect on our liquidity and cash generated from operations. The following sets forth information relating to our liquidity:

During fiscal 2002 and the six months ended December 28, 2002, our cash and equivalents decreased primarily due to our loss from operations and cash payments related to our restructuring programs. We currently expect to incur losses from operations for fiscal 2003. Accordingly, we expect our liquidity to continue to decrease through fiscal 2003. The decrease in working capital was primarily attributable to a decrease in cash and equivalents due to our loss from operations and a decrease in accounts receivable as a result of a decrease in sequential quarterly revenues and a reduction in the days of sales outstanding as a result of improved collections.

We have a $10.0 million line of credit that bears interest at the bank’s prime rate plus 0.5% per annum on any outstanding balances and expires December 27, 2003. As of December 28, 2002, we had no borrowings outstanding under this line of credit and $10.0 million available. This line of credit is collateralized by all of our assets and has certain non-financial covenants. We were in compliance with these non-financial covenants as of December 28, 2002.

Net cash used in operating activities for the six months ended December 28, 2002 was $8.1 million primarily resulting from our net loss, decreases in accounts payable, and a decrease in deferred revenues due to recognition of certain software license revenue and amortization of maintenance contracts, offset by a decrease in accounts receivable due to a reduction in days of sales outstanding and lower sequential quarterly revenues. Net cash used in operating activities was $11.7 million for the three months ended December 29, 2001 primarily resulting from our net loss and an increase in prepaid expenses and other current assets resulting from the prepayment of software royalties and a decrease in deferred maintenance revenues due to a reduction in new maintenance contracts, offset by a decrease in accounts receivable due to lower revenues.

Net cash used in investing activities was $1.4 million and $4.4 million for the six months ended December 28, 2002 and December 29, 2001, respectively, and primarily reflects our investments in computer hardware and software, leasehold improvements and office furniture and equipment. We expect that capital expenditures for the next 12 months will be approximately $6.0 million, primarily for the acquisition of computer hardware and software.

Net cash provided by financing activities was $0.8 million and $1.0 million for the six months ended December 28, 2002 and December 29, 2001, respectively, and consists of the proceeds from stock option exercises and purchases of common stock under our employee stock purchase plan.

On January 21, 2003, our Board of Directors approved a stock repurchase program (the “Program”) whereby we may repurchase up to $10.0 million of our common stock. Any common stock repurchases under the Program may be made over a period of up to twelve months and may be made in the open market, through block trades or otherwise. Depending on market conditions and other factors, these purchases may be commenced or suspended at any time or from time to time without prior notice. Repurchases made under the Program will be funded from available working capital.

On February 3, 2003, we announced that the Board approved a voluntary stock option exchange program (the “option exchange program”). The option exchange program provides eligible holders of outstanding, unexercised options to purchase shares of our Common Stock issued pursuant to our 1996 and 1999 Stock Plans with an exercise price of at least $5.00 per share the opportunity to tender such options in exchange for new replacement options currently expected to be issued on or after September 7, 2003. The ratios of new replacement options to options tendered pursuant to the option exchange program will be as follows: 4 for 5 for options with exercise prices of $5.00 to $9.99; 3 for 5 for options with exercise prices of $10.00 to $19.99; and 2 for 5 for options with exercise prices of $20.00 or more. Members of our Board and our executive officers are not eligible to participate in the option exchange program. The new replacement options will generally have an exercise price equal to the fair market value of MatrixOne Common Stock on the date the new replacement stock options are granted, vest quarterly over a 30-month period and include a 24-month acceleration provision upon change in control. Options to purchase approximately 4.5 million shares of our Common Stock were eligible to be tendered pursuant to the option exchange program. We do not expect the option exchange program to result in any additional compensation charges or variable plan accounting.

We currently anticipate that our current cash and equivalents and available credit facility will be sufficient to fund our anticipated cash requirements for working capital and capital expenditures for at least the next 12 months. However, we may need to raise additional funds in order to fund an expansion of our business, develop new products, enhance existing products and services, or acquire complementary products, businesses or technologies. If additional funds are raised through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders may be reduced, our stockholders may experience additional dilution, and such securities may have rights, preferences or privileges senior to those of our stockholders. Additional financing may not be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, our ability to fund an expansion of our business, take advantage of unanticipated opportunities or develop or enhance our services or products would be significantly limited.

Our commitments and contractual obligations primarily consist of operating leases for facilities, automobiles and office equipment and product development agreements under which we pay software license fees to third parties for development or assistance in development of certain application and integration software. Our commitments and contractual obligations consisted of the following as of December 28, 2002:

Lease commitments in the above table include $0.4 million of operating lease obligations included in the restructuring accrual as of December 28, 2002.

We do not have any off-balance sheet arrangements, other commitments or contractual obligations in addition to those set forth above and those included in our consolidated financial statements as of December 28, 2002.

In June 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 146 (“SFAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities”. SFAS 146 addresses the accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” We will be required to adopt SFAS 146 for any exit or disposal activities that are initiated after December 29, 2002. We are not required to restate any of the components of the restructuring charges recorded during fiscal 2002 or through the six months ended December 28, 2002 as a result of the issuance of SFAS 146.

In December 2002, the FASB issued Statement of Accounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123”. SFAS 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure provisions of FASB Statement No. 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. SFAS 148 also amends APB Opinion No. 28, “Interim Financial Reporting”, to require disclosure about those effects in interim financial statements. We currently do not intend to voluntarily change from the intrinsic value method to the fair value method of accounting for stock-based employee compensation. We will provide the required disclosure about the effects on reported net income (loss) of our accounting policy decisions with respect to stock-based employee compensation beginning with our interim financial statements for the three and nine month periods ending March 29, 2003.

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in the following cautionary statements and elsewhere in this Quarterly Report on Form 10-Q. If any of the following risks were to occur, our business, financial condition or results of operations would likely suffer. In that event, the trading price of our common stock would decline.

We Have a History of Losses, Expect to Incur Losses in the Future and May Not Achieve or Maintain Profitability

We have incurred substantial net losses in the past, and we expect to incur net losses in future periods. We incurred net losses of approximately $15.5 million for the six months ended December 28, 2002 and $28.7 million for fiscal 2002. As of December 28, 2002, we had an accumulated deficit of approximately $74.2 million. We will need to generate significant increases in revenues to achieve and maintain profitability, and we may not be able to do so. If our revenues grow more slowly than we anticipate or decline or if our operating expenses increase more than we expect or cannot be reduced in the event of lower revenues, our business will be significantly and adversely affected. Although we implemented restructuring programs in October 2001 and October 2002 to better align our operations and cost structure with market conditions, these programs may not be sufficient for us to achieve profitability in any future period. Even if we achieve profitability in the future on a quarterly or annual basis, we may not be able to sustain or increase profitability. Failure to achieve profitability or achieve and sustain the level of profitability expected by investors and securities analysts may adversely affect the market price of our common stock.

The Weak Computer Software Market and Worldwide Economic Conditions May Result in Decreased Revenues and Operating Losses

The revenue growth and profitability of our business depends on the overall demand for computer software and services, particularly in the market segments in which we compete. A continued softening of demand for computer software and services caused by the current weak global economy may result in decreased revenues and operating losses. In this weak economy, we may not be able to effectively maintain existing levels of software and service revenues, promote future growth in our software and services revenues or achieve profitability.

Our Quarterly Revenues and Operating Results Are Likely to Fluctuate and if We Fail to Meet the Expectations of Securities Analysts or Investors, Our Stock Price Could Decline

Our quarterly revenues and operating results are difficult to predict, have varied significantly in the past and are likely to fluctuate significantly in the future. We typically realize a significant percentage of our revenues for a fiscal quarter in the second half of the third month of the quarter. Accordingly, our quarterly results may be difficult or impossible to predict prior to the end of the quarter. Any inability to obtain sufficient orders or to fulfill shipments in the period immediately preceding the end of any particular quarter may cause the results for that quarter to fall short of our revenues targets. Any disruption in our ability to conduct our business which occurs, especially in the third month of a quarter as was the case in the first quarter of fiscal 2002 due to the events of September 11, 2001, will likely have a material adverse effect on our operating results for that quarter. In addition, we base our current and future expense levels in part on our estimates of future revenues. Our expenses are largely fixed in the short term. We may not be able to adjust our spending quickly if our revenues fall short of our expectations. Accordingly, a shortfall in revenues in a particular quarter would have an adverse effect on our operating results for that quarter.

In addition, our quarterly operating results may fluctuate for many reasons, including, without limitation:

For these reasons, you should not rely on period-to-period comparisons of our financial results to forecast our future performance. It is likely that in some future quarter or quarters our operating results will be below the expectations of securities analysts or investors. If a shortfall in revenues occurs, the market price of our common stock may decline significantly.

Our Lengthy and Variable Sales Cycle Makes it Difficult for Us to Predict When or if Sales Will Occur and Therefore We May Experience an Unplanned Shortfall in Revenues

Our products have a lengthy and unpredictable sales cycle that contributes to the uncertainty of our operating results. Customers view the purchase of our software as a significant and strategic decision. As a result, customers generally evaluate our software products and determine their impact on existing infrastructure over a lengthy period of time. Our sales cycle has historically ranged from approximately one to nine months based on the customer’s need to rapidly implement a solution and whether the customer is new or is extending an existing implementation. The license of our software products may be subject to delays if the customer has lengthy internal budgeting, approval and evaluation processes. We may incur significant selling and marketing expenses during a customer’s evaluation period, including the costs of developing a full proposal and completing a rapid proof of concept or custom demonstration, before the customer places an order with us. Customers may also initially purchase a limited number of licenses before expanding their implementations. Larger customers may purchase our software products as part of multiple simultaneous purchasing decisions, which may result in additional unplanned administrative processing and other delays in the recognition of our license revenues. If revenues forecasted from a specific customer for a particular quarter are not realized or are delayed to another quarter, we may experience an unplanned shortfall in revenues, which could significantly and adversely affect our operating results.

We May Not Achieve Our Anticipated Revenues if Large Software and Service Orders Expected in a Quarter Are Not Placed or Are Delayed

Although we license our software to numerous customers in any quarter, a single customer often represents more than 10% of our quarterly revenues. We expect that revenues from large orders will continue to represent a large percentage of our total revenues in future quarters. A customer may determine to increase its number of licenses and expand its implementation of our software throughout its organization and to its customers, suppliers and other business partners only after a successful initial implementation. Therefore, the timing of these large orders is often unpredictable. If any large order anticipated for a particular quarter is not realized, delayed to another quarter or significantly reduced, we may experience an unplanned shortfall in revenues, which could significantly and adversely affect our operating results.

If Our Existing Customers Do Not License Additional Software Products From Us, We May Not Achieve Growth in Our Revenues

Our customers’ initial implementations of our software often include a limited number of licenses. Customers may subsequently add licenses as they expand the implementations of our products throughout their enterprises or add software applications designed for specific functions. Therefore, it is important that our customers are satisfied with their initial product implementations. If we do not increase licenses to existing customers, we may not be able to achieve growth in our revenues.

Our Restructuring Programs May Not Achieve Our Desired Results and We May Therefore Continue to Incur Operating Losses

We implemented restructuring programs in October 2001 and October 2002. The primary objective of our restructuring programs has been to reduce our operating expenses in order to align our operations and cost structure with market conditions. These programs included reductions in our workforce, reductions in the use of independent contractors, closure of certain facilities and termination of certain contracts. These workforce reductions could impact the productivity of our remaining employees, including those directly responsible for sales and services, which may negatively affect our future revenues. In addition, the failure to retain and effectively manage our remaining employees could increase our costs and negatively affect our sales and services operations and our ability to attain revenue goals. Failure to achieve the desired results of our restructuring programs could result in reduced revenues and continued operating losses.

Our Services Revenues and Operating Results May Be Adversely Affected if We Are Not Able to Maintain the Billing and Utilization Rates for Our Professional Services Personnel

The billing rates we charge for our professional services and the utilization, or chargeability, of our professional services personnel are significant components of our services revenues, gross margin and operating results. Our billing rates are affected by a number of factors, including the introduction of new services or products by our competitors, the pricing policies of our competitors, demand for professional services and general economic conditions. Our utilization rates are also affected by a number of factors, including seasonal trends, our ability to transition employees from completed professional services engagements to new engagements and our ability to forecast demand of our professional services and thereby maintain an appropriate headcount. Many of the above factors are beyond our control. Accordingly, if we are not able to maintain the rates we charge for our professional services or an appropriate utilization for our professional services personnel, our service revenues and gross margin are likely to decline, which would adversely affect our operating results.

We Occasionally Perform Professional Services Engagements on a Fixed-Price Basis, Which Could Cause a Decline in Our Gross Margins

We occasionally perform professional services engagements on a fixed-price basis. Prior to performing a fixed-price professional services engagement, we estimate the amount of work involved for the engagement. However, we may underestimate the amount of time or resources required to complete a professional services engagement, and we may not be able to charge the customer for the additional work performed. If we do not correctly estimate the amount of time or resources required for a professional services engagement and we are not able to charge the customer for the additional work performed, our gross margins would decline.

Our Future Success Is Uncertain Because We Have Significantly Changed Our Product Line

We shipped the first application within our Value Chain Portfolio of applications in October 2000, and we recently began to offer three targeted PLM solutions. Our strategy is to develop new applications for use in product lifecycle management and to combine them with our eMatrix product collaboration platform, MatrixOne Application Exchange Framework and enterprise interoperability products to create PLM solutions. Our new business focus and strategy may not be successful. In addition, because we have only recently begun to focus our business on the development, license and marketing of our application software and PLM solutions, we may have limited insight into trends that may emerge and affect our business. We face the many challenges, risks and difficulties frequently encountered by companies transitioning to a new product line and using a new business strategy in a rapidly evolving market. If we are unable to successfully implement our business strategy, our operating results will suffer.

We May Not Achieve Anticipated Revenues if Market Acceptance of Our Software Does Not Continue

We believe that revenues from licenses of our software, together with revenues from related professional services, training and maintenance and customer support services, will account for substantially all of our revenues for the foreseeable future. Our future financial performance will depend on market acceptance of our software, including our application and integration products, and any upgrades or enhancements that we may make to our products in the future. As a result, if our software does not achieve and maintain widespread market acceptance, we may not achieve anticipated revenues. In addition, if our competitors release new products that are superior to our software, demand for our products may not accelerate and could decline. If we are unable to increase the number and scope of our integration and application products or ship or implement any upgrades or enhancements to our products when planned, or if the introduction of upgrades or enhancements causes customers to defer orders for our existing products, we also may not achieve anticipated revenues.

The Market for Our PLM Software Is Newly Emerging and Rapidly Changing and Demand for PLM Software May Not Evolve and Could Decline

The market for PLM software is rapidly changing. We cannot be certain that this market will continue to develop and grow or that companies will choose to use our products rather than attempting to develop alternative platforms and applications internally or through other sources. If we fail to establish a significant base of customer references, our ability to market and license our products successfully may be reduced. Companies that have already invested substantial resources in other methods of sharing information during the design, manufacturing and supply process may be reluctant to adopt new technology or infrastructures that may replace, limit or compete with their existing systems or methods. We expect that we will continue to need to pursue intensive marketing and selling efforts to educate prospective customers about the uses and benefits of our products. Therefore, demand for and market acceptance of our software products is subject to a high level of uncertainty.

If We Are Not Successful in Developing New Products and Services that Keep Pace with Technology, Our Operating Results Will Suffer

The market for our software is characterized by rapid technological advances, changing customer needs and evolving industry standards. Accordingly, to realize our expectations regarding our operating results, we depend on our ability to:

We may not be successful in developing and marketing, on a timely and cost-effective basis, either enhancements to our products or new products that respond to technological advances and satisfy increasingly sophisticated customer needs. If we fail to introduce new products, our operating results will suffer. In addition, if new industry standards emerge that we do not anticipate or adapt to, our software products could be rendered obsolete and our business could be materially harmed.

Due to the Weak Global Economy, our Customers May Experience Financial Difficulties and May Represent a Credit Risk

Due to the weak global economy and the uncertainty relating to the prospects for near-term global economic growth, some of our customers may experience financial difficulties and may represent a credit risk to us. If our customers, especially those with limited operating histories and limited access to capital, experience financial difficulties or fail to experience commercial success, we may have difficulty collecting our accounts receivable and be required to record additional allowances for doubtful accounts, which will increase our operating expenses.

The markets in which we offer our software and services are intensely competitive and rapidly changing. Furthermore, we expect competition to intensify, given the newly emerging nature of the market for PLM software and consolidation in the software industry in general. We will not succeed if we cannot compete effectively in these markets. Competitors vary in size and in the scope and breadth of the products and services they offer. Many of our actual or potential competitors have significant advantages over us, including, without limitation:

As a result, our competitors may be in a stronger position to respond quickly to new or emerging technologies and changes in customer requirements. Our competitors may also be able to devote greater resources to the development, promotion and sale of their products and services than we can. Accordingly, we may not be able to maintain or expand our revenues if competition increases and we are unable to respond effectively.

As competition in the PLM software market intensifies, new solutions will come to market. Our competitors may package their products in a manner that may discourage customers from licensing our software. Also, current and potential competitors may establish cooperative relationships among themselves or with third parties or adopt aggressive pricing policies to gain market share. Consolidation in the industry also results in larger competitors that may have significant combined resources with which to compete against us. Increased competition could result in reductions in price and revenues, lower profit margins, loss of customers and loss of market share. Any one of these factors could materially and adversely affect our business and operating results.

Our Revenues Could Decline if We Do Not Develop and Maintain Successful Relationships with Systems Integrators and Complementary Technology Vendors

We pursue business alliances with systems integrators and complementary technology vendors to endorse our software, implement our software, provide customer support services, promote and resell products that integrate with our products and develop industry-specific software products. These alliances provide an opportunity to license our products to our alliance partners’ installed customer bases. In many cases, these parties have established relationships with our existing and potential customers and can influence the decisions of these customers. We rely upon these companies for recommendations of our products during the evaluation stage of the purchasing process, as well as for implementation and customer support services. A number of our competitors have strong relationships with these systems integrators and complementary technology vendors who, as a result, may be more likely to recommend our competitors’ products and services. In addition, some of our competitors have relationships with a greater number of these systems integrators and complementary technology vendors and, therefore, have access to a broader base of enterprise customers. If we are unable to establish, maintain and strengthen these relationships, we will have to devote substantially more resources to the selling and marketing, implementation and support of our products. Our efforts may not be as effective as these systems integrators and complementary technology vendors, which could significantly harm our operating results.

Our International Operations Expose Us to Business Risks Which Could Cause Our Operating Results to Suffer

Our operations outside North America accounted for approximately 37.5% of our total revenues for the six months ended December 28, 2002 and 33.9% and 26.9% of our total revenues for fiscal 2002 and 2001, respectively. Export sales from the United States accounted for approximately 9.7% of our total revenues for the six months ended December 28, 2002 and 3.5% and 3.9% of our total revenues for fiscal 2002 and 2001, respectively. Many of our customers have operations in numerous locations around the globe. In order to attract, retain and service multi-national customers, we have to maintain strong direct and indirect sales and support organizations in Europe and Asia/Pacific. Our ability to penetrate international markets may be impaired by resource constraints and our ability to hire qualified personnel in foreign countries. We face a number of risks associated with conducting business internationally, which could negatively impact our operating results, including, without limitation:

We believe that expansion into new international markets will be necessary for our future success. Therefore, a key aspect of our strategy is to continue to expand our presence in foreign markets. We may not succeed in our efforts to enter new international markets. If we fail to do so, we may not be able to maintain existing levels of revenues and promote growth in our revenues. This international expansion may be more difficult or time-consuming than we anticipate. It is also costly to establish and maintain international facilities and operations and promote our products internationally. Thus, if revenues from international activities do not offset the expenses of establishing and maintaining foreign operations, our operating results will suffer.

Future Acquisitions May Negatively Affect Our Ongoing Business Operations and Our Operating Results

We may expand our operations or market presence by acquiring or investing in complementary businesses, products or technologies that complement our business, increase our market coverage, enhance our technical capabilities or otherwise offer opportunities for growth. These transactions create risks such as:

Our inability to address these risks could negatively impact our operating results. Moreover, any future acquisitions, even if successfully completed, may not generate any additional revenues or provide any benefit to our business.

We Depend on Licensed Third-Party Technology, the Loss of Which Could Result in Increased Costs of or Delays in Licensing Our Products

We license technology from several companies on a non-exclusive basis that is integrated into many of our products. We also license certain integration products from third parties. We anticipate that we will continue to license technology from third parties in the future. This software may not continue to be available on commercially reasonable terms, or at all. Some of the software we license from third parties would be difficult and time-consuming to replace. The loss of any of these technology licenses could result in delays in the licensing of our products until equivalent technology, if available, is identified, licensed and integrated. In addition, the effective implementation of our products may depend upon the successful operation of third-party licensed products in conjunction with our products, and therefore any undetected errors in these licensed products may prevent the implementation or impair the functionality of our products, delay new product introductions or injure our reputation.

If Systems Integrators Are Not Available or Fail to Perform Adequately, Our Customers May Suffer Implementation Delays and a Lower Quality of Customer Service, and We May Incur Increased Expenses

Systems integrators often are retained by our customers to implement our products. If experienced systems integrators are not available to implement our products, we will be required to provide these services internally, and we may not have sufficient resources to meet our customers’ implementation needs on a timely basis. Use of our professional services personnel to implement our products would also increase our expenses. In addition, we cannot control the level and quality of service provided by our current and future implementation partners. If these systems integrators do not perform to the satisfaction of our customers, our customers could become dissatisfied with our products, which could adversely affect our business and operating results.

We May Not Be Able to Increase Revenues if We Do Not Expand Our Sales and Distribution Channels

We will need to expand our direct and indirect global sales operations in order to increase market awareness and acceptance of our software and generate increased revenues. We market and license our products directly through our sales organization and indirectly through our global alliance partner and distributor network. Our ability to increase our global direct sales organization will depend on our ability to recruit, train and retain sales personnel with advanced sales skills and technical knowledge. Competition for qualified sales personnel is intense in our industry. In addition, it may take up to nine months for a new sales person to become fully productive. If we are unable to hire or retain qualified sales personnel, or if newly hired sales personnel fail to develop the necessary skills or reach productivity more slowly than anticipated, we may have difficulty licensing our products, and we may experience a shortfall in anticipated revenues.

In addition, we believe that our future success is dependent upon expansion of our indirect global distribution channel, which consists of our relationships with a variety of systems integrators, complementary technology vendors and distributors. We cannot be certain that we will be able to maintain our current relationships or establish relationships with additional distribution partners on a timely basis, or at all. Our distribution partners may not devote adequate resources to promoting or selling our products and may not be successful. In addition, we may also face potential conflicts between our direct sales force and third-party reselling efforts. Any failure to expand our indirect global distribution channel or increase the productivity of this distribution channel could result in lower than anticipated revenues.

We Depend on Our Key Personnel to Manage Our Business Effectively, and if We Are Unable to Retain Key Personnel, Our Ability to Compete Could Be Harmed

Our ability to implement our business strategy and our future success depends largely on the continued services of our executive officers and other key engineering, sales, marketing and support personnel who have critical industry or customer experience and relationships. None of our key personnel, other than Mark F. O’Connell, our President and Chief Executive Officer, is bound by an employment agreement. We do not have key-man life insurance on any of our employees. The loss of the technical knowledge and management and industry expertise of any of these key personnel could result in delays in product development, loss of customers and sales and diversion of management resources, which could materially and adversely affect our operating results. In addition, our future performance depends upon our ability to attract and retain highly qualified sales, engineering, marketing, services and managerial personnel, and there is intense competition for such personnel. If we do not succeed in retaining our personnel or in attracting new employees, our business could suffer significantly.

If We Are Unable to Obtain Additional Capital as Needed in the Future, Our Business May Be Adversely Affected and the Market Price for Our Common Stock Could Significantly Decline

We have been unable to fund our operations using cash generated from our business operations and have financed our operations principally through the sale of securities. We may need to raise additional debt or equity capital to fund an expansion of our operations, to enhance our products and services, or to acquire or invest in complementary products, services, businesses or technologies. If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock. In addition, we may not be able to obtain additional financing on terms favorable to us, if at all. If adequate funds are not available on terms favorable to us, our business may be adversely affected and the market price for our common stock could significantly decline.

Our Products May Contain Defects that Could Harm Our Reputation, Be Costly to Correct, Delay Revenues and Expose Us to Litigation

Despite testing by us, our alliance partners and our customers, errors may be found in our products after commencement of commercial shipments. We and our customers have from time to time discovered errors in our software products. In the future, there may be additional errors and defects in our software. If errors are discovered, we may not be able to successfully correct them in a timely manner or at all. Errors and failures in our products could result in loss of or delay in market acceptance of our products and damage to our reputation and our ability to convince commercial users of the benefits of our products. In addition, we may need to make significant expenditures of capital resources in order to eliminate errors and failures. Since our products are used by customers for mission-critical applications, errors, defects or other performance problems could also result in financial or other damages to our customers, who could assert warranty and other claims for substantial damages against us. Although our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims, it is possible that such provisions may not be effective or enforceable under the laws of certain jurisdictions. In addition, our insurance policies may not adequately limit our exposure with respect to such claims. A product liability claim, even if unsuccessful, would be costly and time-consuming to defend and could harm our business.

On April 19, 2002, a consolidated amended class action complaint was filed in the United States District Court for the Southern District of New York. The complaint, which supersedes five virtually identical complaints that had been filed from July 24, 2001 to September 5, 2001, names as defendants the Company, two of our officers, and certain underwriters involved in our initial public offering of common stock (“IPO”). The complaint is allegedly brought on behalf of purchasers of our common stock during the period from February 29, 2000 to December 6, 2000 and asserts, among other things, that our IPO prospectus and registration statement violated federal securities laws because they contained material misrepresentations and/or omissions regarding the conduct of our IPO underwriters in allocating shares in our IPO to the underwriters’ customers, and that the Company and the two named officers engaged in fraudulent practices with respect to this underwriters’ conduct. Pursuant to a stipulation between the parties, the Company’s two named officers were dismissed from the lawsuit, without prejudice, on October 9, 2002. The action seeks damages, fees and costs associated with the litigation, and interest. We understand that various plaintiffs have filed substantially similar lawsuits against over three hundred other publicly traded companies in connection with the underwriting of their initial public offerings. We and our officers and directors believe that the allegations in the complaint are without merit and intend to contest them vigorously. The Company, along with the three hundred plus other publicly-traded companies that have been named in substantially similar lawsuits, filed a motion to dismiss the complaint on July 15, 2002. The court heard oral argument on this motion on November 1, 2002. The litigation process is inherently uncertain and unpredictable, however, and there can be no guarantee as to the ultimate outcome of this pending lawsuit. Even if successfully defended, this lawsuit could result in significant expense to us and the diversion of our management and technical resources, which may have a material adverse effect on our operating results.

In the past, securities class action litigation has often been brought against a company following periods of volatility in the price of its securities. Due to the volatility of our stock price, we may be the target of securities litigation in the future. Securities litigation could result in substantial costs and divert management’s attention and resources from our business, which could have a material adverse effect on our business and operating results.

Failure to Protect Our Intellectual Property Could Harm Our Name Recognition Efforts and Ability to Compete Effectively

Currently, we rely on a combination of trademarks, copyrights and common law safeguards, including trade secret protection to protect our intellectual property rights. To protect our intellectual property rights in the future, we intend to rely on a combination of patents, trademarks, copyrights and common law safeguards, including trade secret protection. We also rely on restrictions on use, confidentiality and nondisclosure agreements and other contractual arrangements with our employees, affiliates, customers, alliance partners and others. The protective steps we have taken may be inadequate to deter misappropriation of our intellectual property and proprietary information. A third party could obtain our proprietary information or develop products or technology competitive with ours. We may be unable to detect the unauthorized use of, or take appropriate steps to enforce, our intellectual property rights. We have registered some of our trademarks in the United States and abroad and have other trademark and patent applications pending or in preparation. Effective patent, trademark, copyright and trade secret protection may not be available in every country in which we offer or intend to offer our products and services to the same extent as in the United States. Failure to adequately protect our intellectual property could harm or even destroy our brands and impair our ability to compete effectively. Further, enforcing our intellectual property rights could result in the expenditure of significant financial and managerial resources and may not prove successful.

We Could Incur Substantial Costs Defending Our Intellectual Property from Claims of Infringement

The software industry is characterized by frequent litigation regarding copyright, patent and other intellectual property rights. We may be subject to future litigation based on claims that our products infringe the intellectual property rights of others or that our own intellectual property rights are invalid. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry grows and the functionality of products overlaps. Claims of infringement could require us to reengineer or rename our products or seek to obtain licenses from third parties in order to continue offering our products. Licensing or royalty agreements, if required, may not be available on terms acceptable to us or at all. Even if successfully defended, claims of infringement could also result in significant expense to us and the diversion of our management and technical resources.

Our Stock Price Has Been and May Continue to be Volatile Which May Lead to Losses by Stockholders

The trading price of our common stock has been highly volatile and has fluctuated significantly in the past. During the six months ended December 28, 2002, our stock price fluctuated between a low bid price of $1.78 per share and a high bid price of $7.36 per share. During fiscal 2002, our stock price fluctuated between a low bid price of $4.00 per share and a high bid price of $21.76 per share. We believe that the price of our common stock may continue to fluctuate significantly in the future in response to a number of events and factors relating to our company, our competitors, the market for our products and services and the global economy, many of which are beyond our control, such as:

In addition, the stock market in general, and the market for technology companies in particular, has experienced extreme volatility. This volatility has often been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the market price of our common stock, regardless of our operating performance.

Anti-Takeover Provisions in Our Organizational Documents and Delaware Law Could Prevent or Delay a Change in Control of Our Company

Certain provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that stockholders may consider favorable. These provisions may also prevent changes in our management. These provisions include, without limitation:

Certain provisions of Delaware law may also discourage, delay or prevent someone from acquiring or merging with us.

We have international offices in Canada, England, France, Germany, Italy, Japan, Singapore, Taiwan and the Netherlands. At December 28, 2002 and June 29, 2002, approximately 33.6% and 27.8%, respectively, of our total assets were located at our international subsidiaries. Approximately 37.5% of our total revenues for the six months ended December 28, 2002 and 33.9% and 26.9% of our total revenues for fiscal 2002 and 2001, respectively, were from our operations outside North America. In addition, approximately 28.0% of our expenses for the six months ended December 28, 2002 and 23.7% and 24.8% of our expenses for fiscal 2002 and 2001, respectively, were from our operations outside the United States. These subsidiaries transact business in both local and foreign currency. Therefore, we are exposed to foreign currency exchange risks and fluctuations in foreign currencies, along with economic and political instability in the foreign countries in which we operate, all of which could adversely impact our results of operations and financial condition.

We use forward contracts to reduce our exposure to foreign currency risk and variability in operating results due to fluctuations in exchange rates underlying the value of accounts receivable and accounts payable and intercompany accounts receivable and intercompany accounts payable denominated in foreign currencies held until such receivables are collected and payables are disbursed. A forward contract obligates us to exchange predetermined amounts of specified foreign currencies at specified exchange rates on specified dates. These forward contracts are denominated in the same currency in which the underlying foreign currency receivables or payables are denominated and bear a contract value and maturity date that approximate the value and expected settlement date, respectively, of the underlying transactions. Unrealized gains and losses on open contracts at the end of each accounting period, resulting from changes in the fair value of these contracts, are recognized in earnings in the same period as gains and losses on the underlying foreign denominated receivables or payables are recognized and generally offset. Gains and losses on forward contracts and foreign denominated receivables and payables are included in other income (expense), net.

We do not enter into or hold derivatives for trading or speculative purposes, and we only enter into forward contracts with highly rated financial institutions. At December 28, 2002, there were no outstanding forward contracts.

We plan to increase our use of forward contracts and other instruments in the future to reduce our exposure to exchange rate fluctuations from accounts receivable and accounts payable and intercompany accounts receivable and intercompany accounts payable denominated in foreign currencies, and we may not be able to do this successfully. Accordingly, we may experience economic loss and a negative impact on our results of operations and equity as a result of foreign currency exchange rate fluctuations. Also, as we continue to expand our operations outside of the United States, our exposure to fluctuations in currency exchange rates could increase.

We deposit our cash in highly rated financial institutions in North America, Europe and Asia/Pacific. We invest in diversified United States and international money market mutual funds and United States Treasury and agency securities. At December 28, 2002, we had $108.6 million, $0.1 million, $11.1 million and $1.5 million invested in money market mutual funds in the United States, Canada, Continental Europe and England, respectively. The weighted average interest rate on our investments was 1.53% per annum as of December 28, 2002. Due to the short-term nature of our investments, we believe we have minimal market risk.

Our investments are subject to interest rate risk. All of our investments have remaining maturities of three months or less. If these short-term assets were reinvested in a declining interest rate environment, we would experience an immediate negative impact on other income. The opposite holds true in a rising interest rate environment. Since January 1, 2001, the United States Federal Reserve Board, European Central Bank and Bank of England have significantly decreased certain benchmark interest rates, which has led to a general decline in market interest rates. This decline in market interest rates has resulted in a significant decrease in our interest income. We expect our interest income to decrease during the three months ended March 29, 2003 due to the recent decreases in market interest rates and lower levels of cash available for investment.

Within the 90 days prior to the date of this Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in ensuring the reporting of material information required to be included in our periodic filings with the Securities and Exchange Commission.

There were no significant changes in our internal controls or in other factors that could significantly affect these internal controls subsequent to the date of the most recent evaluation.

On February 29, 2000, the Securities and Exchange Commission declared effective our registration statement on Form S-1 (File No. 333-92731), relating to the initial public offering of our common stock, and we did a concurrent private placement of common stock. We expect to use the net proceeds from the initial public offering and the concurrent private placement for general corporate purposes, including to expand our selling and marketing services organizations, develop new distribution channels, expand our research and development efforts, improve our operational and financial systems and for other working capital purposes. We may also use a portion of the net proceeds to acquire or invest in complementary businesses, products or technologies. Currently, we have no specific understandings, commitments or agreements with respect to any such acquisition or investment. Except as set forth below, we have not allocated any portion of the net proceeds for any specific purpose. Our actual use of the net proceeds from the initial public offering and the concurrent private placement may differ from the uses we have identified. Pending these uses, the net proceeds of the offering and the concurrent private placement are invested in short-term, interest-bearing, investment-grade securities. Through December 28, 2002, we have used the proceeds from the initial public offering and concurrent private placement to pay for the offering expenses, to fund approximately $8.4 million in investments in leasehold improvements, computer hardware and software and office furniture and to fund approximately $9.0 million of working capital to support our operations.

The Company held its annual meeting of stockholders in Boston, Massachusetts on November 8, 2002. Of the 47,069,061 shares outstanding as of the record date, 39,141,279 shares were present or represented by proxy at the meeting. The following actions were voted upon at the meeting: (i) to elect two members to the Board of Directors as Class III Directors to serve for a three-year term and until a successor has been duly elected and qualified or until the earlier of death, resignation or removal: Mark F. O’Connell—For 36,225,579, Withheld 2,915,700; Charles R. Stuckey, Jr.—For 35,911,310, Withheld 3,229,969: (ii) to approve and adopt an amendment to the Company’s 1999 Stock Plan, as amended, to increase the number of shares of Common Stock that may be issued to any one participant during any fiscal year pursuant to the 1999 Stock Plan, as amended, from 300,000 to 1,500,000: For 31,804,783, Against 7,328,347, Abstain 8,149; and (iii) to ratify the selection of Ernst & Young LLP to serve as the Company’s independent auditors for the fiscal year ending June 28, 2003: For 38,591,001, Against 512,348, Abstain 37,930.

The term of office for the following directors continued after the meeting: W. Patrick Decker (Class I), James F. Morgan (Class I) and Daniel J. Holland (Class II).

Exhibit No.		Description

10.1		Loan Modification Agreement between the Company and Silicon Valley Bank dated as of December 24, 2002

10.2		Third Amended and Restated 1996 Stock Plan (incorporated herein by reference to the exhibits to the Company’s Tender Offer Statement on Schedule TO (File No. 005-60481)).

10.3		Amended and Restated 1999 Stock Plan (incorporated herein by reference to the exhibits to the Company’s Tender Offer Statement on Schedule TO (file No. 005-60481)).

99.1		Certification of Chief Executive Officer

99.2		Certification of Chief Financial Officer

The Company filed no Reports on Form 8-K during the three months ended December 28, 2002.

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

		Page
PART I—FINANCIAL INFORMATION
Item 1:	Financial Statements:
	Condensed Consolidated Balance Sheets as of December 28, 2002 (unaudited) and June 29, 2002	1
	Condensed Consolidated Statements of Operations for the Three and Six Month Periods Ended December 28, 2002 and December 29, 2001 (unaudited)	2
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 28, 2002 and December 29, 2001 (unaudited)	3
	Notes to Condensed Consolidated Financial Statements	4
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
	Cautionary Statements	24
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	37
Item 4:	Controls and Procedures	38

PART II—OTHER INFORMATION
Item 1:	Legal Proceedings	39
Item 2:	Changes in Securities and Use of Proceeds	39
Item 4:	Submission of Matters to a Vote of Security Holders	40
Item 6:	Exhibits and Reports on Form 8-K	40
Signatures		41
Certifications		42

	December 28, 2002			June 29, 2002
	(unaudited)
ASSETS
CURRENT ASSETS:
Cash and equivalents	$	131,641		$	139,642
Accounts receivable, less allowance for doubtful accounts of $2,458 and $2,371		27,318			35,794
Prepaid expenses and other current assets		7,663			8,039

Total current assets		166,622			183,475
PROPERTY AND EQUIPMENT, NET		13,904			14,784
OTHER ASSETS		2,486			2,689

	$	183,012		$	200,948

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	8,083		$	10,583
Accrued expenses		20,375			20,663
Deferred revenues		17,991			20,612

Total current liabilities		46,449			51,858

STOCKHOLDERS’ EQUITY:
Preferred stock, $0.01 par value, 5,000 shares authorized and none issued and outstanding		—			—
Common stock, $0.01 par value, 100,000 shares authorized, 47,678 and 47,030 shares issued and outstanding		477			470
Additional paid-in capital		211,472			210,788
Deferred stock-based consideration		(2,111	)		(3,898	)
Accumulated deficit		(74,211	)		(58,685	)
Accumulated other comprehensive income		936			415

Total stockholders’ equity		136,563			149,090

	$	183,012		$	200,948

	Three Months Ended						Six Months Ended
	December 28, 2002			December 29, 2001			December 28, 2002			December 29, 2001
REVENUES:
Software license	$	11,066		$	13,429		$	24,801		$	20,327
Service		16,952			18,598			34,341			36,542

Total revenues		28,018			32,027			59,142			56,869

COST OF REVENUES:
Software license		1,104			1,596			2,513			2,299
Service (1)		11,068			13,791			24,578			28,264

Total cost of revenues		12,172			15,387			27,091			30,563

GROSS PROFIT		15,846			16,640			32,051			26,306

OPERATING EXPENSES:
Selling and marketing (1)		11,801			13,547			24,278			26,376
Research and development (1)		6,581			6,020			13,231			12,170
General and administrative (1)		2,725			3,066			5,580			5,960
Stock-based compensation (1)		831			973			1,695			1,961
Restructuring charges		3,800			3,202			3,800			3,202

Total operating expenses		25,738			26,808			48,584			49,669

LOSS FROM OPERATIONS		(9,892	)		(10,168	)		(16,533	)		(23,363	)

OTHER INCOME (EXPENSE):
Interest income		554			902			1,168			2,262
Other income (expense), net		(46	)		18			(161	)		(59	)

Total other income (expense)		508			920			1,007			2,203

NET LOSS	$	(9,384	)	$	(9,248	)	$	(15,526	)	$	(21,160	)

BASIC AND DILUTED NET LOSS PER SHARE	$	(0.20	)	$	(0.20	)	$	(0.33	)	$	(0.46	)

SHARES USED IN COMPUTING BASIC AND DILUTED NET LOSS PER SHARE		47,451			45,782			47,263			45,605


(1) The following summarizes the allocation of stock-based compensation:

Cost of service revenues	$	209		$	243		$	424		$	491
Selling and marketing		232			280			476			566
Research and development		173			197			355			396
General and administrative		217			253			440			508

Total stock-based compensation	$	831		$	973		$	1,695		$	1,961

	Six Months Ended
	December 28, 2002			December 29, 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(15,526	)	$	(21,160	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		2,547			2,020
Stock-based consideration		1,695			1,961
Provision for doubtful accounts		307			548
Changes in assets and liabilities:
Accounts receivable		8,669			10,480
Prepaid expenses and other current assets		432			(3,053	)
Accounts payable		(2,576	)		(383	)
Accrued expenses		(780	)		(20	)
Deferred revenues		(2,907	)		(2,079	)

Net cash used in operating activities		(8,139	)		(11,686	)

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(1,634	)		(4,569	)
Other assets		207			203

Net cash used in investing activities		(1,427	)		(4,366	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from stock option exercises		529			500
Proceeds from purchases of common stock under employee stock purchase plan		254			458

Net cash provided by financing activities		783			958

EFFECT OF EXCHANGE RATES ON CASH AND EQUIVALENTS		782			(30	)

NET DECREASE IN CASH AND EQUIVALENTS		(8,001	)		(15,124	)
CASH AND EQUIVALENTS, BEGINNING OF PERIOD		139,642			156,349

CASH AND EQUIVALENTS, END OF PERIOD	$	131,641		$	141,225

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for income taxes	$	289		$	209

	Three Months Ended						Six Months Ended
	December 28, 2002			December 29, 2001			December 28, 2002			December 29, 2001
Net loss	$	(9,384	)	$	(9,248	)	$	(15,526	)	$	(21,160	)
Foreign currency translation adjustments		867			(1,023	)		521			14

Comprehensive loss	$	(8,517	)	$	(10,271	)	$	(15,005	)	$	(21,146	)

	Employee Severance and Fringe Benefits			Facilities and Leases			Contract Terminations			Total
Restructuring charges – fiscal 2002	$	2,466		$	514		$	222		$	3,202
Non-cash adjustments – fiscal 2002		(85	)		(184	)		(121	)		(390	)

Adjusted restructuring charges – fiscal 2002		2,381			330			101			2,812
Cash payments – fiscal 2002		(1,726	)		(306	)		(101	)		(2,133	)

Accrual balance as of June 29, 2002		655			24			—			679
Cash payments – fiscal 2003		(350	)		(24	)		—			(374	)

Remaining accrual as of December 28, 2002	$	305		$	—		$	—		$	305

(In millions)	Employee Severance and Fringe Benefits			Facilities and Leases			Contract Terminations			Total
Restructuring charges – fiscal 2002	$	2.5		$	0.5		$	0.2		$	3.2
Non-cash adjustments – fiscal 2002		(0.1	)		(0.2	)		(0.1	)		(0.4	)

Adjusted restructuring charges – fiscal 2002		2.4			0.3			0.1			2.8
Cash payments – fiscal 2002		(1.7	)		(0.3	)		(0.1	)		(2.1	)

Accrual balance as of June 29, 2002		0.7			—			—			0.7
Cash payments – fiscal 2003		(0.4	)		—			—			(0.4	)

Remaining accrual as of December 28, 2002	$	0.3		$	—		$	—		$	0.3

(In millions, except days)	December 28, 2002	June 29, 2002
Cash and equivalents	$131.6	$139.6
Working capital	$120.2	$131.6
Days sales outstanding for the quarter ended	89 Days	102 Days

	Remaining Six Months of		Fiscal Year
(In millions)	Fiscal 2003		2004		2005		2006		2007		Thereafter
Leases	$	2.5	$	4.3	$	3.4	$	2.9	$	2.5	$	5.9
Development agreements		0.5		—		—		—		—		—

	$	3.0	$	4.3	$	3.4	$	2.9	$	2.5	$	5.9


Dated: February 11, 2003	By:	/s/ MAURICE L. CASTONGUAY
		Maurice L. Castonguay Chief Financial Officer, Senior Vice President of Finance and Administration and Treasurer (principal financial
		and chief accounting officer)

	Three Months Ended				Six Months Ended
	December 28, 2002		December 29, 2001		December 28, 2002		December 29, 2001
Revenues:
Software license	39.5	%	41.9	%	41.9	%	35.8	%
Service	60.5		58.1		58.1		64.2

Total revenues	100.0		100.0		100.0		100.0

Cost of Revenues:
Software license	3.9		5.0		4.2		4.0
Service	39.5		43.0		41.6		49.7

Total cost of revenues	43.4		48.0		45.8		53.7

Gross profit	56.6		52.0		54.2		46.3

Operating Expenses:
Selling and marketing	42.1		42.3		41.1		46.4
Research and development	23.5		18.8		22.4		21.4
General and administrative	9.7		9.6		9.4		10.5
Stock-based compensation	3.0		3.0		2.9		3.5
Restructuring charges	13.6		10.0		6.4		5.6

Total operating expenses	91.9		83.7		82.2		87.4

Loss from Operations	(35.3	)	(31.7	)	(28.0	)	(41.1	)
Other Income (Expense), Net	1.8		2.8		1.7		3.9

Net Loss	(33.5	)%	(28.9	)%	(26.3	)%	(37.2	)%