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

FORM 10-Q

Commission File Number: 000-30027

Moldflow Corporation
(Exact name of registrant as specified in its charter)

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

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

        There were 9,999,359 shares of our common stock, par value $0.01, outstanding on May 8, 2003.

MOLDFLOW CORPORATION
FORM 10-Q
For the Quarter Ended March 29, 2003

Table of Contents

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PART I. FINANCIAL INFORMATION

ITEM 1. UNAUDITED FINANCIAL STATEMENTS

Moldflow Corporation

Condensed Consolidated Balance Sheet

(in thousands)

(unaudited)

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

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Moldflow Corporation

Condensed Consolidated Statement of Operations

(in thousands, except per share data)

(unaudited)

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

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Moldflow Corporation

Condensed Consolidated Statement of Cash Flows

(in thousands)

(unaudited)

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

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MOLDFLOW CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.    Basis of Presentation and Nature of Business

        Moldflow Corporation ("Moldflow" or the "Company") designs, develops, manufactures and markets computer software applications for the design, engineering and manufacture of injection-molded plastic parts and, as such, revenues are derived primarily from the plastic design and manufacturing industry. The Company sells its products primarily to customers in the United States, Europe, Asia and Australia.

        The accompanying unaudited condensed consolidated financial statements include the accounts of Moldflow Corporation and its wholly-owned subsidiaries. The condensed consolidated financial statements have been prepared by the Company in accordance with the rules and regulations of the Securities and Exchange Commission ("SEC") regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended June 30, 2002 included in the Company's Annual Report on Form 10-K. The June 30, 2002 condensed consolidated balance sheet was derived from the Company's audited consolidated financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting only of those of a normal recurring nature, necessary for a fair presentation of results for the interim periods presented. The results of operations for the three-month and nine-month periods ended March 29, 2003 are not necessarily indicative of the results to be expected for any future period or the full fiscal year. Certain prior year amounts have been reclassified to conform to the fiscal 2003 presentation.

        The Company's fiscal year end is June 30. During the fiscal year, the Company follows a schedule in which each interim quarterly period ends on the Saturday of the thirteenth full week of the reporting period.

2.    Net Income (Loss) Per Common Share

        The following table presents the calculation for both basic and diluted net income (loss) per common share:

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        Weighted average common stock equivalents related to stock options of 1,524,000 and 1,413,000 shares were outstanding for the three and nine months ended March 29, 2003, respectively, but were not included in the calculation of diluted net loss per share, as their inclusion would be antidilutive due to the net loss for those periods. Weighted average common stock equivalents related to stock options of 579,000 and 1,008,000 shares were outstanding for the three and nine months ended March 30, 2002, respectively, but were not included in the calculation of diluted income per share, as their inclusion would be antidilutive, as the weighted average exercise price of these options was greater than the weighted average fair value of the underlying shares in those periods.

3.    Derivative Financial Instruments and Hedging Activities

        The Company has established a hedging program designed to reduce the exposure to changes in currency exchange rates.

        At March 29, 2003, currency options and collars designated as hedging instruments with notional amounts of $2.5 million, $7.6 million and $1.9 million to exchange Euros, Japanese yen and Australian dollars for U.S. dollars, respectively, were outstanding. The fair values of the hedging instruments, as derived from dealer quotations, were recorded as components of other current assets or other current liabilities, depending on the amount of the valuation. At March 29, 2003, the total fair values of all currency options and collars held by the Company of $292,000 and $130,000 were recorded as components of other current assets and other current liabilities, respectively. Net unrealized losses on options and collars that qualified as hedging instruments of $69,000 were included in accumulated other comprehensive income. The Company expects these instruments to affect earnings over the next fifteen months. During the first and third fiscal quarters, the Company discontinued hedge accounting for the excess portion of instruments that were used to hedge transactions considered no longer probable of occurring. At March 29, 2003, these instruments had notional amounts of $464,000, $922,000 and $110,000 to exchange Euros, Japanese yen and Australian dollars for U.S. dollars, respectively. During the three-month and nine-month periods ended March 29, 2003, losses of $50,000 and $112,000, respectively, were recorded as components of other income and expense on the effective portion of options that were settled. For the three-month and nine-month periods ended March 29, 2003, unrealized losses of $3,000 and unrealized gains of $25,000, respectively, were recognized on the ineffective portion of options and collars dedesignated as hedging instruments.

        At March 30, 2002, currency options and collars designated as hedging instruments with notional amounts of $6.4 million, $38.4 million and $7.3 million to exchange Euros, Japanese yen and Australian dollars for U.S. dollars, respectively, were outstanding. The fair values of these instruments, as derived from dealer quotations, were recorded as components of other current assets or other current liabilities, depending on the amount of the valuation. At March 30, 2002, instruments with fair values of $446,000 and $(370,000) were recorded as components of other current assets and other current liabilities, respectively. Net unrealized gains on these instruments of $127,000 were included in accumulated other comprehensive income. During the three and nine month periods ended March 30, 2002, gains of $123,000 and $199,000, respectively, were recorded as components of other income and expense on the effective portion of options that were settled. For the three-month and nine-month periods ended March 30, 2002, a gain of $31,000 was recognized on the ineffective portion of these options.

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4.    Acquisition of Côntrole Processus Industriels

        On January 9, 2003, the Company acquired substantially all of the assets and the ongoing operations of Côntrole Processus Industriels s.a.r.l. ("CPI"), a provider of production monitoring systems to the French plastics industry, for a cash purchase price of $802,000. In addition, the Company paid $93,000 of costs directly related to the acquisition. The Company believes that the acquisition of CPI will increase the Company's presence in the European product monitoring market allowing it to better serve its customers. For this reason the purchase price exceeds the fair value of net tangible and intangible assets, resulting in goodwill. The results of CPI have been included in the Company's consolidated financial statements since the date of the acquisition.

        The purchase price has been allocated to the assets acquired and liabilities assumed at their estimated fair values as of the date of the acquisition, based upon estimates made by management of the Company. Certain of the acquired assets were intangible in nature, including the acquired customer base and non-compete agreements, the fair values of which were determined through generally accepted valuation methodologies. The excess of the total purchase price over the amounts allocated to the assets acquired and liabilities assumed was recorded as goodwill. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition. The allocation of the purchase price is subject to refinement.

        The estimated useful life of the acquired customer base and non-compete covenants is 42 months and 12 months, respectively. No portion of the goodwill or other intangible assets is expected to be deductible for tax purposes.

        The following summarized unaudited pro forma consolidated results of operations of the Company reflect the effect of the CPI acquisition as if it had occurred at the beginning of the periods presented. The unaudited pro forma consolidated results of operations presented below are not necessarily indicative of operating results which would have been achieved had the acquisition been consummated

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as of the beginning of the periods presented and should not be construed as representative of future operations.

5.    Intangible Assets

        Intangible assets acquired in the Company's acquisitions include goodwill, customer base, developed technology and non-compete agreements. All of the Company's acquired intangible assets, except for goodwill, are subject to amortization over their estimated useful lives. No significant residual value is estimated for the intangible assets.

        In March 2003, the Company initiated a corporate restructuring plan that resulted in the impairment of certain developed technology originally acquired in the fiscal 2001 purchase of Branden Technologies Inc. (see Note 9). A charge of $217,000 was recorded to write-off the net carrying value of this developed technology, which was related to the Company's EZ-Track product. Amortization expense for intangible assets, other than goodwill, for the three months ended March 29, 2003 and March 30, 2002 was $176,000 and $164,000, respectively. Amortization expense for intangible assets, other than goodwill, for the nine months ended March 29, 2003 and March 30, 2002 was $494,000 and $492,000, respectively.

        The components of other intangible assets are as follows (in thousands):

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        The following table summarizes the expected remaining amortization of other intangible assets as of March 29, 2003:

6.    Software Development Costs

        Costs associated with the development of computer software and related products are expensed prior to establishing technological feasibility, as defined by Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," and capitalized thereafter until commercial release of the software products. Development costs eligible for capitalization prior to the first quarter of fiscal 2002 were not significant. The Company established technological feasibility of Moldflow Plastics Insight version 3.0 ("MPI 3.0") in the first quarter of fiscal 2002 and released the product commercially in November 2001. In accordance with SFAS No. 86, research and development costs of $602,000 were capitalized as a component of fixed assets. In the second quarter of fiscal 2003, the net carrying value of these costs was reclassified from fixed assets to other assets.

        In the nine months ended March 29, 2003, the Company established technological feasibility of three additional products. Research and development costs of $170,000 were capitalized in the second fiscal quarter related to MPI 4.0 and Shotscope 2.6, both of which were commercially released in December 2002. Research and development costs of $148,000 were capitalized in the three months ended March 29, 2003 related to Moldflow Manufacturing Solutions ("MMS") 1.0, which was commercially released in March 2003. All such costs have been included in other assets and are being amortized to cost of product revenue over a five-year period. At March 29, 2003, gross capitalized software development costs totaled $920,000 and accumulated amortization of capitalized development costs totaled $170,000. Related amortization expense for the three months and nine months ended March 29, 2003 was $40,000 and $103,000, respectively.

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7.    Common Stock, Treasury Stock and Stock Plans

        On September 19, 2001, the Board of Directors authorized the Company to repurchase up to 500,000 shares of its outstanding common stock. In September 2001, the Company reacquired 50,000 shares for $464,000, an average cost of $9.28 per share. In September 2002, the Company reacquired an additional 194,165 shares of its outstanding common stock for $909,000, an average cost of $4.68 per share. As of March 29, 2003, 58,748 of these shares were reissued under the Company's Employee Stock Purchase Plan and 185,417 shares remained in treasury.

        On November 19, 2002, the stockholders of the Company approved an amendment to the Company's 2000 Stock Option and Incentive Plan (the "2000 Option Plan") authorizing the Company to issue up to an additional 1,500,000 shares of common stock pursuant to various stock incentive awards under the 2000 Option Plan.

        A summary of the Company's stock option activity follows:

        No compensation cost has been recognized for employee stock-based awards for the three and nine months ended March 29, 2003. Had compensation cost been determined based on the fair value at the grant dates, the Company's net income (loss) would have been the pro forma amounts indicated in the table below. Because options vest over several years and additional option grants are expected to

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be made in future years, the pro forma results are not representative of the pro forma results for future years.

        The fair value of each option grant was estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions:

        On January 29, 2003, the Board of Directors of the Company adopted a Shareholder Rights Plan and declared a dividend distribution of one preferred stock purchase right (a "Right") for each outstanding share of the Company's common stock to shareholders of record as of the close of business on January 30, 2003. Initially, these rights will not be exercisable and will trade with the shares of the Company's common stock. Each share of common stock newly issued after that date also will carry with it one Right. Under the Shareholder Rights Plan, a Right generally will become exercisable if a person becomes an "acquiring person" by acquiring 15% or more of the common stock of the Company or if a person commences a tender offer that could result in that person owning 15% or more of the common stock of the Company. If a person becomes an "acquiring person," each holder of a Right (other than the acquiring person) would be entitled to purchase, at the then-current exercise price, such number of shares of preferred stock which are equivalent to shares of the Company's common stock having a value of twice the exercise price of the Right. If the Company is acquired in a merger or other business combination transaction after any such event, each holder of a Right would then be entitled to purchase, at the then-current exercise price, shares of the acquiring company's common stock having a value of twice the exercise price of the Right.

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8.    Comprehensive Income

        Comprehensive income is comprised of net income (loss) and other comprehensive income and losses. Other comprehensive income includes certain changes in equity that are excluded from net income, such as cumulative foreign currency translation adjustments. Other comprehensive income also includes unrealized gains and losses on the Company's hedging instruments and unrealized gains and losses on the Company's marketable securities.

        The following table presents the calculation of comprehensive income:

9.    Restructuring Plans

March 2003 Plan

        In March 2003, the Company initiated a corporate restructuring plan (the "March 2003 plan") related to its acquisition of CPI (see Note 4). The March 2003 plan included the involuntary termination of four technical employees and a reduction of space at a leased facility, related to the integration of CPI's operations. In addition, the March 2003 plan included the write-off of inventories and other assets and certain intangible assets originally acquired in the purchase of Branden Technologies in fiscal 2001, all such items deemed impaired by the acquisition of a similar product in connection with the CPI transaction. Activities under the March 2003 plan are expected to be complete within six months.

        As a result of the March 2003 plan, the Company recorded pre-tax charges and related accruals in the three months ended March 29, 2003 of $617,000. Of this charge, $179,000 related to the write-off of inventories and, as such, was included as a component of the cost of product revenue. The remainder of the charge was recorded as restructuring charges in the Company's Condensed Consolidated Statement of Operations. The Company expects to incur additional charges related to these actions in its fourth fiscal quarter; however, these amounts are not expected to be significant.

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        The following table presents the pre-tax charges incurred by category of expenditure, and related restructuring reserve accruals included in accrued expenses in the Company's balance sheet (in thousands):

April 2002 Plan

        In April 2002, the Company enacted a corporate restructuring plan (the "April 2002 plan"). The April 2002 plan was enacted to resize the Company and to reduce overhead costs. The April 2002 plan included the involuntary termination of 37 employees, the closing of certain leased offices and the reduction in size of other leased offices. All significant activities under the April 2002 plan were completed as of March 29, 2003. As a result of the April 2002 plan, the Company recorded pre-tax charges and related accruals in fiscal 2002 of $1.3 million. The remaining accrual balances as of March 29, 2003 relate to long-term contractual obligations from facility commitments that will be paid over six years. The following table presents the balance of the accrued restructuring charges (in thousands):

10.    Credit Facilities

        In December 2002, the Company renewed its unsecured $5.0 million working capital credit facility with a domestic bank. The terms of the facility, which expires December 5, 2003, are substantially the same as that of the previous facility. The available borrowing base of the facility is subject to a calculation that is based upon eligible accounts receivable. Advances may be in the form of loans, letters of credit, foreign exchange contracts or other cash management lines. Loans against the facility bear interest at the bank's prime rate. The facility includes certain restrictive covenants, all of which the Company was in compliance with as of March 29, 2003. These covenants include certain liquidity and profitability measures and restrictions that limit the ability of the Company to merge, acquire or sell certain assets without prior approval from the bank. As of March 29, 2003, the Company had employed $1.9 million of the available borrowing base through outstanding foreign exchange contracts and letters of credit. These advances do not incur interest charges. As of March 29, 2003, there were no loans advanced against the facility, and the remaining available borrowing base was $3.0 million.

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        Certain subsidiaries of the Company have established credit facilities with two separate financial institutions primarily for the purposes of establishing foreign exchange contracts. Advances against these facilities bear interest at the institutions' published rates plus 2% per annum. These credit facilities are unsecured. Advances against these facilities are guaranteed by the Company. There were no advances against these facilities as of March 29, 2003.

        Certain subsidiaries of the Company have established other credit facilities totaling $177,000 with two separate financial institutions for general working capital requirements and foreign exchange contracts. Advances against these facilities bear interest at the institutions' published rates, plus 1.5% per annum. Advances against one of these facilities are secured by a $127,000 term deposit and the assets of a subsidiary of the Company. There were no advances against these facilities as of March 29, 2003.

11.    Segment and Geographic Information

        The Company is engaged in one reportable industry segment: the development, marketing and support of software products for the plastic design and manufacturing industry.

        Geographic information regarding the Company's operations follows (in thousands):

        Revenue from unaffiliated customers in Japan for the three months ended March 29, 2003 and March 30, 2002 was $2.7 million and $2.0 million (28% and 21% of total revenue), respectively. Revenue from unaffiliated customers in Japan for the nine months ended March 29, 2003 and

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March 30, 2002 was $6.3 million and $5.6 million (24% and 21% of total revenue), respectively. Substantially all of the revenue in the Americas region is derived from the United States.

        All of the net fixed assets included in the Americas are located in the United States.

12.    Contingencies, Commitments and Guarantor Arrangements

        In November 2002, the Financial Accounting Standards Board ("FASB") issued FIN No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34." The Interpretation requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken by issuing the guarantee. The Interpretation also requires additional disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees it has issued. The accounting requirements for the initial recognition of guarantees became applicable on a prospective basis for guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for all guarantees outstanding, regardless of when they were issued or modified as of December 15, 2002. The adoption of FIN No. 45 did not have a material effect on the Company's consolidated financial statements.

        In the normal course of business, the Company has indemnified third parties and has commitments and guarantees under which it may be required to make payments in certain circumstances. These indemnities, commitments and guarantees include: its indemnities to various lessors in connection with facility leases; indemnities to customers related to intellectual property and performance of services subcontracted to other providers; indemnities to vendors that guarantee expenses incurred by employees of the Company; indemnities and guarantees to financial institutions related to sales of the Company's equity securities and performance under credit facilities of the Company's subsidiaries; and indemnities to directors and officers of the Company to the maximum extent permitted under the laws of the State of Delaware. The duration of these indemnities, commitments and guarantees varies, and in certain cases, is indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. The Company has never incurred material costs to settle claims or defend lawsuits related to these indemnities, commitments and guarantees. As a result, the estimated fair value of these agreements is minimal. Accordingly, no liabilities have been recorded for these agreements as of March 29, 2003.

        The Company warrants that its products will perform in all material respects in accordance with its standard published specifications in effect at the time of delivery of the products to the customer for a

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period of 90 days from the date of shipment or any longer period that may be required by local law. The Company records a liability based upon its history of claims against the contractual warranty provisions, which, as of March 29, 2003, was $44,000. The following table describes changes to the liability for the nine months ended March 29, 2003 (in thousands):

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

Forward-Looking Statements

        This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. You can identify these statements by forward-looking words such as "may," "will," "expect," "anticipate," "believe," "estimate," and "continue" or similar words. You should read statements that contain these words carefully because they discuss our future expectations, contain projections of our future results of operations or of our financial condition, or state other "forward-looking" information. We believe that it is important to communicate our future expectations to our investors. However, there may be events in the future that we are not able to accurately predict or control and that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Investors are cautioned that all forward-looking statements involve risks and uncertainties, and actual results may differ materially from those discussed as a result of various factors, including those factors described in "Risk Factors and Important Factors That May Affect Future Results" beginning on page 27. Readers should not place undue reliance on our forward-looking statements. We do not undertake any obligation to update any of our forward-looking statements to reflect events occurring after the date of this report.

Business Overview

        Our primary business is the development, sale and support of software applications for the design and manufacture of injection molded plastic parts. We develop software products internally and through cooperative research relationships with a number of public and private educational and research organizations around the world. We categorize our products into two groups, Design Optimization Solutions and Manufacturing Solutions. Our Design Optimization Solutions allow a product designer or engineer to simulate the manufacture of a plastic part to determine the optimal part design and part/mold combination. Our Design Optimization Solutions include our Moldflow Plastics Insight ("MPI") series for in-depth mold design and our Moldflow Plastics Advisers ("MPA") series for part design and high-level mold design. Our Manufacturing Solutions allow plant engineers and managers to automate production and maintain and optimize manufacturing conditions throughout the manufacturing process. Through April 2003, our Manufacturing Solutions included three products: Moldflow Plastics Xpert, Moldflow Shotscope and EZ-Track. Our Moldflow Plastics Xpert ("MPX") series for production set-up, optimization, control and monitoring was introduced in fiscal 1999. Shotscope is a shop floor product that monitors, analyzes and assists in the scheduling of injection molding production processes. EZ-Track provides real-time, plant-wide production monitoring and reporting. Both Shotscope and EZ-Track were launched under the Moldflow brand in fiscal 2001. In April 2003, we introduced Moldflow Manufacturing Solutions ("MMS") 1.0, which integrates our MPX and Shotscope applications on a common platform. MMS 1.0 is a collaborative manufacturing management ("CMM") system for the plastics injection molding and metal die casting industries that captures and makes available extensive process and production data for use in real-time business performance management. CMM is the framework for organizing and controlling the key business processes of a manufacturing enterprise.

        On January 9, 2003, the Company acquired substantially all of the assets and the ongoing operations of Côntrole Processus Industriels s.a.r.l. ("CPI"), a provider of production monitoring systems to the French plastics industry, for $895,000 of cash, including direct acquisition costs. We believe that the acquisition of CPI will increase our presence in the European product monitoring market, allowing us to better serve our customers.

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        We sell our products and services internationally through our direct sales operations in 14 countries. We also sell through a network of distributors and value-added resellers and through distribution arrangements with developers of other design software products.

Critical Accounting Policies and Significant Judgments and Estimates

        The preparation of consolidated financial statements requires estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, management evaluates its estimates and judgments, including those related to bad debts, inventories, income taxes, warranty obligations, intangible assets, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

        The accounting policies that we believe are most critical to fully understand our consolidated financial statements include: revenue recognition; valuation allowances; acquisition accounting; impairment of intangible assets; goodwill and other long-lived assets; and hedge accounting. For a more detailed explanation of the judgments included in these areas, refer to the Company's Annual Report on Form 10-K for the year ended June 30, 2002.

Results of Operations

        We generate revenue from two principal sources:

•

license fees for our packaged software products, and



•

services revenue derived from maintenance and support services related to our software products, consulting, training and material testing.

        Product revenue.    Typically, our customers pay an up-front, one-time fee for our products. The amount of the fee depends upon the number and type of software modules licensed, the associated hardware components and the number of the customers' employees or other users who can access the software product simultaneously. Our MPA product is subject to the terms of a "click-wrapped" software license agreement that is included as part of each customer's installation process. Revenue for our iMPA product, a fully functional, application service provider version of our Part Adviser product, is earned on a pay-per-use basis and, to date, has not been significant. For sales of our other products, we generally require a signed license agreement. In addition, we receive royalty payments from developers of other software products related to the bundling of our software with their design software programs.

        Services revenue.    We derive revenue from maintenance and support contracts that require us to provide technical support services to customers and unspecified product upgrades and enhancements on a when-and-if-available basis. We also provide consulting and implementation services, training of customers' employees and material testing services.

        Cost of product revenue.    Cost of product revenue consists primarily of the costs associated with hardware components for our Manufacturing Solutions products, compact discs and related packaging material, duplication and shipping costs and the salaries of our distribution personnel. In some cases, we pay royalties to third parties for usage-based licenses of their products that are embedded in our products. Product royalties are expensed when the related obligation arises, which is generally upon the license of our products, and are included in cost of product revenue. Also included in cost of product revenue is amortization expense related to capitalized software development costs. In the three and

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nine months ended March 29, 2003, cost of product revenue also included a charge to write-off certain inventory in connection with our March 2003 restructuring plan.

        Cost of services revenue.    Cost of services revenue consists primarily of salary, fringe benefit and facility related costs of our maintenance and support, consulting and training activities and of our material testing laboratories, and is expensed when incurred. Additionally, from time to time, we engage outside consultants to meet peaks in customer demand for consulting and implementation services.

        Research and development.    We employ a development staff to develop new products and enhance our existing products. Product development expenditures, which include salaries, benefits, travel and facilities costs, are generally charged to operations as incurred. SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," requires the capitalization of certain software development costs subsequent to the establishment of technological feasibility up to the point of the product's release. We established technological feasibility of MPI 3.0 in the first quarter of fiscal 2002 and released the product commercially in November 2001. In accordance with SFAS No. 86, research and development costs of $602,000 were capitalized related to MPI 3.0. In the second quarter of fiscal 2003, we established technological feasibility of MPI 4.0 and Shotscope 2.6 resulting in the capitalization of $170,000 of research and development costs. In the third quarter of fiscal 2003, we established technological feasibility of MMS 1.0 resulting in the capitalization of $148,000 of research and development costs. All such capitalized costs are being amortized to cost of product revenue over five years, the estimated economic life of the related products.

        Selling and marketing.    We sell our products primarily through our direct sales force and indirect distribution channels. Selling and marketing expenses consist primarily of salaries, commissions to our sales staff, employee benefits costs, sales office facilities, travel and promotional events such as trade shows, advertising, print and web-based collateral materials, and public relations programs.

        General and administrative.    General and administrative expenses include compensation, routine legal, audit, insurance and other costs of our executive management, finance, information technology, human resources and administrative support activities.

        Restructuring charges.    In the three months ended March 29, 2003, we incurred charges related to actions we took to restructure our business. The restructuring was a result of our January 2003 acquisition of CPI, and was enacted to integrate CPI's operations into our existing operations and to incorporate CPI's products into our current production monitoring product line. This restructuring plan included the involuntary termination of four technical employees, a reduction of space at a leased facility, the write-off of inventory and other assets and the write-off of certain intangible assets. All such charges and expense, except the charge to write-off inventories, have been included as restructuring charges.

        Amortization of other intangible assets.    These costs represent the amortization of other intangible assets recorded in connection with our acquisitions. These assets include developed technology, customer base and non-compete agreements.

        Interest income, net.    Interest income, net includes interest income earned on invested cash balances, net of our cost of borrowings, including interest cost incurred on our working capital lines of credit.

        Other income (loss), net.    Other income (loss), net includes realized and unrealized gains and losses arising from translation of foreign currency denominated asset and liability balances, recognized gains and losses on our foreign currency hedging instruments, and other non-operating income and expense items.

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        Provision for income taxes.    Our income tax expense includes federal, state and foreign income taxes. The determination of our provision for income tax expense requires significant management judgment regarding forecasts of net income and tax obligations in the various jurisdictions in which the Company operates and includes the tax effects of certain items of income and expense that are reported in differing periods for financial statement and tax return purposes. Accordingly, our effective tax rate may vary from period to period based on changes in estimated taxable income or loss, changes to the valuation allowance, changes to federal, state or foreign tax laws, changes in our business across different jurisdictions with varying country, state and local income tax rates, deductibility of certain costs and expenses by jurisdiction and as a result of acquisitions.

        The following table sets forth statement of operations data for the periods indicated as a percentage of total revenue:

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Three Months Ended March 29, 2003 compared to Three Months Ended March 30, 2002

        Revenue.    Total revenue for the three months ended March 29, 2003 was $9.5 million, slightly increased from $9.4 million for the three months ended March 30, 2002. In the same period, product revenue decreased 8%, or $424,000, to $4.6 million from $5.0 million. The following table sets forth our product revenue by product group:

        The decrease in product revenue in the third quarter of fiscal 2003 was a result of the continued economic slowdown experienced in the markets we address. Demand for our products is largely driven by the demand for the end products of our customers. The industries in which many of our customers operate, including the consumer products, telecommunications and electronics industries have been among those most severely impacted by the prolonged economic slowdown. As such, these companies have typically reduced their spending on capital items including spending on our products. A continuation of this general economic slowdown could materially and adversely affect us in the future by continuing to decrease our revenue.

        Product revenue from our Design Optimization Solutions for the three months ended March 29, 2003 decreased $251,000, or 6%, to $4.0 million from $4.2 million for the three months ended March 30, 2002. Product revenue from our Manufacturing Solutions for the three months ended March 29, 2003 decreased $173,000, or 22%, to $627,000 from $800,000 for the three months ended March 30, 2002. We believe that the general economic slowdown described above resulted in fewer investments being made in new product designs and molds, particularly in the automotive, electronics and consumer markets, which form a significant part of our customer base, which decreased our Design Optimization Solutions product revenue. We believe the decrease in product revenue from our Manufacturing Solutions is due to the nature of the product line, which is typically characterized by longer selling cycles and higher sales prices than our Design Optimization Solutions.

        We added 77 new customers in the third quarter of fiscal 2003, compared to 122 new customers in the same period of fiscal 2002. Sales to new customers represented 40% of total product revenues in the third quarter of fiscal 2003, compared to 42% in the same period of fiscal 2002. We sold 130 seats of Design Optimization Solutions products and 112 seats of Manufacturing Solutions products in the third quarter of fiscal 2003, compared to 191 seats and 103 seats, respectively, in the corresponding period of fiscal 2002. Pricing of individual products within these product families can vary greatly, and the mix of products sold during a given period can significantly impact our average sales price per seat. As such, we do not believe that average sales prices per seat provide a meaningful measure of our business.

        Services revenue increased 10%, or $452,000, to $4.9 million for the three months ended March 29, 2003, from $4.4 million for the three months ended March 30, 2002. This increase was

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primarily in the sale of maintenance contracts, which is the result of historical growth in our customer base arising from product license sales.

        No customer accounted for more than 10% of our total revenue during the three-month periods ended March 29, 2003 and March 30, 2002.

        Cost of revenue.    The cost of product revenue increased 37%, or $224,000, to $829,000 for the three months ended March 29, 2003, from $605,000 for the three months ended March 30, 2002. Included in the three months ended March 29, 2003 was a charge of $179,000 to write-off certain inventory in conjunction with our acquisition of CPI. The remaining increase was primarily attributable to increased employee expenses, commission expenses to third parties and royalty costs, partially offset by decreased cost of materials due to the decline in revenues from our Manufacturing Solutions products.

        The cost of services revenue decreased 7%, or $23,000, to $323,000 for the three months ended March 29, 2003, from $346,000 for the three months ended March 30, 2002. This decrease was primarily due to reduced compensation expense resulting from the decrease in headcount under the April 2002 restructuring plan.

        Research and development.    Research and development expenses decreased 11%, or $198,000, to $1.6 million for the three months ended March 29, 2003, from $1.8 million for the three months ended March 30, 2002. This decrease was primarily due to the impact of our elimination of 12 technical positions under our April 2002 restructuring plan and our capitalization of $148,000 of research and development costs in accordance with SFAS No. 86 related to our development of MMS 1.0. The impact of the reduction of four technical positions in conjunction with our March 2003 restructuring plan was largely offset by our acquisition of the operations of CPI, which added 8 technical positions.

        Selling and marketing.    Selling and marketing expenses increased 3%, or $127,000, to $4.8 million for the three months ended March 29, 2003, from $4.7 million for the three months ended March 30, 2002. This increase was primarily due to increased employee expenses, resulting in part from unfavorable foreign exchange movements, and increased professional service fees, partially offset by reduced spending on promotional activities.

        General and administrative.    General and administrative expenses increased 15%, or $248,000, to $1.9 million for the three months ended March 29, 2003, from $1.6 million for the three months ended March 30, 2002. The increase was primarily due to increased employee expenses, resulting in part from unfavorable foreign exchange movements, and increases in professional service fees, including the cost of audit and other accounting services, partially offset by reductions in bad debt expense.

        Restructuring charges.    In the three months ended March 29, 2003, we incurred charges related to our restructuring plan enacted to integrate CPI's operations into our operations and to incorporate CPI's products into our current production monitoring product line. These charges are more fully described in the section below titled, "Restructuring."

        Amortization of other intangible assets.    These costs represent the amortization of other intangible assets recorded in connection with our acquisitions, including developed technology and protective covenants. Amortization expense increased 7%, or $12,000, to $176,000 for the three months ended March 29, 2003, from $164,000 for the three months ended March 30, 2002. The increase was due to our acquisition of CPI in January 2003, which resulted in the addition of $185,000 of new intangible assets. This increase was partially offset by the reduction in amortization expense that resulted from our March 2003 restructuring plan that included the write-off of certain intangible assets which were acquired in our purchase of Branden Technologies in March 2001.

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        Interest income, net.    Interest income, net decreased 9%, or $25,000, to $263,000 for the three months ended March 29, 2003 from $288,000 for the three months ended March 30, 2002. The decrease was primarily the result of declining interest rates and the conversion of marketable securities to cash and other highly liquid instruments.

        Other income (loss), net.    Net other income (loss) decreased 160%, or $284,000, to a loss of $106,000 for the three months ended March 29, 2003, from income of $178,000 for the three months ended March 30, 2002. Net other income (loss) includes realized and unrealized foreign exchange gains and losses on intercompany account balances and realized and unrealized gains and losses on our foreign exchange derivative instruments.

        Provision for income taxes.    The provision for income taxes decreased 9%, or $23,000, to $225,000 for the three months ended March 29, 2003, from $248,000 for the three months ended March 30, 2002. In spite of our overall net loss, we incurred income taxes in certain foreign jurisdictions that could not be offset in the financial statement tax provision by tax benefits arising from losses in other jurisdictions.

Nine Months Ended March 29, 2003 compared to Nine Months Ended March 30, 2002

        Revenue.    Total revenue for the nine months ended March 29, 2003 was $26.7 million, slightly decreased from $26.8 million for the nine months ended March 30, 2002. In the same period, product revenue decreased 10%, or $1.4 million, to $12.5 million from $13.9 million. The following table sets forth our product revenue by product group: