MSC SOFTWARE CORP - 10-Q Quarterly Report

QuickLinks -- Click here to rapidly navigate through this document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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

For the Period Ended September 30, 2002

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

For the Transition Period From To

Commission File Number 1-8722

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

Delaware
(State or Other Jurisdiction of Incorporation or Organization)

95-2239450
(I.R.S. Employer Identification No.)

2 MacArthur Place
Santa Ana, California
(Address of Principal Executive Offices)

92707
(Zip Code)

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

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

As of November 1, 2002, the number of shares outstanding of the Registrant's Common Stock, par value $0.01 per share, was 29,774,415.

MSC.SOFTWARE CORPORATION
INDEX TO FORM 10-Q
SEPTEMBER 30, 2002

			Page
PART I. FINANCIAL INFORMATION
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets September 30, 2002 (Unaudited) and December 31, 2001	2
		Condensed Consolidated Statements of Operations (Unaudited) Three and Nine Months Ended September 30, 2002 and 2001	3
		Condensed Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended September 30, 2002 and 2001	4
		Notes to Unaudited Condensed Consolidated Financial Statements	5
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	15
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25
	Item 4.	Controls and Procedures	25
PART II. OTHER INFORMATION
	Item 3.	Defaults Upon Senior Securities	26
	Item 6.	Exhibits and Reports on Form 8-K	27

MSC.SOFTWARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS

				September 30, 2002			December 31, 2001
				(Unaudited)
ASSETS
Current Assets:
	Cash and Cash Equivalents			$	30,655,000		$	86,056,000
	Investments				3,936,000			3,484,000
	Trade Accounts Receivable, Net of Allowance of $3,194,000 and $2,548,000 at September and December, Respectively				81,367,000			82,276,000
	Deferred Tax Charges				17,546,000			13,875,000
	Other Current Assets				30,856,000			12,309,000

		Total Current Assets			164,360,000			198,000,000
Property and Equipment, Net					35,678,000			31,209,000
Capitalized Software Costs, Net					24,678,000			25,952,000
Goodwill and Indefinite Lived Intangibles, Net					193,948,000			151,732,000
Other Intangible Assets, Net					74,153,000			21,623,000
Other Assets					11,217,000			5,139,000

			TOTAL ASSETS	$	504,034,000		$	433,655,000

LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
	Accounts Payable			$	32,925,000		$	22,289,000
	Line of Credit				6,666,000			—
	Current Portion of Note Payable				15,958,000			1,333,000
	Deferred Revenue				52,757,000			48,578,000
	Compensation and Related Expenses				13,791,000			12,767,000
	Restructuring Reserve				8,011,000			1,404,000
	Other Current Liabilities				17,301,000			17,807,000

		Total Current Liabilities			147,409,000			104,178,000

Deferred Income Taxes					35,957,000			14,489,000
Note Payable, Less Current Portion					43,542,000			—
Notes Payable to Shareholders, Net					24,261,000			24,178,000
Subordinated Notes Payable, Net					6,772,000			9,185,000
Other Long Term Liabilities					7,012,000			4,653,000
Commitments and Contingencies
Shareholders' Equity:
	Preferred Stock, $0.01 Par Value, 10,000,000 Shares Authorized; No Shares Issued and Outstanding				—			—
	Common Stock, $0.01 Par Value, 100,000,000 Shares Authorized; 29,741,700 and 28,653,100 Issued and Outstanding at September and December, Respectively				298,000			287,000
	Additional Paid-in Capital				281,963,000			270,071,000
	Accumulated Other Comprehensive Loss				(4,394,000	)		(8,206,000	)
	Retained Earnings (Accumulated Deficit)				(38,509,000	)		15,097,000
	Treasury Shares, At Cost (40,000 Shares)				(277,000	)		(277,000	)

		Total Shareholders' Equity			239,081,000			276,972,000

			TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	504,034,000		$	433,655,000

See accompanying notes to unaudited condensed consolidated financial statements.

MSC.SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

			Three Months Ended September 30,						Nine Months Ended September 30,
			2002			2001			2002			2001
REVENUE:
	Software		$	35,303,000		$	32,980,000		$	112,686,000		$	98,905,000
	Services			26,287,000			15,728,000			62,955,000			42,872,000
	Systems			19,440,000			13,958,000			66,945,000			14,204,000

		Total Revenue		81,030,000			62,666,000			242,586,000			155,981,000

COST OF REVENUE:
	Software			5,744,000			6,838,000			17,286,000			18,313,000
	Services			14,976,000			9,200,000			39,307,000			23,391,000
	Systems			17,586,000			11,173,000			54,513,000			11,370,000

		Total Cost of Revenue		38,306,000			27,211,000			111,106,000			53,074,000

GROSS PROFIT				42,724,000			35,455,000			131,480,000			102,907,000

OPERATING EXPENSE:
	Research and Development			6,589,000			5,920,000			19,261,000			16,339,000
	Selling, General and Administrative			33,763,000			24,954,000			109,093,000			66,598,000
	Restructuring and Other Impairment Charges			6,016,000			1,894,000			13,815,000			1,894,000
	Write-Off of Acquired In-Process R&D			—			—			2,380,000			—
	Amortization of Goodwill and Other Intangibles			1,910,000			2,726,000			4,656,000			8,175,000

		Total Operating Expense		48,278,000			35,494,000			149,205,000			93,006,000

OPERATING INCOME (LOSS)				(5,554,000	)		(39,000	)		(17,725,000	)		9,901,000

OTHER EXPENSE:
	Interest Expense			2,088,000			1,412,000			4,434,000			4,614,000
	Other Expense (Income), Net			876,000			(1,184,000	)		(600,000	)		(1,374,000	)

		Total Other Expense, Net		2,964,000			228,000			3,834,000			3,240,000

INCOME (LOSS) BEFORE PROVISION (BENEFIT) FOR INCOME TAXES AND CUMULATIVE CHANGE IN ACCOUNTING PRINCIPLE				(8,518,000	)		(267,000	)		(21,559,000	)		6,661,000
Provision (Benefit) for Income Taxes				(2,720,000	)		(67,000	)		(7,253,000	)		2,650,000

NET INCOME (LOSS) BEFORE CUMULATIVE CHANGE IN ACCOUNTING PRINCIPLE				(5,798,000	)		(200,000	)		(14,306,000	)		4,011,000
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE				—			—			(39,300,000	)		—

NET INCOME (LOSS)			$	(5,798,000	)	$	(200,000	)	$	(53,606,000	)	$	4,011,000

BASIC EARNINGS (LOSS) PER SHARE BEFORE CUMULATIVE CHANGE IN ACCOUNTING PRINCIPLE			$	(0.20	)	$	(0.01	)	$	(0.49	)	$	0.22

DILUTED EARNINGS (LOSS) PER SHARE BEFORE CUMULATIVE CHANGE IN ACCOUNTING PRINCIPLE			$	(0.20	)	$	(0.01	)	$	(0.49	)	$	0.21

BASIC EARNINGS (LOSS) PER SHARE			$	(0.20	)	$	(0.01	)	$	(1.82	)	$	0.22

DILUTED EARNINGS (LOSS) PER SHARE			$	(0.20	)	$	(0.01	)	$	(1.82	)	$	0.21

Basic Weighted-Average Shares Outstanding				29,626,000			24,729,000			29,379,000			17,835,000

Diluted Weighted-Average Shares Outstanding				29,626,000			24,729,000			29,379,000			19,309,000

See accompanying notes to unaudited condensed consolidated financial statements.

MSC.SOFTWARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

					Nine Months Ended September 30,
					2002			2001
CASH FLOWS FROM OPERATING ACTIVITIES:
	Net Income (Loss)				$	(53,606,000	)	$	4,011,000
	Adjustments to Reconcile Net Income (Loss) to Net Cash Provided By Operating Activities:
		Provision for Doubtful Accounts				905,000			(246,000	)
		Depreciation and Amortization of Property and Equipment				7,951,000			4,528,000
		Amortization of Capitalized Software Costs				7,761,000			7,678,000
		Amortization of Goodwill and Other Intangibles				4,656,000			8,175,000
		Write-off of Acquired IPR&D				2,380,000			—
		Impairment of Capitalized Software				4,751,000			—
		Amortization of Discounts				386,000			519,000
		Loss on Disposal of Property and Equipment				15,000			7,000
		Deferred Income Taxes				(994,000	)		(69,000	)
		Non-Cash Debenture Interest, Net				—			1,029,000
		Cumulative Effect of Change in Accounting Principle				39,300,000			—
		Other				861,000			19,000
		Changes in Assets and Liabilities, Net of Effect of Acquisitions:
			Trade Accounts Receivable			15,333,000			6,418,000
			Other Current Assets			(16,696,000	)		(5,016,000	)
			Accounts Payable			3,711,000			(1,237,000	)
			Deferred Revenue			(7,111,000	)		9,021,000
			Compensation and Related Expenses			1,566,000			(638,000	)
			Restructuring Reserve			1,742,000			568,000
			Other Current and Long-Term Liabilities			(1,797,000	)		(1,261,000	)

				Net Cash Provided By Operating Activities		11,114,000			33,506,000

CASH FLOWS FROM INVESTING ACTIVITIES:
	Acquisition of Property and Equipment					(8,633,000	)		(16,596,000	)
	Cash Paid For Acquisition of MDI, Net					(111,283,000	)		—
	Cash Paid For Other Business Acquired, Net					(4,418,000	)		(5,764,000	)
	Capitalized Software Development Costs					(10,692,000	)		(10,244,000	)
	Other Investing Activities					(2,559,000	)		(2,470,000	)

				Net Cash Used In Investing Activities		(137,585,000	)		(35,074,000	)

CASH FLOWS FROM FINANCING ACTIVITIES:
	Net Borrowings (Repayments) on Line of Credit or Debt					64,833,000			(5,636,000	)
	Redemption of Convertible Subordinated Debentures					—			(1,041,000	)
	Issuance of Common Stock in Public Offering					—			67,424,000
	Issuance of Common Stock (Options and Warrants)					4,795,000			10,106,000

				Net Cash Provided By Financing Activities		69,628,000			70,853,000

EFFECT OF CHANGES IN EXCHANGE RATES ON CASH						1,442,000			(3,955,000	)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS						(55,401,000	)		65,330,000
Cash and Cash Equivalents at Beginning of Period						86,056,000			28,806,000

CASH AND CASH EQUIVALENTS AT END OF PERIOD					$	30,655,000		$	94,136,000

See accompanying notes to unaudited condensed consolidated financial statements.

MSC.SOFTWARE CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002

NOTE 1—BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of MSC.Software Corporation (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002.

The balance sheet as of December 31, 2001 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

Certain amounts in the 2001 condensed consolidated financial statements have been reclassified to conform to the 2002 presentation.

For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2001.

NOTE 2—RECENTLY ISSUED ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141 ("SFAS No. 141"), "Business Combinations", and No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets." Under the new rules, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. Other intangible assets continue to be amortized over their useful lives. In connection with the adoption of SFAS 142, the useful lives of such intangibles were evaluated and no changes were deemed necessary. Upon adoption of SFAS No. 142 in the first quarter of 2002, the Company ceased to amortize approximately $56,000,000 of goodwill and other indefinite lived intangibles acquired prior to July 1, 2001. We recorded $1,671,000 and $5,007,000 of amortization on these amounts during the three and nine months ended September 30, 2001, respectively. SFAS No. 142 does not require retroactive restatement for all periods presented.

The following information reflects the Company's results of operations as if SFAS 142 had been adopted on January 1, 2001:

		Three Months Ended September 30,						Nine Months Ended September 30,
		2002			2001			2002			2001
		(Unaudited)						(Unaudited)
Reported Net Income (Loss)		$	(5,798,000	)	$	(200,000	)	$	(53,606,000	)	$	4,011,000
	Amortization of Goodwill and Indefinite Lived Intangibles		—			1,671,000			—			5,007,000

Adjusted Net Income (Loss)		$	(5,798,000	)	$	1,471,000		$	(53,606,000	)	$	9,018,000

Basic Earnings (Loss) Per Share		$	(0.20	)	$	0.06		$	(1.82	)	$	0.51

Diluted Earnings (Loss) Per Share		$	(0.20	)	$	0.05		$	(1.82	)	$	0.47

Under SFAS No. 142, goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. The Company's reporting units are generally consistent with the operating segments underlying the segments identified in Note 9—Segment Information. This methodology differs from the Company's previous policy, as permitted under accounting standards existing at that time, of using undiscounted cash flows on an enterprisewide basis to determine if goodwill is recoverable.

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

Prior to performing the review for impairment, SFAS No. 142 required that all goodwill deemed to be related to the entity as a whole be assigned to all of the Company's reporting units. This differs from the previous accounting rules where goodwill was assigned only to the businesses of the company acquired. As a result, effective January 1, 2002, approximately $61,000,000 of the goodwill generated in the AES acquisition, which was previously allocated to the Systems reporting unit, has been reallocated to the Software and Services reporting units.

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

In July 2002, the FASB issued Statement No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by SFAS 146 include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operations, plant closing or other exit or disposal activities. SFAS 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged. As the provisions of SFAS 146 are required to be applied prospectively after the adoption date, management cannot determine the potential effects that adoption of SFAS 146 will have on the Company's consolidated financial statements.

NOTE 3—BUSINESS ACQUISITIONS

Mechanical Dynamics, Inc.

On April 19, 2002, the Company, through a wholly owned subsidiary, completed the acquisition of the outstanding common stock of Mechanical Dynamics, Inc. ("MDI") through a tender offer. MDI develops, markets and supports functional virtual prototyping solutions. The Company believes that the

acquisition of MDI will expand the Company's core software offerings, complement the Company's existing product and service offerings, and increase the Company's presence in the product lifecycle management market to better serve customers.

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

The acquisition of MDI has been accounted for as a purchase, and accordingly, the results of operations of MDI since April 19, 2002 are included in the Company's condensed consolidated statement of operations. An independent valuation of the intangible assets acquired has been performed and the allocation of the purchase price reflected in the September 30, 2002 condensed consolidated balance sheet is as follows:

Net Tangible Assets Acquired		$	17,464,000	(1)
Fair Value of Intangible Assets Acquired, net of deferred tax			33,068,000
Fair Value of In-Process R&D			2,170,000
Goodwill and Indefinite Lived Intangibles			78,802,000

	Total Cost of Acquistion	$	131,504,000

Cash Paid for outstanding MDI common shares		$	116,877,000
Cash Paid for outstanding MDI stock options			10,531,000
Direct Costs of Acquisition			4,096,000

		$	131,504,000

(1): Includes $5,794,000 of restructuring costs related to MDI (Note 5).

Net tangible assets acquired include cash, accounts receivable and fixed assets and liabilities assumed principally include accounts payable, accrued compensation and accrued expenses. During the third quarter, the Company finalized its integration plan for MDI. Accordingly, the company recognized additional liabilities in connection with the acquisition of MDI of $1,634,000 during the quarter. The liabilities recognized included severance and related charges associated with a worldwide reduction in force of MDI employees, transaction costs, costs related to closing redundant facilities and terminating contracts and other exit costs associated with the acquisition.

Intangible assets acquired include $31,110,000 of technology acquired to be amortized over ten years and $23,100,000 of identified intangibles. Identified intangibles consist primarily of trademark and trade name and were deemed to have indefinite lives.

A portion of the purchase price has been allocated to acquired in-process research and development. In-process research and development ("IPR&D") were identified and valued through analysis of data provided by MDI concerning developmental products, their stage of development, the time and resources needed to complete them, if applicable, their expected income generating ability, target markets and associated risks. The Company retained an independent valuation firm to assist the Company in determining the fair value of the acquired assets. The primary technique utilized in valuing

the acquired IPR&D was the Income Approach, which includes an analysis of the markets, cash flows and risks associated with achieving such cash flows.

Developmental projects that had reached technological feasibility were classified as developed technology, and the value was assigned to technology acquired and capitalized as Intangible Assets. Where the developmental projects had not reached technological feasibility and had no future alternative uses, they were classified as IPR&D and charged to expense upon closing of the acquisition.

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

The estimates used in valuing IPR&D were based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable.

The following summarized unaudited pro forma consolidated results of operations reflects the effect of the MDI acquisition as if it had occurred on January 1, 2001. The unaudited pro forma consolidated results of operations presented below are not necessarily indicative of operating results which would have been achieved had the acquisition been consummated as of January 1, 2001 and should not be construed as representative of future operations.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2002			2001			2002			2001
	(Unaudited)						(Unaudited)
Revenue	$	81,030,000		$	76,727,000		$	256,997,000		$	197,373,000

Net Income (Loss) before Cumulative Change in Accounting Principle	$	(5,798,000	)	$	(597,000	)	$	(17,318,000	)	$	2,262,000

Net Income (Loss)	$	(5,798,000	)	$	(597,000	)	$	(56,618,000	)	$	2,262,000

Basic Earnings (Loss) Per Share Before Cumulative Change in Accounting Principle		(0.20	)		(0.02	)		(0.59	)		0.13

Diluted Earnings (Loss) Per Share Before Cumulative Change in Accounting Principle		(0.20	)		(0.02	)		(0.59	)		0.12

Basic Earnings (Loss) Per Share	$	(0.20	)	$	(0.02	)	$	(1.93	)	$	0.13

Diluted Earnings (Loss) Per Share	$	(0.20	)	$	(0.02	)	$	(1.93	)	$	0.12

Advanced Enterprise Solutions, Inc.

In July 2001, the Company acquired AES. The following summarized unaudited pro forma consolidated results of operations reflects the effect of the AES acquisition as if it had occurred on January 1, 2001. The unaudited pro forma consolidated results of operations presented below are not

necessarily indicative of operating results which would have been achieved had the acquisition been consummated as of January 1, 2001 and should not be construed as representative of future operations.

	Nine Months Ended September 30, 2001
	(Unaudited)
Revenue	$	192,839,000

Net Income	$	5,000,000

Basic Earnings Per Share	$	0.22

Diluted Earnings Per Share	$	0.20

EASY5

In May 2002, the Company acquired certain assets and technology known as EASY5 ("EASY5") for cash of $4,418,000 and the assumption of certain liabilities. As a result of this transaction, the Company recognized goodwill of approximately $2,714,000 and other identifiable intangibles of $2,940,000. The Company also acquired $210,000 of in-process research and development costs, which were expensed in the second quarter of 2002.

NOTE 4—CAPITALIZED SOFTWARE COSTS

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2002			2001			2002			2001
	(Unaudited)						(Unaudited)
Capitalized Software Development Costs	$	(3,399,000	)	$	(3,181,000	)	$	(10,692,000	)	$	(10,244,000	)
Amortization of Capitalized Software Costs		2,396,000			3,323,000			7,761,000			7,678,000
Write-off of Impaired Capitalized Software Cost		992,000			—			4,751,000			—

	$	(11,000	)	$	142,000		$	1,820,000		$	(2,566,000	)

Amortization expense associated with capitalized software costs is reported in cost of software revenue, and capitalized software development costs, net of reserves, are reported as a reduction of research and development expense.

Capitalized product development costs and projected revenues are reviewed quarterly to determine if any impairment in value has occurred that would require an adjustment in the carrying value or change in expected useful lives under the guidelines established under SFAS No. 86. During the three and nine months ended September 30, 2002, the Company recognized a non-cash, pre-tax impairment charge of $992,000 and $4,751,000, respectively, related to capitalized software development costs. This charge has been included in restructuring and other impairment charges in the accompanying financial statements. The impairment was primarily due to the abandonment of certain products as a result of the acquisition of MDI as well as the Company's restructuring during the second and third quarter.

NOTE 5—RESTRUCTURING RESERVE

During the three and nine months ended September 30, 2002, the Company recorded total restructuring charges of $6,658,000 and $14,858,000, respectively. Of this amount, the Company recorded $1,634,000 and $5,794,000, respectively, of restructuring costs related to the integration of MDI into the Company, including severance and related charges associated with a worldwide reduction in force of MDI employees, transaction costs, costs related to closing redundant facilities and

terminating contracts and other exit costs associated with the acquisition. In accordance with Emerging Issues Task Force Issue No. 95-3, "Recognition of Liabilities in Connection with a Purchase Business Combination" ("EITF 95-3"), the costs related to the integration of MDI into the Company were included in the purchase price allocation, resulting in additional goodwill.

The remaining $5,024,000 and $9,064,000 was recorded as a charge to income in the three and nine months ended September 30, 2002, respectively. The restructuring charges for the three months ended September 30, 2002 consist of $5,259,000 of charges related to workforce reductions, $929,000 to the impairment of assets caused by the terms of the MDI acquisition and $470,000 to the consolidation of existing office facilities and other costs. The restructuring charges for the nine months ended September 30, 2002 consist of $11,609,000 of charges related to workforce reductions, $1,943,000 to the impairment of assets caused by the terms of the MDI acquisition and $1,306,000 to the consolidation of existing office facilities and other costs.

During the third quarter of 2001, the Company recorded total restructuring charges of $2,457,000. Of this amount, the Company recorded $563,000 of restructuring costs related to the integration of AES into the Company. In accordance with EITF 95-3, the costs related to the consolidation of AES office facilities were included in the purchase price allocation, resulting in additional goodwill. The remaining $1,894,000 was recorded as a charge to income in the third quarter of 2001. The restructuring charges for 2001 consist of $1,807,000 of charges related to the consolidation of existing office facilities and $650,000 to asset write-downs.

Prior to the date of the financial statements, management with the appropriate level of authority, approved and committed the Company to a plan of termination which included the benefits terminated employees would receive. Prior to September 30, 2002, the expected termination benefits were communicated to employees in detail sufficient to enable them to determine the nature and amounts of their individual severance benefits.

The Company estimated the cost of exiting and terminating the facility leases based on the contractual terms of the agreements and then current real estate market conditions. The Company determined that it would take approximately six to twenty-four months to sublease the various properties that will be vacated in connection with the consolidation program.

Amounts related to the lease expense (net of anticipated sublease proceeds) related to the consolidation of facilities will be paid over the respective lease terms. The Company anticipates completing implementation of its restructuring program during the next twelve months.

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

		Three Months Ended September 30,						Nine Months Ended September 30,
		2002			2001			2002			2001
		(Unaudited)						(Unaudited)
Balance at Beginning of Period		$	5,675,000		$	767,000		$	1,404,000		$	1,340,000
	Charges to Expense		5,024,000			1,894,000			9,064,000			1,894,000
	Acquisition Related Additions		1,634,000			563,000			5,794,000			563,000
	Amounts Paid or Realized		(4,322,000	)		(992,000	)		(8,251,000	)		(1,565,000	)

Balance at End of Period		$	8,011,000		$	2,232,000		$	8,011,000		$	2,232,000

NOTE 6—EARNINGS (LOSS) PER SHARE

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

			Three Months Ended September 30,						Nine Months Ended September 30,
			2002			2001			2002			2001
			(Unaudited)						(Unaudited)
Numerator:
	Numerator for Basic Earnings (Loss) Per Share - -Net Income (Loss) Before Cumulative Change		$	(5,798,000	)	$	(200,000	)	$	(14,306,000	)	$	4,011,000
	Cumulative Change in Accounting Principle			—			—			(39,300,000	)		—

	Numerator for Basic Earnings (Loss) Per Share—Net Income (Loss)		$	(5,798,000	)	$	(200,000	)	$	(53,606,000	)	$	4,011,000

Denominator:
	Denominator for Basic Earnings (Loss) Per Share—Weighted-Average Shares Outstanding			29,626,000			24,729,000			29,379,000			17,835,000
	Effect of Dilutive Securities:
		Employee Stock Options, Stock Purchase Plan and Common Stock Warrants		—			—			—			1,474,000

	Denominator for Diluted Earnings (Loss) per Share			29,626,000			24,729,000			29,379,000			19,309,000

BASIC EARNINGS (LOSS) PER SHARE BEFORE CUMULATIVE CHANGE IN ACCOUNTING PRINCIPLE			$	(0.20	)	$	(0.01	)	$	(0.49	)	$	0.22

DILUTED EARNINGS (LOSS) PER SHARE BEFORE CUMULATIVE CHANGE IN ACCOUNTING PRINCIPLE			$	(0.20	)	$	(0.01	)	$	(0.49	)	$	0.21

BASIC EARNINGS (LOSS) PER SHARE			$	(0.20	)	$	(0.01	)	$	(1.82	)	$	0.22

DILUTED EARNINGS (LOSS) PER SHARE			$	(0.20	)	$	(0.01	)	$	(1.82	)	$	0.21

The computation of diluted earnings (loss) per share for the three months ended September 30, 2002 and 2001 excludes approximately 7,836,000 and 7,697,000 shares, respectively, relating to the possible exercise of outstanding stock options and warrants. The computation of diluted earnings (loss) per share for the nine months ended September 30, 2002 and 2001 excludes approximately 7,836,000 and 902,000 shares, respectively, relating to the possible exercise of outstanding stock options and warrants. These items were not included in the computation of diluted earnings (loss) per share as their effect would have been anti-dilutive.

NOTE 7—OTHER CURRENT ASSETS AND LIABILITIES

The components of other current assets are as follows:

		September 30, 2002		December 31, 2001
		(Unaudited)
Income Tax Receivable		$	12,781,000	$	1,322,000
Prepaid Expenses			8,885,000		4,508,000
Other Current Assets			9,190,000		6,479,000

	Total Other Current Assets	$	30,856,000	$	12,309,000

The components of other current liabilities are as follows:

		September 30, 2002		December 31, 2001
		(Unaudited)
Sales Tax Payable		$	4,554,000	$	2,681,000
Contributions to Profit Sharing Plan			2,097,000		2,509,000
Interest Payable			1,842,000		1,078,000
Royalties Payable			1,477,000		1,192,000
Commissions Payable			1,474,000		2,634,000
Income Taxes Payable			—		5,308,000
Other Accrued Liabilities			5,857,000		2,405,000

	Total Other Current Liabilities	$	17,301,000	$	17,807,000

NOTE 8—NOTES PAYABLE

In connection with the acquisition of MDI common stock, the Company entered into a Revolving Credit and Term Loan Agreement, and subsequent amendments, ("Loan Agreement") with various financial institutions ("Lenders"). The Loan Agreement includes a $65,000,000 term loan and a $6,728,000 revolving line of credit, all of which was borrowed to partially fund the acquisition of MDI.

As of September 30, 2002, the Company was out of compliance with certain required financial covenants of the Loan Agreement. In November 2002, the Company entered into a new Loan and Security Agreement ("New Loan Agreement") with new lenders ("New Lenders") to replace the existing Loan Agreement. The New Loan Agreement includes a $55,000,000 term loan and a $15,000,000 revolving line of credit. Borrowings under the revolving line of credit are limited to a borrowing base of up to 85% of eligible domestic accounts receivable, as defined. On November 19, 2002, the Company repaid all amounts outstanding under the Loan Agreement from proceeds of the New Loan Agreement consisting of $55,000,000 of the term loan and $6,666,000 of the revolving line of credit. The Company previously repaid $4,500,000 of the Loan Agreement with existing cash in October and November 2002.

The term loan is secured by substantially all of the Company's assets and bears interest at the New Lender's prime rate plus 5%. Advances on the revolving line of credit bear interest at the New Lender's prime rate plus 2.25%. The revolving line of credit and term loan expires in November 2006.

Principal maturities related to the term loan, including principal payments made in October and November under the Loan Agreement, are as follows:

Year Ending December 31,	Amount
2002	$	5,646,000
2003		13,750,000
2004		13,750,000
2005		13,750,000
2006		12,604,000

	$	59,500,000

The Company's balance sheet reflects the principal payments under the new loan agreement and amounts repaid in October and November 2002. The New Loan Agreement required an origination fee of approximately $2,100,000, which will be amortized to expense over the 48 months of the term loan. In addition, an annual facility fee of 1.50% of the total outstanding commitment will be paid and expensed quarterly. Approximately $1,500,000 of deferred loan costs related to the previous Loan Agreement will be expensed in November 2002. The New Loan Agreement requires maintenance of certain financial and non-financial covenants.

NOTE 9—SEGMENT INFORMATION

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

segments. The revenues and gross margins attributable to these segments are included in the following table:

			Three Months Ended September 30,				Nine Months Ended September 30,
			2002		2001		2002		2001
			(Unaudited)				(Unaudited)
Revenues:
	Software		$	35,303,000	$	32,980,000	$	112,686,000	$	98,905,000
	Services			26,287,000		15,728,000		62,955,000		42,872,000
	Systems			19,440,000		13,958,000		66,945,000		14,204,000

		Total Revenue	$	81,030,000	$	62,666,000	$	242,586,000	$	155,981,000

Gross Profit:
	Software		$	29,559,000	$	26,142,000	$	95,400,000	$	80,592,000
	Services			11,311,000		6,528,000		23,648,000		19,481,000
	Systems			1,854,000		2,785,000		12,432,000		2,834,000

		Gross Profit	$	42,724,000	$	35,455,000	$	131,480,000	$	102,907,000

International operations consist primarily of foreign sales offices selling software developed in the United States combined with local service revenue. Revenue is attributed to the country in which the customer is located. The following table summarizes the revenues of the Company's operations by geographic location:

			Three Months Ended September 30,				Nine Months Ended September 30,
			2002		2001		2002		2001
			(Unaudited)				(Unaudited)
Revenues:
	The Americas (1)		$	39,817,000	$	33,966,000	$	130,748,000	$	73,980,000
	Europe			19,457,000		15,620,000		55,354,000		41,649,000
	Asia-Pacific			21,756,000		13,080,000		56,484,000		40,352,000

		Total Revenue	$	81,030,000	$	62,666,000	$	242,586,000	$	155,981,000

(1): Substantially the United States

The following table summarizes the identifiable assets of the Company's operations by geographic location:

			September 30, 2002		December 31, 2001
			(Unaudited)
Identifiable Assets:
	The Americas (1)		$	419,854,000	$	369,352,000
	Europe			39,214,000		37,238,000
	Asia-Pacific			44,966,000		27,065,000

		Total Identifiable Assets	$	504,034,000	$	433,655,000

(1): Substantially the United States

The net assets of the Company's foreign subsidiaries (excluding intercompany items) totaled $37,787,000 and $34,329,000 as of September 30, 2002 and December 31, 2001, respectively. Long-lived assets included in these amounts were $10,304,000 and $10,296,000 as of September 30, 2002 and December 31, 2001, respectively.

NOTE 10—COMPREHENSIVE INCOME (LOSS)

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

		Three Months Ended September 30,						Nine Months Ended September 30,
		2002			2001			2002			2001
		(Unaudited)						(Unaudited)
Net Income (Loss)		$	(5,798,000	)	$	(200,000	)	$	(53,606,000	)	$	4,011,000
Change in Accumulated Translation Adjustment			110,000			(368,000	)		3,471,000			(3,955,000	)
Change in Unrealized Investment Gain, Net of Tax			(662,000	)		(291,000	)		341,000			(579,000	)

	Comprehensive Loss	$	(6,350,000	)	$	(859,000	)	$	(49,794,000	)	$	(523,000	)

The Company does not provide any deferred tax benefit for the change in accumulated translation adjustment because the recoverability of the benefit is not anticipated in the foreseeable future. The amount of tax associated with the unrealized investment gain as of September 30, 2002 was $1,509,000.

NOTE 11—COMMITMENTS AND CONTINGENCIES

In October 2001, the Federal Trade Commission ("FTC") issued an administrative challenge to the Company's acquisition of two competitors in 1999, alleging that the Company had substantially lessened competition in the Nastran market as a result of the acquisitions. In July 2002, a settlement was proposed, which was accepted by the FTC and made available for public comment in August 2002. On November 1, 2002, the FTC approved the settlement. The settlement requires the Company to divest to up to two acquirers ("Acquirers") all intellectual property (including computer code) related to the most current version of MSC.Nastran, as of the date of the settlement, all intellectual property acquired in the 1999 acquisitions, and all information related to customers using MSC.Nastran in the United States. In addition, for all customers that converted or convert to a paid-up license after June 24, 1999 through the first anniversary after the divestiture, the Company is required to allow the customer to terminate the paid-up agreement and to obtain a refund of a pro-rata portion of the consideration for the paid-up license if the customer decides to change from MSC.Nastran to the Acquirer's version of Nastran. The Company is currently in negotiations with several potential Acquirers. Until a final agreement has been reached with one or more Acquirers the effect of the settlement on the Company's financial statements cannot be determined. Accordingly, no amounts have been recorded in the accompanying financial statements related to the settlement.

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

BUSINESS

MSC.Software Corporation is a leader in providing high-end engineering analysis technology. We develop and market mechanical computer-aided engineering, or CAE, software and virtual prototyping solutions for use principally by engineers and designers in industry, research laboratories and universities. Our solutions allow our customer's "design-to-manufacture" team greater freedom to innovate design concepts, optimize complex solutions and exploit materials as a design variable. We also are an information systems reseller and integrator, addressing the needs of small and medium size product development and manufacturing companies.

RESULTS OF OPERATIONS

The following table sets forth items included in the condensed consolidated statements of operations data as percentages of total revenue for the three and nine months ended September 30, 2002 and 2001.

			Three Months Ended September 30,				Nine Months Ended September 30,
			2002		2001		2002		2001
REVENUE:
	Software		43.6	%	52.6	%	46.4	%	63.4	%
	Services		32.4	%	25.1	%	26.0	%	27.5	%
	Systems		24.0	%	22.3	%	27.6	%	9.1	%

		Total Revenue	100.0	%	100.0	%	100.0	%	100.0	%

COST OF REVENUE:
	Software		7.1	%	10.9	%	7.1	%	11.7	%
	Services		18.5	%	14.7	%	16.2	%	15.0	%
	Systems		21.7	%	17.8	%	22.5	%	7.3	%

		Total Cost of Revenue	47.3	%	43.4	%	45.8	%	34.0	%

GROSS PROFIT			52.7	%	56.6	%	54.2	%	66.0	%

OPERATING EXPENSE:
	Research and Development		8.1	%	9.5	%	7.9	%	10.5	%
	Selling, General and Administrative		41.7	%	39.8	%	45.0	%	42.7	%
	Restructuring Charges		7.4	%	3.0	%	5.7	%	1.2	%
	Write-Off of Acquired In-Process R&D		0.0	%	0.0	%	1.0	%	0.0	%
	Amortization of Goodwill and Other Intangibles		2.4	%	4.4	%	1.9	%	5.2	%

		Total Operating Expense	59.6	%	56.7	%	61.5	%	59.6	%

OPERATING INCOME (LOSS)			(6.9	%)	(0.1	%)	(7.3	%)	6.4	%

OTHER EXPENSE:
	Interest Expense		2.6	%	2.2	%	1.8	%	3.0	%
	Other Expense (Income), Net		1.0	%	(1.9	%)	(0.2	%)	(0.9	%)

		Total Other Expense, Net	3.6	%	0.3	%	1.6	%	2.1	%

INCOME (LOSS) BEFORE PROVISION (BENEFIT) FOR INCOME TAXES AND CUMULATIVE CHANGE IN ACCOUNTING PRINCIPLES			(10.5	%)	(0.4	%)	(8.9	%)	4.3	%
Provision (Benefit) for Income Taxes			(3.3	%)	(0.1	%)	(3.0	%)	1.7	%

NET INCOME (LOSS) BEFORE CUMULATIVE CHANGE IN ACCOUNTING PRINCIPLE			(7.2	%)	(0.3	%)	(5.9	%)	2.6	%

Three Months Ended September 30, 2002 vs. Three Months Ended September 30, 2001

Net Income (Loss)—Consolidated net loss was ($5,798,000), or ($0.20) per share, in 2002 compared to consolidated net loss of ($200,000), or ($0.01) per share, in 2001.

Revenue—We reported revenue of $81,030,000 in 2002 compared to $62,666,000 in 2001, an increase of $18,364,000, or 29%.

Software Revenue—Software revenue was $35,303,000 for 2002 compared to $32,980,000 for the prior year, an increase of $2,323,000, or 7%. The increase was primarily attributed to an increase in paid-up licenses and the acquisition of MDI, offset by a decrease in recurring software revenues. Software revenue generated from the recently acquired MDI was $4,155,000 or 12% of total software revenue. Software revenue consists of licensing fees, which are fees charged for the right to use our software or a third parties' software. Software is sold through monthly, annual or longer lease arrangements and through paid-up license arrangements, whereby the customer purchases a long-term license for the use of the software.

Services Revenue—Services revenue was $26,287,000 for 2002 compared to $15,728,000 for the prior year, an increase of $10,559,000, or 67%. Services revenue includes maintenance, support, consulting and training services. Consulting and training services range from installation and basic consulting to software modification and customization to meet specific customer needs and training. Software support revenue was $14,451,000, or 55% of total services revenue, for 2002 compared to $8,648,000, or 55% of total services revenue, for 2001, an increase of $5,803,000, or 67%. Revenue from consulting and training services was $11,836,000, or 45% of total services revenue, for 2002 compared to $7,080,000, or 45% of total services revenue, for 2001, an increase of $4,756,000, or 67%. The increase in services revenue was primarily due to an increase in maintenance revenue related to paid-up licenses and the acquisition of MDI. The recently acquired MDI generated software support revenue of $4,049,000, or 28% of total software support revenue, and consulting and training services revenue of $4,135,000, or 35% of total consulting and training services revenue.

Systems Revenue—Systems revenue includes the resale and integration of computer hardware and operating systems and was $19,440,000 for 2002 compared to $13,958,000 for 2001, an increase of $5,482,000, or 39%. The increase in systems revenue in 2002 was primarily due to weaker than normal sales in September 2001 following the terrorist attacks on September 11, 2001.

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

			Three Months Ended September 30,				Revenue Growth				% of Total Revenue
			2002		2001		$		%		2002		2001
Revenue:
	The Americas		$	39,817,000	$	33,966,000	$	5,851,000	17	%	49	%	54	%
	Europe			19,457,000		15,620,000		3,837,000	25	%	24	%	25	%
	Asia-Pacific			21,756,000		13,080,000		8,676,000	66	%	27	%	21	%

		Total Revenue	$	81,030,000	$	62,666,000	$	18,364,000	29	%	100	%	100	%

The Americas reported a decrease of $403,000 in software revenue, an increase of $2,906,000 in services revenue and an increase of $3,348,000 in systems revenue. The increase in revenue for the Americas was primarily due to the acquisition of MDI which generated $1,095,000 of software revenue and $2,604,000 of services revenue in the Americas during the current quarter. Paid-up software licenses in the Americas increased during the quarter, but was offset by a decrease in recurring software revenues.

Europe reported a decrease of $408,000 in software revenue, an increase of $3,689,000 in services revenue and an increase of $556,000 in systems revenue. The increase in revenue for Europe was primarily due to the acquisition of MDI and an increase in maintenance revenue, offset by a reduction in paid-up licenses in the third quarter of 2002. Revenue in Europe generated from the recently acquired MDI was $1,551,000 of software revenue and $2,615,000 of services revenue.

Asia-Pacific reported increases of $3,134,000 in software revenue, $3,964,000 in services revenue and $1,578,000 in systems revenue. The increase in revenue for Asia-Pacific was primarily due to increases in paid-up software licenses, increases in systems revenue and the acquisition of MDI. Revenue in Asia-Pacific generated from the recently acquired MDI was $1,509,000 of software revenue and $2,965,000 of services revenue.

Revenue growth in 2002 was also impacted from favorable foreign currency translation rates for the Euro and the Japanese Yen as compared to the prior year. Revenue for the three months ended September 30, 2002 would have been approximately $78,894,000 if translated using the prior year quarter's foreign currency translation rates. Revenue in local currencies increased 13% and 63% in Europe and Asia-Pacific, respectively. Our international operations in Europe and Asia-Pacific are sales organizations with high gross profit margins, which is due to these operations having minimal software development expenses. As a result, we are exposed to the effects of foreign currency fluctuations of the United States Dollar versus the Japanese Yen and the Euro.

Cost of Revenue—In accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed", cost of revenue expense includes period expenses directly related to revenue as well as the amortization of capitalized software costs. Total cost of revenue was $38,306,000, or 47% of total revenue, compared to $27,211,000, or 43% of total revenue, for the prior year.

Cost of Revenue—Software—Cost of revenue—software was $5,744,000, or 16% of software revenue, for 2002 compared to $6,838,000, or 21% of software revenue, for the prior year. These amounts include software amortization of $2,396,000 and $3,323,000 for 2002 and 2001, respectively. The decrease in cost of revenue—software was primarily due to a decrease in software amortization in 2002.

Cost of Revenue—Services—Cost of revenue—services was $14,976,000 or 57% of services revenue, for 2002 compared to $9,200,000, or 58% of services revenue, for the prior year.

Cost of Revenue—Systems—Cost of revenue—systems was $17,586,000 or 90% of systems revenue, for 2002 compared to $11,173,000, or 80% of systems revenue, for 2001. The increase in cost of revenue—systems was primarily due to several significant computer hardware sales with low margins during the third quarter of 2002 and fewer systems integration transactions, which typically generate higher margins than computer hardware transactions.

Gross Profit—Gross profit, which is total revenue less cost of revenue, was $42,724,000, or 53% of total revenue, for 2002, compared to $35,455,000, or 57% of total revenue, for 2001, an increase of $7,269,000, or 21%. The decrease in gross profit as a percentage of revenue was primarily due to the lower margins on systems revenue described above.

Operating Expense—Operating expense was $48,278,000 for 2002 compared to $35,494,000 for the prior year, an increase of $12,784,000, or 36%. As with revenue, our expenses are impacted by foreign currency fluctuations. Operating expenses (including cost of revenue) in the current year would have been approximately $1,448,000 lower if translated using the prior year's foreign currency translation rates.

Research and Development—In accordance with SFAS No. 86, research and development expense is reported net of the amount capitalized. Research and development expense for 2002 was $6,589,000

compared to $5,920,000 for 2001, an increase of $669,000, or 11%. The total gross investment in research and development activities for 2002 was $9,988,000, or 16% of total software and services revenue, compared to $9,101,000, or 19% of total software and services revenue, for the prior year. Capitalized software development costs were $3,399,000 for 2002 compared to $3,181,000 for the prior year, an increase of $218,000, or 7%. The amount of product development capitalized in any given period is a function of many factors, including the number of products under development at any point in time as well as their stage of development. Our product development process is continually under review to improve efficiency and product quality, and to reduce time to market. Due to the continual change in the product development process, there can be no assurance that the level of development capitalized in future periods will be comparable to current capitalized levels.

Capitalized product development costs and projected revenues are reviewed quarterly to determine if any impairment in value has occurred that would require an adjustment in the carrying value or change in expected useful lives under the guidelines established under SFAS No. 86. In the third quarter of 2002, $992,000 of capitalized software development costs was deemed to be impaired and was written off in accordance with SFAS No. 86. This charge has been included in restructuring and other impairment charges in the accompanying financial statements. The impairment was primarily due to the abandonment of certain products as a result of the acquisition of MDI as well as our restructuring during the quarter.

Selling, General and Administrative—Selling, general and administrative expense was $33,763,000, or 42% of total revenue, for 2002 compared to $24,954,000, or 40% of total revenue, for 2001, an increase of $8,809,000, or 35%. Selling, general and administrative expenses in 2002 increased as compared to 2001 primarily as a result of the acquisition of MDI in April 2002.

Restructuring and Other Impairment Charges—Restructuring charges were $5,024,000, or 6% of total revenue, for 2002 compared to $1,894,000, or 3% of total revenue, for 2001. The restructuring charges in the third quarter of 2002 consist of $4,012,000 of charges related to workforce reductions, $684,000 to the impairment of assets caused by the terms of the MDI acquisition and $328,000 to the consolidation of existing office facilities and other costs. In addition, we recorded the $992,000 of capitalized software impairments described above. In the third quarter of 2001, the restructuring charges consist of $1,389,000 of charges related to the consolidation of office facilities and $505,000 to asset write-downs.

Amortization of Goodwill and Other Intangibles—Amortization of goodwill and other intangibles was $1,910,000 for 2002 compared to $2,726,000 for 2001. In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets". Upon adoption of SFAS No. 142 in the first quarter of 2002, we ceased to amortize approximately $56,000,000 of goodwill and other indefinite lived intangibles acquired prior to July 1, 2001. We recorded $1,671,000 of amortization on these amounts during the third quarter of 2001. In accordance with SFAS 142, the goodwill resulting from the AES and MDI acquisitions have never been amortized.

Operating Income—Operating loss was ($5,554,000) for 2002 compared to operating loss of ($39,000) for 2001.

Total Other Expense—Total other expense was $2,964,000 for 2002 compared to $228,000 for 2001, an increase of $2,736,000.

Interest Expense—Interest expense was $2,088,000 for 2002 compared to $1,412,000 for 2001, an increase of $676,000, or 48%. The increase in interest expense is primarily due to the debt incurred in connection with the acquisition of MDI, offset by the conversion and redemption of our convertible subordinated debentures in the third quarter of 2001.

Other Expense (Income), Net—Other expense was $876,000 for 2002 compared to other income of ($1,184,000) for 2001. Other income includes interest income, gains and losses on property and equipment, currency translation gains and losses, and other non-operating income and expense.

Provision (Benefit) for Income Taxes—The income tax provision (benefit) is recorded each quarter by estimating the anticipated effective income tax rate for the entire year. Our estimated effective annual income tax rate for 2002 is 34% and was 39% in 2001. The decrease in this estimated effective income tax rate is due to lower pre-tax earnings in 2002.

Nine Months Ended September 30, 2002 vs. Nine Months Ended September 30, 2001

Net Income (Loss)—Consolidated net loss was ($53,606,000), or ($1.82) per share, in 2002 compared to net income of $4,011,000, or $0.21 per diluted share, in 2001.

Revenue—We reported revenue of $242,586,000 in 2002 compared to $155,981,000 in 2001, an increase of $86,605,000, or 56%.

Software Revenue—Software revenue was $112,686,000 for 2002 compared to $98,905,000 for the prior year, an increase of $13,781,000, or 14%. The increase was primarily attributed to an increase in paid-up licenses and the acquisition of MDI, offset by a decrease in recurring software revenues. Software revenue generated from the recently acquired MDI was $9,855,000 or 9% of total software revenue.

Services Revenue—Services revenue was $62,955,000 for 2002 compared to $42,872,000 for the prior year, an increase of $20,083,000, or 47%. Software support revenue was $35,852,000, or 57% of total services revenue, for 2002 compared to $25,214,000, or 59% of total services revenue, for 2001, an increase of $10,638,000, or 42%. Revenue from consulting and training services was $27,103,000, or 43% of total services revenue, for 2002 compared to $17,658,000, or 41% of total services revenue, for 2001, an increase of $9,445,000, or 53%. The increase was primarily due to the acquisition of MDI and an increase in maintenance revenue. The recently acquired MDI generated software support revenue of $7,598,000, or 21% of total software support revenue, and consulting and training services revenue of $7,190,000, or 27% of total consulting and training services revenue.

Systems Revenue—Systems revenue was $66,945,000 for 2002 compared to $14,204,000 for 2001. The increase in systems revenue in 2002 was primarily due to the acquisition of AES in July 2001, as well as weaker than normal sales in September 2001 following the terrorist attacks on September 11, 2001.

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

			Nine Months Ended September 30,				Revenue Growth				% of Total Revenue
			2002		2001		$		%		2002		2001
Revenue:
	The Americas		$	130,748,000	$	73,980,000	$	56,768,000	77	%	54	%	47	%
	Europe			55,354,000		41,649,000		13,705,000	33	%	23	%	27	%
	Asia-Pacific			56,484,000		40,352,000		16,132,000	40	%	23	%	26	%

		Total Revenue	$	242,586,000	$	155,981,000	$	86,605,000	56	%	100	%	100	%

The Americas reported increases of $3,578,000 in software revenue, $5,614,000 in services revenue and $47,576,000 in systems revenue. The increase in systems revenue was due to our acquisition of AES in July 2001. The increase in software and services revenue for the Americas was primarily due to the acquisition of MDI in April 2002, which generated $2,368,000 of software revenue and $4,586,000 of services revenue in 2002. The remaining increase in the Americas software and services revenue was

due primarily to increases in paid-up software licenses, offset by a decrease in recurring software revenues.

Europe reported increases of $4,583,000 in software revenue, $7,105,000 in services revenue and $2,017,000 in systems revenue. The increase in revenue for Europe was primarily due to the acquisitions of AES and MDI and an increase in maintenance revenue, offset by a reduction in paid-up licenses in the third quarter of 2002. Revenue in Europe generated from the recently acquired MDI was $3,378,000 of software revenue and $4,791,000 of services revenue.

Asia-Pacific reported increases of $5,619,000 in software revenue, $7,365,000 in services revenue and $3,148,000 in systems revenue. The increase in revenue for Asia-Pacific was primarily due to increases in paid-up software licenses and the acquisition of AES and MDI. Revenue in Asia-Pacific generated from the recently acquired MDI was $4,109,000 of software revenue and $5,411,000 of services revenue.

Revenue growth in 2002 was also impacted from unfavorable foreign currency translation rates for the Euro and the Japanese Yen as compared to the prior year. Revenue for the nine months ended September 30, 2002 would have been approximately $243,736,000 if translated using the prior year's foreign currency translation rates. Revenue in local currencies increased 31% and 46% in Europe and Asia-Pacific, respectively. Our international operations in Europe and Asia-Pacific are sales organizations with high gross profit margins, which is due to these operations having minimal software development expenses. As a result, we are exposed to the effects of foreign currency fluctuations of the United States Dollar versus the Japanese Yen and the Euro.

Cost of Revenue—Total cost of revenue was $111,106,000, or 46% of total revenue for 2002, compared to $53,074,000, or 34% of total revenue, for the prior year.

Cost of Revenue—Software—Cost of revenue—software was $17,286,000, or 15% of software revenue, for 2002 compared to $18,313,000, or 19% of software revenue, for the prior year. These amounts include software amortization of $7,761,000 and $7,678,000 for 2002 and 2001, respectively.

Cost of Revenue—Services—Cost of revenue—services was $39,307,000 or 62% of services revenue, for 2002 compared to $23,391,000, or 55% of services revenue, for the prior year. The increase in cost of revenue—services was primarily due to an increase in headcount during the first nine months of 2002.

Cost of Revenue—Systems—Cost of revenue—systems was $54,513,000 or 81% of systems revenue, for 2002 compared to $11,370,000, or 80% of systems revenue, for 2001.

Gross Profit—Gross profit was $131,480,000, or 54% of total revenue, for 2002, compared to $102,907,000, or 66% of total revenue, for 2001, an increase of $28,573,000, or 28%. The decrease in gross profit as a percentage of revenue was primarily due to the lower margins on systems revenue as compared with software and services and the decreased gross margin on services revenue as described above.

Operating Expense—Operating expense was $149,205,000 for 2002 compared to $93,006,000 for the prior year, an increase of $56,199,000, or 60%. As with revenue, our expenses are impacted by foreign currency fluctuations. Operating expenses (including cost of revenue) in the current year would have been approximately $523,000 higher if translated using the prior year's foreign currency translation rates.

Research and Development—Research and development expense for 2002 was $19,261,000 compared to $16,339,000 for 2001, an increase of $2,922,000, or 18%. The total gross investment in research and development activities for 2002 was $29,953,000, or 17% of total software and services revenue, compared to $26,583,000, or 19% of total software and services revenue, for the prior year. Capitalized software development costs were $10,692,000 for 2002 compared to $10,244,000 for the prior year, an

increase of $448,000, or 4%. The amount of product development capitalized in any given period is a function of many factors, including the number of products under development at any point in time as well as their stage of development. Our product development process is continually under review to improve efficiency and product quality, and to reduce time to market. Due to the continual change in the product development process, there can be no assurance that the level of development capitalized in future periods will be comparable to current capitalized levels.

During the nine months ended September 30, 2002, $4,751,000 of capitalized software development costs were deemed to be impaired and were written off in accordance with SFAS No. 86. This charge has been included in restructuring and other impairment charges in the accompanying financial statements. The impairment was primarily due to the abandonment of certain products as a result of the acquisition of MDI as well as the Company's restructuring during 2002.

Selling, General and Administrative—Selling, general and administrative expense was $109,093,000, or 45% of total revenue, for 2002 compared to $66,598,000, or 43% of total revenue, for 2001, an increase of $42,495,000, or 64%. Selling, general and administrative expenses in 2002 increased as compared to 2001 partially as a result of the acquisition of AES in July 2001 and the acquisition of MDI in April 2002. In addition, legal fees totaling approximately $9,500,000 were expensed in the nine months ended September 30, 2002 in connection with an FTC administrative proceeding related to two acquisitions we completed in 1999. The FTC proceeding has been settled and we do not expect to incur any significant new legal fees related to this matter.

Restructuring and Other Impairment Charges—Restructuring charges were $9,064,000, or 4% of total revenue, for 2002, compared to $1,894,000, or 1% of total revenue, for 2001. The restructuring charges in 2002 consist of $7,516,000 of charges related to workforce reductions, $994,000 to the impairment of assets caused by the terms of the MDI acquisition and $554,000 to the consolidation of office facilities and other costs. In addition, we recorded the $4,751,000 of capitalized software impairments described above. In the third quarter of 2001, the restructuring charges consist of $1,389,000 of charges related to the consolidation of office facilities and $505,000 to asset write-downs.

Write-Off of Acquired In-Process R&D—FASB Interpretation No. 4, "Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method," requires that any portion of the purchase price allocated to assets to be used in research and development projects that have no alternative future use be charged to expense at the date of the acquisition. Accordingly, during 2002, we wrote off $2,170,000 of in-process research and development acquired in connection with the acquisition of MDI and $210,000 of in-process research and development acquired in connection with the acquisition of EASY5.

Amortization of Goodwill and Other Intangibles—Amortization of goodwill and other intangibles was $4,656,000 for 2002 compared to $8,175,000 for 2001. In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets". Upon adoption of SFAS No. 142 in the first quarter of 2002, we ceased to amortize approximately $56,000,000 of goodwill and other indefinite lived intangibles acquired prior to July 1, 2001. We recorded $5,007,000 of amortization on these amounts during the nine months ended September 30, 2001. In accordance with SFAS 142, the goodwill resulting from the AES and MDI acquisitions has never been amortized. During the second quarter of 2002, we completed the required transitional impairment test under the new rules and recorded a one-time, non-cash charge of $39,300,000 to reduce the carrying value of the goodwill related to our Systems reporting unit. The impairment relates entirely to the Company's Systems reporting unit, which was almost entirely generated from the AES acquisition. Such charge is non-operational in nature and is reflected as a cumulative effect of change in accounting principle. In calculating the impairment charge, the fair value of the impaired reporting unit underlying the Systems reporting unit was estimated using either a discounted cash flow methodology or recent comparable transactions. We engaged an independent

valuation firm to assist us in determining the impairment charge. The impairment primarily resulted from an increase in the Company's stock price immediately prior to the date that the AES acquisition was announced and valued for accounting purposes, as well as a decline in market multiples in the information systems reseller industry.

Operating Income (Loss)—Operating loss was ($17,725,000) for 2002 compared to operating income of $9,901,000 for 2001.

Total Other Expense—Total other expense was $3,834,000 for 2002 compared to $3,240,000 for 2001, an increase of $594,000, or 18%.

Interest Expense—Interest expense was $4,434,000 for 2002 compared to $4,614,000 for 2001, a decrease of $180,000, or 4%. The reduction in interest expense is primarily due to the conversion and redemption of our convertible subordinated debentures in the third quarter of 2001, offset by the interest expense on our new debt incurred in connection with the acquisitions of AES and MDI.

Other Income—Other income was $600,000 for 2002 compared to $1,374,000 for 2001. Other income includes interest income, gains and losses on property and equipment, currency translation gains and losses, and other non-operating income and expense.

Provision (Benefit) for Income Taxes—The income tax provision (benefit) is recorded each quarter by estimating the anticipated effective income tax rate for the entire year. Our estimated effective income tax rate for 2002 is 34% and was 39% in 2001. The decrease in this estimated effective income tax rate is due to lower pre-tax earnings in 2002.

CRITICAL ACCOUNTING POLICIES

We have identified the following as critical accounting policies to our company: revenue recognition, allowance for doubtful accounts and litigation, capitalized software costs and valuation of long-lived and intangible assets and goodwill. These critical accounting policies have been applied during the nine months ended September 30, 2002 consistent with prior periods and the year ended December 31, 2001.

For further information, refer to the discussion of critical accounting policies included in Management's Discussion and Analysis in the Company's Annual Report on Form 10-K for the year ended December 31, 2001.

LIQUIDITY AND CAPITAL RESOURCES

In the past, working capital needed to finance our operations has been provided by cash on hand and by cash flow from operations. We believe that cash generated from operations will continue to provide sufficient capital for normal working capital needs in the foreseeable future. We may engage in additional financing methods that we believe are advantageous, particularly to finance acquisitions. Net cash provided by operating activities was $11,114,000 for the nine months ended September 30, 2002 compared to net cash provided by operating activities of $33,506,000 for the nine months ended September 30, 2001. The decrease in cash provided by operations is primarily due to the operating losses we have incurred during 2002, including the legal costs totaling approximately $9,500,000 during 2002 in connection with the FTC administrative proceeding. Our working capital (current assets minus current liabilities) at September 30, 2002 was $16,951,000 compared to $93,822,000 at December 31, 2001, a decrease of $76,871,000, or 82%. Cash and cash equivalents at September 30, 2002 was $30,655,000 compared to $86,056,000 at December 31, 2001, a decrease of $55,401,000, or 64%. The decrease in working capital and cash is primarily the result of the cash paid to acquire MDI, which was funded by existing cash and new debt.

In connection with the acquisition of MDI, we entered into a Revolving Credit and Term Loan Agreement and subsequent amendments ("Loan Agreement"), with various financial institutions ("Lenders"). The Loan Agreement includes a $65,000,000 term loan and a $6,728,000 revolving line of credit, all of which was borrowed to partially fund the acquisition of MDI. We also used existing cash of approximately $58,000,000 to complete the acquisition.

As of September 30, 2002, we were out of compliance with certain required financial covenants of the Loan Agreement. In November 2002, we entered into a new Loan and Security Agreement ("New Loan Agreement") with new lenders ("New Lenders") to replace the existing Loan Agreement. The New Loan Agreement includes a $55,000,000 term loan and a $15,000,000 revolving line of credit. Borrowings under the revolving line of credit are limited to a borrowing base of up to 85% of eligible domestic accounts receivable, as defined. On November 19, 2002, we repaid all amounts outstanding under the Loan Agreement from proceeds of the New Loan Agreement consisting of $55,000,000 of the term loan and $6,666,000 of the revolving line of credit. We previously repaid $4,500,000 of the Loan Agreement with existing cash in October and November 2002.

The term loan is secured by substantially all of our assets and bears interest at the New Lender's prime rate plus 5%. Advances on the revolving line of credit bear interest at the New Lender's prime rate plus 2.25%. The revolving line of credit expires in November 2006.

Principal maturities related to the term loan, including cash paid in October and November under the Loan Agreement, are as follows:

Year Ending December 31,	Amount
2002	$	5,646,000
2003		13,750,000
2004		13,750,000
2005		13,750,000
2006		12,604,000

	$	59,500,000

The New Loan Agreement required an origination fee of approximately $2,100,000, which will be amortized to expense over the 48 months of the term loan. In addition, an annual facility fee of 1.50% of the total outstanding commitment will be paid and expensed quarterly. The New Loan Agreement requires maintenance of certain financial and non-financial covenants.

In 1999, we issued subordinated notes payable in connection with an acquisition in the aggregate principal amount of $14,236,000. The subordinated notes payable bear interest at 8% with interest payments due semi-annually in January and July. The estimated interest payment in January 2003 is $320,000. In February 2002, the holder of these subordinated debentures used $3,000,000 of such debt as payment for the exercise of warrants. The entire remaining principal balance as of September 30, 2002 of $8,000,000 is due by June 2009.

In connection with the acquisition of AES in July 2001, we issued subordinated notes payable to the former shareholders of AES in the aggregate principal amount of $20,000,000. The notes bear interest at 7% with interest only payments due semi-annually in January and July. The estimated interest payment in January 2003 is $700,000. The entire principal balance as of September 30, 2002 of $20,000,000 is due in July 2004. We also assumed a note payable to Dassault Systemes of America Corporation ("DSA") as part of the acquisition of AES. The note bears interest at 3.2%. We will repay the principal balance of the loan from commissions earned by selling DSA products. Any remaining unpaid principal balance will be due in June 2003. The outstanding principal of the DSA note payable at September 30, 2002 was $4,779,000.

We expect to continue to invest a substantial portion of our revenues in the development of new computer software technologies and products and the enhancement of certain existing products. During

the first nine months of 2002 and 2001, we expended a total of $29,953,000 and $26,583,000, respectively, on development efforts, of which $10,692,000 and $10,244,000, respectively, were capitalized. Product development costs and the capitalization rate may vary depending, in part, on the number of products and the stage of development of the products in process.

During the first nine months of 2002 and 2001, we acquired $8,633,000 and $16,596,000, respectively, of new property and equipment. The decrease in 2002 was primarily due to additional costs in 2001 associated with the relocation of our Corporate Headquarters to a new facility in Santa Ana, California. Capital expenditures also included upgrades in computer equipment in order to keep current with technological advances and upgrades of facilities worldwide. Our capital expenditures vary from year to year, as required by business needs. We intend to continue to expand the capabilities of our computer equipment used in the development and support of our proprietary software products.

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

INFLATION

Inflation in recent years has not had a significant effect on our business.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

The forward-looking statements in this report, including statements concerning projections of our future results, operating profits and earnings, are based on current expectations and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by those statements. The risks and uncertainties include but are not limited to:

•: The timely development and market acceptance of new versions of our software products;
•: Dependence on certain industries;
•: The impact of the Internet on our business;
•: Timely development of products which, among other things, must accommodate industry trends such as increasing computing power and increased usage of workstations;
•: Fluctuations of the United States dollar versus foreign currencies;
•: Economic conditions in Asia-Pacific, Europe and the United States;
•: Our ability to reduce costs without adversely impacting revenues or in response to revenue shortfalls;
•: Successful involvement of international and domestic business partners;
•: Our ability to attract, motivate and retain salespeople, programmers and other key personnel;
•: Successful integration of acquired companies;
•: Potential disruption from natural hazards;
•: Timing of orders from customers;
•: Our ability to protect our intellectual property rights;
•: Successful compliance with the Federal Trade Commission approved settlement dated October 29, 2002;
•: Risks inherent in conducting international business;
•: Strong competition in the product lifecycle management and system integrator industries;

•: Volatility of the price of our common stock;
•: The adoption by us of certain anti-takeover provisions; and
•: Continued demand for our products, including MSC.Nastran, MSC.Patran, MSC.Marc, MSC.Dytran, MSC.MVision, MSC.Nastran for Windows, MSC.Working Model 4D and MSC.Adams.

The forward-looking statements in this report, as well as subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf, are hereby expressly qualified in their entirety by the cautionary statements in this section of this report and by the discussion of "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2001.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to the impact of foreign currency fluctuations and interest rate changes.

Foreign Currency Risk—International revenues are approximately 46% of our total revenues. International sales are made mostly from our two foreign sales subsidiaries in Germany and Japan and are typically denominated in the local currency of each country. These subsidiaries also incur most of their expenses in the local currency. Accordingly, all foreign subsidiaries use the local currency as their functional currency.

Our international business is subject to risks typical of an international business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially adversely impacted by changes in these or other factors.

Our exposure to foreign exchange rate fluctuations arises in part from intercompany accounts in which cash from sales of our foreign subsidiaries are transferred back to the United States. These intercompany accounts are typically denominated in the functional currency of the foreign subsidiary in order to centralize foreign exchange risk with the parent company in the United States. We are also exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into United States Dollars in consolidation. As exchange rates vary, these results, when translated, may vary from expectations and adversely impact overall expected profitability. The effect of foreign exchange rate fluctuations in 2002 was not significant.

Interest Rate Risk—Our exposure to market rate risks for changes in interest rates relates to any borrowings under our line of credit and notes payable. We have not used derivative financial instruments in our investment portfolio. We invest our excess cash primarily in debt instruments of U.S. municipalities and other high-quality issuers and, by policy, limit the amount of credit exposure to any one issuer. We protect and preserve our invested funds by limiting default, market and reinvestment risk.

Investment Risk—We periodically evaluate whether any declines in fair value of our investments are other-than-temporary. This evaluation consists of a review of qualitative and quantitative factors. We had no such impairments during 2001 or 2002.

Because of the factors stated throughout this document and in our Annual Report on Form 10-K, as well as other variables affecting our operating results, past financial performance should not be considered a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods.

ITEM 4. CONTROLS AND PROCEDURES

Within the 90 days prior to the date of this report, an evaluation was performed, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to the Securities Exchange Act of 1934, as amended, Rule 13a-14c. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective. There have been no significant changes in our internal controls or in other factors which could significantly affect internal controls subsequent to the date the evaluation was performed.

PART II—OTHER INFORMATION

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

As of September 30, 2002, we were out of compliance with certain required financial covenants of the our Revolving Credit and Term Loan Agreement related to EBITDA. In addition, we were out of compliance with a minimum cash covenant during and subsequent to the third quarter of 2002. In November 2002, we entered into a new Loan and Security Agreement with new lenders and repaid all amounts outstanding under the Revolving Credit and Term Loan Agreement. The terms and conditions of the new Loan and Security Agreement are described under the caption "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources".

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)	Exhibit Number
	3.1	Certificate of Incorporation of MSC.Software Corporation, as amended (filed as Exhibit 3.1 of MSC.Software Corporation's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1999, and incorporated herein by reference).
	3.2	Restated Bylaws of MSC.Software Corporation (filed as Exhibit 3.2 to MSC.Software Corporation's Annual Report on Form 10-K filed for the fiscal year ended January 31, 1996, and incorporated herein by reference).
	3.3	Certificate of Designations of Junior Participating Preferred Stock (filed as Exhibit 2.2 to The MacNeal-Schwendler Corporation's Registration Statement on Form 8-A filed October 13, 1998, and incorporated herein by reference).
	4.1	The MacNeal-Schwendler Corporation Indenture dated as of June 17, 1999 with Chase Manhattan Bank & Trust Company N.A. as Trustee (filed as Exhibit 4.1 to a Current Report on Form 8-K filed July 1, 1999, and incorporated herein by reference).
	4.2	The MacNeal-Schwendler Corporation Warrant Agreement dated as of June 18, 1999 with The MacNeal-Schwendler Corporation acting in the capacity of Warrant Agent (filed as Exhibit 4.2 to a Current Report on Form 8-K filed July 1, 1999, and incorporated herein by reference).
	4.3	Rights Agreement dated as of October 5, 1998 between The MacNeal-Schwendler Corporation and ChaseMellon Shareholder Services, L.L.C., as Rights Agent, including the Form of Right Certificate (Exhibit A), the Summary of Rights to Purchase Junior Participating Preferred Stock (Exhibit B) and the Form of Certificate of Designations of Junior Participating Preferred Stock (Exhibit C) (filed as Exhibit 2.1 to The MacNeal-Schwendler Corporation's Registration Statement on Form 8-A filed October 13, 1998 and incorporated herein by reference).
	4.4	Indenture, dated as of August 18, 1994, between MSC.Software Corporation and Chemical Trust Company of California, as trustee (filed as part of MSC.Software Corporation's Registration Statement on Form S-3 (No. 33-83174), and incorporated herein by reference).
	4.5	First Supplemental Indenture, dated September 22, 1994, between MSC.Software Corporation and Chemical Trust Company of California, as trustee (filed as Exhibit 4.2 of MSC.Software Corporation's Quarterly Report on Form 10-Q for the quarterly period ended October 31, 1994, and incorporated herein by reference).
	4.6	Second Supplemental Indenture, dated December 14, 1994, between MSC.Software Corporation and Chemical Trust Company of California, as trustee (filed as Exhibit 4.3 of MSC.Software Corporation's Quarterly Report on Form 10-Q for the quarterly period ended October 31, 1994, and incorporated herein by reference).

	4.7	Agreement And Plan Of Merger Dated As Of March 15, 2002 among MSC.Software Corporation, MSC Acquisition II Corp. And Mechanical Dynamics, Inc., (filed as Exhibit 99(d)(1) of MSC.Software Corporation's Schedule To Tender Offer Statement Under Section 14(D)(1) Or 13(E)(1) Of The Securities Exchange Act Of 1934, and incorporated herein by reference).
	10.1	Revolving Credit And Term Loan Agreement Dated As Of April 18, 2002 Between MSC.Software Corporation, Comerica Bank and BNP Paribas, As Co-Lead Arrangers, Comerica Bank, As Administrative Agent, BNP Paribas And Key Corporate Capital, Inc., As Co-Syndication Agents, and U.S. Bank National Association And The Bank Of Nova Scotia, As Co-Documentation Agents. (Filed as Exhibit 4.1 of MSC.Software Corporation's Form 8-K filed on May 6, 2002, and incorporated herein by reference).
	10.2	First Amendment to Revolving Credit And Term Loan Agreement and Waiver Dated As Of July 23, 2002 Between MSC.Software Corporation, Comerica Bank and BNP Paribas, As Co-Lead Arrangers, Comerica Bank, As Administrative Agent, BNP Paribas And Key Corporate Capital, Inc., As Co-Syndication Agents, and U.S. Bank National Association And The Bank Of Nova Scotia, As Co-Documentation Agents. (Filed as Exhibit 10.2 of MSC.Software Corporation's Form 10-Q filed on August 14, 2002, and incorporated herein by reference).
	10.3	Second Amendment to Revolving Credit And Term Loan Agreement and Waiver Dated As Of July 23, 2002 Between MSC.Software Corporation, Comerica Bank and BNP Paribas, As Co-Lead Arrangers, Comerica Bank, As Administrative Agent, BNP Paribas And Key Corporate Capital, Inc., As Co-Syndication Agents, and U.S. Bank National Association And The Bank Of Nova Scotia, As Co-Documentation Agents. (Filed as Exhibit 10.3 of MSC.Software Corporation's Form 10-Q filed on August 14, 2002, and incorporated herein by reference).
	10.4	Loan and Security Agreement Dated as of November 18, 2002 Between MSC.Software Corporation, as Borrower and Foothill Capital Corporation, as the Arranger and Administrative Agent. **
		** Indicates filed herewith.
(b)	Form 8-K
		Current Report on Form 8-K/A filed July 2, 2002, event date: April 19, 2002 (Items 2 and 7).

SIGNATURE

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

	MSC.SOFTWARE CORPORATION (Registrant)


Date: November 19, 2002	By:	/s/ LOUIS A. GRECO LOUIS A. GRECO—Chief Financial Officer (Mr. Greco is the Principal Financial and Accounting Officer and has been duly authorized to sign on behalf of the Registrant)

CERTIFICATION

I, Frank Perna, Jr., certify that:

1.

I have reviewed this quarterly report on Form 10-Q of MSC.Software Corporation;

2.

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.

The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a): designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b): evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c): presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a): all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b): any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.: The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 19, 2002

By:

/s/ FRANK PERNA, JR.

FRANK PERNA, JR.
Chairman of the Board and Chief Executive Officer

CERTIFICATION

I, Louis A. Greco, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of MSC.Software Corporation;

2.

3.

4.

a): designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b): evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c): presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

a): all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b): any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.: The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 19, 2002

By:

/s/ LOUIS A. GRECO

LOUIS A. GRECO
Chief Financial Officer

QuickLinks

FORM 10-Q
INDEX TO FORM 10–Q
CONDENSED CONSOLIDATED BALANCE SHEETS
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
PART II—OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURE
CERTIFICATION
CERTIFICATION